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BPO: MsourcE Vs Convergys - Views on News from Equitymaster
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BPO: MsourcE Vs Convergys
Apr 18, 2005

MphasiS BFL is a mid-sized software company operating in the Indian technology space. Its main areas of expertise are enterprise architecture, business process reengineering, financial services and BPO. It is one of the few technology companies that earn a major portion of its revenues from the BPO business and in fact, earn margins that are higher in BPO than IT services. The company has recently announced quarterly and annual results for FY05. In this article, we attempt to make a comparison between MphasiS’ BPO unit, (erstwhile MsourcE) and Convergys, a US-based, listed BPO company offering services in the customer service and contact center space, HR outsourcing, billing services and software for the global communications industry.

A clear case of ‘David Vs Goliath’
A comparison between the two companies clearly shows that it is a literal ‘David Vs Goliath’ comparison. In fact, despite growing revenues at a scorching pace in the past 3 years (83% CAGR), MphasiS’ BPO business is still a mere 3% of Convergys’ size. On the operating profits front, it compares slightly more favourably, being about 6% of Convergys.

How they stack up...
(US$ m) FY05* CAGR (FY03-FY05)
MsourcE Convergys MsourcE Convergys
Net sales 65 2,488 83.4% 4.3%
Operating profit/(loss) 19 327 - -8.5%
Operating margin 28.7% 13.1%
No. of employees 5,634 66,300 47.6% 16.6%
Revenue per employee (US$) 11,564 37,522 24.3% -10.5%
Operating profit per employee(US$) 3,324 4,932 - -21.5%
*In case of Convergys FY05 = December ended 2004 (CY04)

Operating metrics – MsourcE shows the way…
A comparison of the growth rates of the two companies shows that MsourcE has grown at a considerably faster rate than Convergys, growing nearly three-and-a-half times in size from FY03 to FY05. However, it also needs to be noted that Convergys is currently still over 38 times the size of MsourcE at nearly US$ 2.5 bn and thus, it is obviously a difficult task to maintain the kind of growth that MsourcE has shown over the years.

An analysis of the growth patterns over the past three years shows that by and large, Convergys has shown very flat growth in single digits. The company divides its revenues into two segments: Customer Management Group (CMG), which caters to the customer service, collections and HR outsourcing space and Information Management Group (IMG), which provides outsourced services and billing software products and services to the global communications industry. Revenues from the CMG have been growing at a decent pace, clocking a double-digit CAGR of 12% from CY02 to CY04. However, this has been offset by the decline in revenues of the IMG, which have fallen by a CAGR of 9% over the period. CMG contributes around 70% to overall revenues. As a result, growth in this segment has more than compensated for the decline in IMG revenues.

The decline in IMG revenues has been a factor of the global recession in the telecom sector, pricing pressure and clients opting to augment existing billing systems rather than make investments in new systems. Aided by the fact that CMG revenues have grown at a decent pace, this has resulted in a decline in the share of IMG revenues. The ultimate effect has been a decline in operating margins by over 500 basis points in CY04. This is because IMG is a higher margin business. In fact, IMG operating profits have reduced at a CAGR of 26% from CY02 to CY04, resulting in a reduction in operating margins by nearly 500 basis points for the segment and by as much as 400 basis points for overall revenues.

Convergys has also been unable to control its costs. Costs of products and services have grown at a CAGR of 10% annually over the period, while selling, general and administrative expenses (SG&A) have grown at a CAGR of 12%. This has been the case mainly due to increase in CMG expenses. A combination of pricing pressure, increased costs associated with implementation of large outsourcing orders, increased product and SG&A costs and acquisition costs have resulted in a tight squeeze on operating margins on an overall basis. Given the fact that it is a company of such significant size, it is surprising that it has been unable to leverage on SG&A costs incurred in the past.

MsourcE on the other hand, has seen a scorching growth in revenues, growing at a CAGR of over 83% over the period. Operating margins have shown a positive improvement and are more than double those enjoyed by Convergys currently. The employee base of MsourcE has grown at a CAGR of nearly 48%, reflecting the need to scale up due to high growth expectations. However, due to the considerably higher increase in revenues, the revenues per employee have grown at a CAGR of 24%. For Convergys, on the other hand, employee base has grown at a CAGR of nearly 17% even on such a high base. Since revenues have grown at an un-enthusing CAGR of 4%, this has resulted in a considerable fall in productivity, with revenues per employee falling by nearly 11% CAGR over the period. The gap has thus reduced considerably between MsourcE and Convergys, though Convergys still earns revenues per employee that are more than thrice what MsourcE earns.

MsourcE costs have grown at a CAGR of 54% over the period, but this has been more than offset by the impressive growth in revenues over the period. Operating profit per employee has improved significantly over the period, growing from a loss in FY03 to US$ 3,324 in FY05, a growth of 470% over FY04. Convergys on the other hand, has seen profit per employee shrink at a CAGR of 22% over the period (US$ 4,932), due to a considerable increase in employee base, compared to a 9% CAGR fall in operating profits during the period.

Conclusion

As we have seen, on most of the operating metrics, MsourcE fares better than Convergys. However, it should be noted that Convergys has grown on a considerably larger base than MsourcE, which is a relative newcomer in the BPO business when compared to Convergys. Even so, Convergys’ performance on the operating metrics taken for comparison does not show it in a favourable light. Despite the fact that it is so large, it has been unable to leverage its large base to spread its costs and become cost-competitive. In fact, even MsourcE has seen costs shoot up at a rapid rate, but it has managed to grow revenues at a much quicker rate so as to mitigate any negative impact on margins.

Going forward, however, we believe that it is necessary for MsourcE to shift a greater proportion of business to non-voice-based services like transaction processing, equity and financial research and analytics, tax processing and HR outsourcing. Voice-based services run the risk of commoditisation in the near future and even though the share of these services has been reducing in BPO revenues, they still constitute well over 80% of revenues. We believe that it is necessary for the company to reduce the share of voice-based services at a faster pace. Convergys has a presence in the high-end IMG business, where it offers high-end software products to the communications industry. MsourcE must aim at tapping such high-end business through development of competencies in this area.

Convergys’ effective tax rate is also at a high 35%-plus. MsourcE has been taking advantage of tax write-backs due to losses incurred in previous years. From FY06, this will come to an end, thus impacting margins. It remains to be seen as to the exact extent of impact it will have on the company. It is also necessary to reduce client concentration. In FY05, the largest client accounted for 21% of revenues. Client diversification is necessary in order to mitigate risk of one client ramping down business due to other concerns. However, Convergys’ largest client, Cingular, also contributes to 20% of revenues.

MsourcE is of a considerably smaller size than Convergys and going forward, as we have mentioned above, it must reduce the share of voice-based revenues, which risk being commoditised. Infosys’ BPO unit, Progeon, earns around 80% of revenues from non-voice services, a virtual 180-degree shift compared to MsourcE. Margins are higher in this business, attrition rates tend to be lower and competition is lesser due to the high level of skills required to provide such services.

As far as valuations are concerned, MphasiS BFL at the current price of Rs 241 trades at a price-to-earnings multiple of 15.2 times FY05 earnings. This is at the higher end of the valuation spectrum. Convergys on the other hand, gets a valuation of 18.1 times CY04 earnings. In our view, the premium that Convergys gets in terms of valuations reflects the fact that it is considerably larger than Mphasis and offers higher-end BPO services to it clients. It remains to be seen the kind of valuations the markets are willing to give MphasiS going forward, as it makes efforts to move up the BPO value chain, a necessity in what is expected to be a highly competitive market characterised by commoditisation of lower-end services.

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