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Firstsource Solutions IPO

ICICI OneSource (now Firstsource Solutions) has an IPO between Jan 29 and Feb 2 (2007) with the following details:

Price: Rs. 54 to Rs. 64.
Shares: 6.93 cr. shares (6 cr. new shares, .93 sale by existing shareholder)
Dates: Jan 29 to Feb 02, 2007
Total post issue capital: 41.62 cr. shares

Valuation: P/E of 28
The total valuation of the company, post IPO, at the higher band is Rs. 2664 cr. The last nine months have shown a 62 cr. net profit. This means a nine month EPS of Rs. 1.75 per share, which when annualised gives us an EPS of Rs. 2.33 per share. This means, at the higher band, the valuation is a P/E of 27.47.

Now is this cheap? Let’s take a look at WNS Global Services, India’s second largest BPO (after the privately owned Genpact). Net profit of WNS are about $6 million in the Jul-Sep 06 quarter, annualised at $24 million. In rupees, that is 108 cr., which is about twice the size of Firstsource. Revenues of WNS are about $350 million annualised, which is twice firstsource’s size. WNS is priced at about $30 per share, which is a P/E of 60. Assuming that the market leader gets a 20% higher pricing than others, the P/E of Firstsource should probably be at 45-50 levels. Which is nearly double the IPO offer.

What’s the IPO money being used for?
Remember that 93 lakh shares are for sale by an investor, so that much money won’t be available to the company. At the higher band, the company will get Rs. 400 cr. Let’s see how it proposes to use the money.

Firstly, 180 cr. of the proceeds will be kept for acquisition. This is good news, because there needs to be some consolidation in the BPO space.

Secondly the company intends to invest in a new facility in Chennai which should be ready by March 31, 2007, at a cost of 14.26 cr. Another 32 cr. has been earmarked for other locations.

The company intends to repay a loan of 45 cr in 2008. This may or may not involve a pre-payment, but in the light of interest rates going up, I feel they might prepay.

Expenses and working capital: The remaining money – about 130 cr. at the higher band – is kept for issue expenses and working capital. Unfortunately no cap has been placed, percentage wise, on the expenses, and this is a small source of worry.

Competition
Firstsource has been ranked #5 among non-captive BPOs in India, after Genpact, WNS, Wipro BPO and HCL BPO. Genpact is private and the Wipro and HCL BPOs are arms of a larger public software company. WNS is the only other public company, but its financial results for the December 06 quarter will only be available on Feb 13. That’s after this IPO closes, so we have to compare earlier figures.

As I’ve mentioned, the P/E of 27.5 on the last nine-months, on an annualised basis, is attractive and much lower than WNS’s valuation. I believe that the issue is very conservatively priced, and shareholders can expect a much higher P/E of about 50 or so. The CAGR of Firstsource, from 2004 has grown from 60 lakh to 24 cr in 2006, with the first 9 months of 2007 yielding 62 cr. That’s a growth of over 100% yearly, indicative of a good growth story.


Advantages

Multi-location: There are already delivery centers in the US, UK, Argentina and one more coming up in Philippines, which is a lower cost country than India and also has the important distinction of being able to serve Japanese companies easily.

Inorganic growth: Acquisition of customers will happen also by buying out other companies, which, along with the organic growth they have shown, will show a faster increase in revenues and profits.

Not just voice: While some other companies focus on the now commoditised voice delivery (phone agents), Firstsource has moved into other areas including check processing, loan servicing, marketing analytics and compliance. This is a better margin business and less commoditised, plus requires a greater skillset and knowledge base. So competition in that sector will only be from large players, a significant advantage and entry barrier.

Recent acquisition: Firstsource recently acquired BPM, a US based BPO which will add revenues and income to the company, visible perhaps in this quarter onwards.
Results upto December 31 in the offer document
Firstsource has provided results upto December 31, 2006 in the offer document. This is commendable. In recent IPOs, like Info Edge, there were no recent results available for comparison, in fact Info Edge has not even declared it’s July to September 06 quarterly results to the stock exchanges! In that respect I like it that Firstsource has chosen to be as transparent as possible.

Recent shares sold
Recently, shares of Firstsource Limited have been transferred to Galleon, an institutional investor, at a price of Rs. 62 per share. This is less than the price of Rs. 64 at the upper band, but Galleon has agreed to pay the difference if the actual price of the issue is greater than Rs. 62. This is showing serious confidence in the company, plus the strong ethical stand that this share sale will not be at a lower cost that what other general shareholders will pay.

Prior to this there were some option conversions to Westbridge (a PE firm) which being option conversions were created longer back and only exercised recently. Such transfers do not reflect today’s price, but of the price when the option was created which is longer back.

I had mentioned in my earlier IPO analysis of Info Edge (Naukri) that in their case, they sold to institutions at Rs. 245 – a far lower amount than paid by shareholders at Rs. 320 – that such lower valuation sales to institutions immediately prior to the issue amounts to taking money away from other shareholders. In this case though, there is no such problem.

Dependence on a few clients
Five clients account for about 50% of income in the last nine months, and losing such clients will cause revenue losses. But this will probably change with the IPO money being used for expansion and acquisitions. Any organic or inorganic growth is likely to keep the dependence down, and stabilise the business.

Recommendation
I recommend a buy for this IPO. Subscribe at the higher end of the band. I think this is one of the stronger and more capable players in this space and will yield good results.

But subscribe on the last day of the IPO, looking at oversubscription. If the issue is more than 5 times oversubscribed, you should probably look at buying in the secondary market – though if you don’t mind locking your money for a while, you should apply in the primary market as well. I’ll post the subscription statistics here on Feb 1.

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