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BPOs: Opportunity not worth missing - Views on News from Equitymaster
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BPOs: Opportunity not worth missing
Jan 4, 2008

The Indian BPO services sector was under severe pressure in 2007 largely due to the rupee's appreciation against the US dollar. This is because BPO companies earn a substantial part of their revenues in US dollar terms (almost over 95%) and the cost is entirely in rupee terms. With appreciating rupee, while BPO companies are no doubt growing in US dollar terms, the growth in rupee terms has taken a beating. Over that, there is pressure on margins on account of wage hikes and higher service tax on lease rentals. The returns on stocks of pure BPO players have been poor. The price of Allsec Technologies, a BPO registered in Chennai, came down from Rs 370 in Jan 2007 to Rs 135 in December. Same is the case with Firstsource Solutions, which has not moved from the IPO price since its listing in Feb last year. But are the private equity (PE) investors thinking on the same line as investors in stock market?

First things first, these BPO companies are here to do business. They will not close down their business just because the rupee has appreciated and margins are declining due to it. The STPI scheme is expiring in March 2009 as a result of which the BPO companies will cease to avail tax benefits, which will put additional burden on their margins. To counter this issue, BPO companies have come out with three strategies. First, they are trying to locate and are opening more delivery centres abroad to serve those markets and second they are trying to win more business from the domestic market. More domestic business would mean that the facilities could be used during the daytime as well, increasing seat utilisation. Third, these companies are spreading to Tier II and III cities thereby cutting their operational costs by about 15%.

The PE investors perhaps are not thinking the same way as investors in the secondary markets. As per media reports, almost US$ 200 m came into the BPO sector in 2007 in companies, which are in very early stages of their growth. Currently, the US mortgage industry is troubled by sub-prime crisis. But in the long run, the outsourcing is only likely to increase rapidly when troubled firms resort to cost cutting.

So, for BPOs operating in the mortgage vertical, it translates into a huge opportunity. How? Mortgage processing job is around 5% of the outstanding loan amount (almost US$ 2 trillion), which can be offshored and translates to business worth US$ 100 bn. If only 10% of this US$ 100 bn is offshored to India (the percentage actually is higher) this translates to business of US$ 10 bn. And to the surprise of readers, the revenues of the BPO companies from the mortgage vertical are just US$ 200 m. So the potential upside is almost 50 times.

Perhaps the Tier I IT companies are fast to tap this opportunity. TCS has made many acquisitions in platform based transactional BPO, while staying away from low margin voice-based business. It acquired Comnicron in Chile, which facilitated its entry into global pensions BPO. Then it formed Dilegenta in CY07 in which it owns 76% by entering into a JV with Pearl Group's BPO division in UK for 486 m. And at the fag end of the year it took controlling stake in Swiss banking software and services specialist TKS-Teknosoft. Infosys also on its part has entered into a US$ 250 m multi-year contract with Philips to provide Finance & Accounting (F&A) services and the processing of purchasing orders and has acquired three-shared service centers located in India, Poland and Thailand from Philips.

The opportunities are huge in this space, the only problem being that of supply (skilled labour). As a top management personnel of an IT company indicated to us sometime back, "We can easily grow at 40% YoY if we can add more people. But, where are the people?"

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