Thursday, January 29, 2015

Firstsource Solutions: Buy in Bulk
CMP: Rs.29.35
Firstsource Solutions Ltd is a global provider of customized BPO (Business Process Outsourcing) services to the Banking & Financial Services, Insurance, Telecommunications, Media and Publishing and Healthcare sectors. The company’s clients include Fortune 500, FTSE 100 & Nifty 50 companies. Firstsource has a “rightshore” delivery model with operations in India, Philippines, Sri Lanka, UK and U.S. 

Prime Triggers: 
(i) Firstsource Solutions’ wholly owned subsidiary - Firstsource
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Group USA, Inc., has successfully made its seventh quarterly repayment of $11.25 million on its outstanding debt on December 31, 2014.
(ii) According to the latest shareholding pattern, the promoters' holding in the company stood at 56.25% (controlling stake), while ICICI Bank Ltd, the ace investor, Rakesh Jhunjhunwala and Goldman Sachs India Fund Ltd holds 4.85%, 3.76% and 1.27% respectively. FIIs hold 8.25% of the shares of the company. 
(iii) It is from the reputed RP-Sanjib Goenka group, who are also the promoters of CESC Ltd (Calcutta Electric Supply Corporation, the flagship company of the RP-Sanjiv Goenka Group). In 2012, the Kolkata-based CESC Ltd (RP-Sanjiv Goenka Group) agreed to pay around Rs.400 crore for a 49.5% holding in the ICICI-promoted BPO firm, paving the way for the partial exit of existing shareholders ICICI Bank, private equity firm Temasek and Metavante Investments. Now, Firstsource Solutions Ltd is a step-down subsidiary of CESC Ltd. It is pertinent to mention here that, Sanjiv Goenka's brother Harsh owns mid-sized IT services provider, the BSE and NSE listed Zensar Technologies Ltd.
(iv) India-based BPOs have been steadily moving up the value chain as low-value call centre operations move to locations such as the Philippines. In the immediate future, impending healthcare reforms in the US and Banking reforms in India, are likely to give BPOs like Firstsource a boost.
(v) In November, 2014, there were media reports that Anand Rathi, which has the stock among its high conviction ideas, believes with the interest-cost burden lightening because of debt repayments, and focus shifting to accelerating growth, return ratios could improve. 
(vi) Over the past two years, the company has been trying hard to go up the value chain by going beyond the low cost offerings. The company's revenue growth expected to gain momentum as the company concentrated on growing revenues and improving profitability by weeding out low cost contracts and undertaking price increases. The elevation of Rajesh Subramaniam — who was part of the founding team — as CEO and acquisition of majority stake by the Sanjeev Goenka group were seen as big positives.
(vii) On the back of improved margin Firstsource Soultions, the IT arm of  the R P Sanjiv Goenka group, reported a 36.8% rise in net profit at Rs.61.2 crore for the quarter ended September, 2014 compared to a net profit of Rs.44.8 crore during the corresponding period last year. The Business Process Management (BPM) services company’s net sales for the period declined 2.1 per cent to Rs.774 crore, against Rs.790 crore. “Our focus has entirely been on bottom-line growth. We have closed a number of loss making accounts, beside other cost cutting measure,” said Sanjiv Goenka, chairman, RP-Sanjiv Goenka Group.
(viii) The company has won deals worth $45 million in the September 2014 quarter, up from $36 million signed in the June 2014 quarter. Revenue from top clients also grew at a healthy pace of 4.8% Q-o-Q, while revenues from the top five clients declined marginally. With the large telecom client walking away, analysts have cut their forecasts for the current year. However, a strong deal pipeline will ensure better growth for the company in FY16. The company has indicated that it expects growth to pick up pace in FY16. Sharekhan says the company has  indicated that the topline would grow seven-eight per cent y-o-y in FY16, even as growth in FY15 would be impacted by vendor consolidation and client ramp downs.
(viii) Though the turnaround has been delayed, analysts believe that the growth in the coming years would be better than the last few years, as the company has strong capabilities in the telecom and healthcare vertical. Also, the company is looking at launching product platforms, which would improve revenue potential of the company. According to Sharekhan, which has a buy on the stock, the stock trades at a reasonable valuations.
(ix) In November, 2014, there were media reports which quoted, Mahantesh Sabarad, Deputy Head of Research at SBI Capital Securities who said, he is bullish on Firstsource Solutions. He said: "It  is a rare kind of IT stock which has debt on its book. We will see that increasingly as the business goes ahead and they have been signing good amounts of deal, for example this quarter gone by, they have signed deals worth USD 45 million, the quarter before it was somewhere around USD 31-33 million." "Increasing deal wins, good amount of cash flow coming in and deleveraging of balance sheet is the story on Firstsource and that is why we like the stock, Rs.55 is the price target in the stock," he said.
(x) The Hindu Business Line gave a buy on 8 September, 2014:
Firstsource Solutions (FSL) is a leading global provider of customised business process management (BPM) services to the healthcare, telecom and media and banking, financial services and insurance (BFSI). The company has over 100 global clients including 21 Fortune 500 and 9 FTSE 100 companies. After a difficult F10-12 period, the company has shown a resolute recovery over F13-F14 aided by a fresh lease of life from their new owners. We believe, the company can a) catapult itself to cover lost ground; b) set it on an elevated revenue growth path from 2HF15e onwards; c) flag down an improvement in margins; and d) recompense it with superior free cash flows (FCFs). All this while FSL would shrink its debt pile making a strong investment case in its favour.
Key risk: Impairment of goodwill from past acquisitions that exceeds networth, could impede valuation uptick.

Caution: The business process outsourcing (BPO) sector has been facing headwinds over recent years. The industry was faced with rising competitive intensity, on one hand, and pricing pressures on the other. Firstsource Solutions Ltd has been battling with these problems in the past couple of years and the ill-timed acquisition of Med Assist at $330 million in 2007. The company has been trying for a turnaround over the past two years, as revenues and margins fell to eight per cent and Ebit margin fell to four per cent in FY12. After the September quarter numbers, some analysts have cut the company's earnings estimates as the turnaround is expected to be delayed.
In the September quarter, Firstsource reported a sequential revenue growth of 2.4 per cent but a year-on-year decline of 2.1 per cent to Rs.774 crore. Analysts claim this is below estimates as a large client walked away. Along with disappointing revenue growth, EBIT margins too were below estimates at 10% and remained flat q-o-q sequentially. Emkay Global has cut its FY15/16 earnings per share estimates by eight to 10% to Rs.3.6/4.7, respectively, as the brokerage is factoring in lower revenue growth and operating margin assumptions for both years.
However, even at an EFY15, EPS of Rs.3.6-4.7 (worst case scenario), the share should be trading around Rs.40-45, against the CMP of Rs.29.35.

Conclusion: The shares of the company might have made a temporary bottom on the candle-stick chart. Q4 (March Quarter) is typically a high margin and a high revenue quarter for the BPO business and hence the investors are suggested to buy the scrip of Firstsource Solutions Ltd, in Bulk and keep holding for sometime; to get one of the best returns. The short term target for the scrip is Rs.34, while the SL is Rs.27.
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