Stock of the Month (April 2013) – Firstsource Solutions
02 April, 2013
Price: Rs. 10.69
This Stock Analysis report presents a long term outlook and the future prospects of Firstsource Solutions Limited.
FCCB Repayment and de-leveraging
One of the biggest worries for the Company had been the outstanding FCCB redemption obligation. The total debt levels of the Firstsource Solutions Limited (“FSL” or the “Company“) stood at Rs. 2,646 Cr at the end of Q2 of FY 2013. In December 2013, the Company repaid its outstanding Foreign Currency Convertible Bonds (FCCBs) of ~ 1,290 Cr.
The FCCB debt repayment was made possible by
► Using Company’s cash reserves which had grown significantly on account of preferential allotment of shares made to Spen Liq Private Limited (look at the second investment rationale for more details)
► External commercial borrowings to the tune of ~ Rs. 370 Cr.
This has brought down the total debt levels of the Company from Rs. 2,646 Cr. to Rs. 1,724 Cr.
At the end of Q2, FY 2013 (i.e. September 2013), the majority shareholding of the Company which was a little below 20 % was with the then promoters ICICI Bank Limited. On 26 October 2013, the SP-Sanjiv Goenka group’s firm, CESC Ltd (Spen Liq Private Limited, a unit of CESC), announced its plans to acquire a controlling stake of 34.5% in the Company for up to Rs. 640 Cr. in cash (the Company used part of this money to repay its FCCB obligation, mentioned above). Spen Liq Private Limited followed this up with an open offer announcement to buy an additional 26% stake in the Company from the open market.
As of 31 March 2013, (i.e. the last reported shareholding), Spen Liq Private Limited held 56.86% shares in the Company. Having a single largest shareholder and a strong promoter group will help the company in improving efficiency of management.
Improving Financial Position
In FY 2013, Firstsource Solutions registered a revenue growth of ~ 24.99 % over the same period of the previous year. In the last few quarters, FSLs financial performance has shown consistent signs of improvement with the operating profit margin increasing from 8.25 % to 11.15 % and the net profit margin improving from 4.37 % to 5.70 %. This has been possible partly on account of greater penetration in the EU market which resulted in higher realisations and partly because of an improvement in the telecom & media and healthcare verticals.
Fragile state of global economy and currency volatility
The global economic conditions have been and continue to be somewhat challenging with tighter credit conditions and slower growth since the financial crisis which started in the middle of FY 2008. The recovery has been the slowest in recent times and even after 4 financial years, the economy is not yet back on track and many downside risks remain. In the United States, unemployment is still high but. In the Europe, sovereign debt problems continue to be a concern and may derail the recovery. Political turmoil in Middle East continues to threaten oil supply. India has been struggling with record high inflation numbers which has restricted the RBI from cutting key interest rates. Global economic conditions and confidence in recovery affect the Company’s clients’ businesses and the markets they serve. While we believe that we are nearing the end of a bad economic cycle any meaningful improvement in the economy will primarily depend upon progress on the following fronts:
♦ European sovereign debt crisis;
♦ The structural challenges which the US employment market is facing; and
♦ The state of high inflation in India.
The average Indian rupee/U.S. dollar exchange rate was approximately 48.53 per $1.00 in FY 2012. For FY 2013, it has been 54.28 per $1.00. The average Indian rupee/pound sterling exchange rate was approximately 77.40 per £1.00 in FY 2012. For FY 2013, it has been 85.86 per £1.00. This volatility in currencies is likely to continue in future as well. Accordingly, the Company’s operating results have been and will continue to be impacted by fluctuations in the exchange rate between the Indian rupee and the pound sterling and the Indian rupee and the U.S. dollar, as well as exchange rates with other foreign currencies such as Euro, Philippine Peso, Canadian Dollar, Australian Dollar and Sri Lankan Rupee.
Competition from other cheaper markets
The market for BPO services is evolving rapidly and dynamically and has become highly competitive over the years. The competition it faces will continue to intensify. The Company competes for business with a variety of companies in each of its business units. These competitors include offshore third party ‘pure-play’ BPO providers’ largely in India and Philippines, local / onshore BPO providers in US and Europe, BPO divisions of global IT companies and in-house captives of potential clients. There could also be newer competitors entering the market. In order to stay competitive, the Company must make significant investments in strengthening domain capabilities, process excellence, standardization and innovation, apart from adhering to global operating standards such as ISO 27001, Six Sigma, COPC, SAS 70, PPMS, HFMA Peer Review Status etc. and be able to offer high class services and solutions at a cheaper price.
Anti outsourcing legislations in the west
One of the impacts of the global financial crisis and recession has been increased unemployment in the developed countries such as US and UK. The response to this rising unemployment has been the rise of legislation aimed at protecting domestic industries and jobs by various anti-trade measures. The issue of companies outsourcing services to organizations operating in other countries such as India has increasingly become a sensitive topic and subject of intense political discussion in these countries. In the US, there have been anti off-shoring legislations aimed at making offshore outsourcing prohibitive or less attractive. In the United Kingdom, there is a prevailing legislation, TUPE (Transfer of Undertakings (Protection of Employment) Regulations), enacted based on the European Union Acquired Rights Directive. UK has also witnessed increased resistance from labour unions against the use of foreign labour. Most of these measures are more of political rhetoric and against the spirit of free trade, yet the pressure on western governments and their political compulsions could have a materially negative impact of the Company in case stricter anti-outsourcing legislations are enacted.