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Hinduja Global Solutions: Research meet extracts

Sep 16, 2010

We recently met up with the management of Hinduja Global Solutions (HGSL) to understand the company's business and its plans going forward.

Before we get into the details, here's a brief background on the company.

HGSL is part of Hinduja Group. The company was previously known as HTMT Global Solutions, which was demerged from Hinduja TMT in 2006. The IT/ITES business (BPO) of Hinduja TMT was demerged to form HTMT Global Solutions. The name HTMT Global Solutions was changed to Hinduja Global Solutions in 2008.

However, if we go way back to the incorporation of the company, it originally started off as an IT division for Ashok Leyland back in 1993. This division used to carry out services such as ERP and systems integrations for the commercial vehicle major.

In the year 2000, it entered the BPO space. Over the years, the company has grown in size through both organic and inorganic routes. HGSL's revenues during 2006 stood at about US$ 60 m. Currently it stands at US$ 225 m. The company has presence in six countries and has about 29 centres worldwide. These include centres in India, the Philippines, US, Mauritius, and UK. Its current client base stands at 107.

The company earns nearly 80% of its revenues from the BPO space. From this, about 90% is from voice based (mostly from US and Philippines) services, while the balance come from chat and email support. The remaining 20% (of total revenues) come from the KPO space (knowledge process outsourcing).

HGSL derives nearly 85% of its revenues from international markets. Business from the US contributes to about 45% of its total revenues. Mauritius and the Philippines are the other major contributors.

Customer concentration: HGSL's top customer forms about 16% of its revenues, while its top five customers contribute to about 50%. Further, its top 10 and top 20 customers contribute to about 65% and 82% of revenues. These all are figures of the quarter ended June 2010.

Around 17% of revenues from the top customer may seem as a concern for HGSL. However, the management believes that it enjoys a strong and long lasting relationship with this client and as such is not a real threat to the company.

Vertical-wise revenues: HGSL caters to clients from various sectors - telecom & technology, consumer electronics, products services & retail, and health insurance. During the June 2010 quarter, these segments contributed to about 25%, 23% and 29% of revenues respectively.

The company's exposure to banking and financial services (BFS) is quite low at about 6%. This was the key reason its business was not really hampered during the crisis period. As per the management, this lower exposure to the BFS is not a deliberate move by the company.

Moving on, the chemicals and biotech segments contribute to about 5% of revenues, while the balance comes from other segments.

As mentioned above, revenues from the top five clients contribute to around 50% of revenues. From this, health and insurance, telecom and BFS form about 27%, 18% and 5% respectively.

Employee count: During FY08, HGSL had about 12,600 employees on its payroll. The current head count stands at about 16,000. Around two-third are based in India, with about 70% catering to the domestic clients (in verticals such as telecom, banking and e-commerce) and the balance servicing international clients.

From the balance employee numbers, about 16% of employees are based in the Philippines, 11% in the US, and about 5% in UK. As per the management, the company is aiming at adding about 1,000 employees each year.

One major concern for the company is its high attrition level of 50%. While the numbers may be alarming, it is believed that this is quite common in the BPO space. Anyways, HGSL's numbers are a tad on the higher side.

Over the past three years (FY08 to FY10), the employee costs (as a percentage of revenues) have dropped from 63.5% in FY08 to 59.4% in FY10. This basically means that the increase in revenue per employee is faster as compared to the increase in cost per employee.

Financial performance: Over the past three years, HGSL's revenues have grown at an average annual rate of 18%, while profits have grown by 22% (including extraordinary items). On excluding extraordinary items (mainly includes forex transactions), profits have grown at slightly faster pace of 23%. Operating margins have increased from 14.7% to 17.3% during this period.

Strong balance sheet: HGSL has a strong balance sheet with its debt to equity ratio at 0.1 times (FY10). However, its net working capital to sales stands at a high figure of 87%. While this may seem very high, it must be noted that the company has huge cash piled up on its books. At the end of FY10, the company had Rs 6.4 bn worth of cash on its books as compared to the total assets of Rs 12 bn.

The company is believed to be looking out for acquisitions and as such has piled up this amount of cash. But the strange bit is that this cash has been on its books for a while now. In FY08 and FY09, the cash on books stood at Rs 4.9 bn and Rs 6.6 bn. While the company made an acquisition a few months ago, the size was very small (4.5 m Pounds).

In FY10, HGSL generated about Rs 670 m as free cash flow. It plans to invest about Rs 400 to Rs 450 m going forward, which basically means that its capex requirement can be easily met through internal accruals. That brings us back to the cash on books.

As per the management, it is scouting for acquisitions. However, it made clear that it is not willing to overpay for any company. This has been the precise reason why it has not acquired any company (although it had bid for some) in the past 2-3 years.

But this pile up of cash on books has been taking a toll on the company's return ratios as it is earning very low returns on the same. As per the data provided in the annual reports, the company has been earning a very low interest rate of about 4-5% on its cash.

As per the management, it is aiming to touch revenues of US$ 500 m in 2-3 years and about US$ 1 bn after 4-5 years. As such, a few large ticket or mid-sized acquisitions would be on the anvil sometime in the future.

Competition: HGSL faces competition from BPO majors such as Aegis, Firstsource, WNS, IBM, Cognizant and Infosys, amongst others. However, the management believes that it has an upper hand over these players as it is a pure play BPO company. Plus, it is believed that HGSL is very strong name in the CRM space.

Plans going forward: HGSL's financial performance over the past few quarters has been not so encouraging. But this has been mainly due to the currency volatility. As per the management, revenues have been increasing in US dollar terms. However, in Indian rupee terms, revenues have remained flat.

In addition, the company's margins have taken a hit on the back of expenses towards moving to Tier-III cities. As per the management, the company has been facing pricing pressures in the domestic market and as such is looking at moving out to Tier-III cities. This would help it improve margins in the process. As per the management, it does not foresee any problem with the quality of talent as the company would be tapping the migrating population (those who would be looking to move to larger cities). And since they would be the largest player in town, they would be able to acquire good talent.

Also, HGSL is looking at focusing on the Philippines as the preference towards that country has increased (from the clients' side) as well as the preference for near-shore options has increased over time. As per the management, the quality of voice in this region is good.

Key risks: Apart from competition, and the high attrition rate, the company foresees client continuity and currency risks as the biggest concerns. However, the concern over the latter is somewhat mitigated as nearly 40-45% of revenues are hedged naturally (through expenses in US dollars). As such, only the balance 30-35% of revenues needs to be hedged.

What to expect?

At the current price of Rs 431, the stock is trading at a multiple of 8 times (adjusted for extraordinary items) its trailing twelve month earnings. The company has been seeing tough times over the past few quarters as its margins and profits have been under pressure. If its plans to improve margins go as per targets, it could see a good turnaround in numbers. However, this could take some time to happen.

As for its plans for acquisitions, it would only make sense to use up the cash more effectively. But considering that the cash that has been piling up for a while now, it can only leave one guessing on when HGSL would actually go in for an acquisition.

The company paid dividend of Rs 20 per share during FY10. This makes the current dividend yield of 4.6% quite attractive.

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