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Sunday, September 03, 2006

Businessline - HOV Services: Invest at cut-off


Investors with a penchant for high risk and seeking to diversify their IT services portfolio can consider participating in the book-built offer by HOV Services. This business process outsourcing (BPO) company is making the offer in the price band of Rs 200-240 per share.

At the lower and upper end of the price band, the price-earnings multiple works out to 15-18 times the consolidated per share earnings for 2005-06 on the existing equity base. Bidding at the cut-off price will be appropriate in this offer, as investors will remain eligible to participate, even if the final offer price is fixed at a lower level.

Considering the risks and the overall financials, the pricing is quite stiff at the upper-end of the price band. We would be more comfortable if the final price is fixed at the lower end of the price band, which may leave adequate room for capital appreciation. HOV Services is a focussed player in the F&A (Finance and Accounting) BPO market, with good client relationships and domain focus created through a string of acquisitions.

On the flip side, however, it remains exposed to the risks of high client concentration, intense competition and pricing pressures in the voice-related lower end of the BPO value chain. Of the nearly Rs 90 crore to be raised through this offer, as much as Rs 65.5 crore is to be infused as capital into HOV's subsidiary, HOV Services LLC, for redemption of non-interest-bearing Class B units issued. Only the balance is to be used towards capital expenditure.

The positive signals

As part of the F&A market, HOV Services and its six subsidiaries operate across three business lines: Accounts Receivable Management (ARM), Enterprise Management Tools and Services (EMTS), and Insurance and Tax Services (ITS). Of the total revenues of Rs 163.8 crore for 2005-06, ARM accounted for 45.2 per cent, with ITS and EMTS contributing 42.3 per cent and 12.5 per cent respectively. In ARM, the company caters to a part of the low-end voice services.

However, since it also handles the entire gamut of third-party debt collection, the stickiness of its clients is likely to be fairly high. The other key segment — ITS — provides services to the surety insurance industry. HOV Services has clients that span the Fortune 1000 category across the four key verticals — telecom, insurance, healthcare and financial services.

According to the offer document, most of its clients have been with it for over five years. For the year-ended March 31, 2006, customers from the telecom, insurance and healthcare verticals contributed about 25 per cent each of the revenues, which opens up cross-selling opportunities from its clients across its three business lines.

Risks and challenges

The client concentration levels have been relatively high. For the year-ended March 31, 2006, HOV Services' top ten clients accounted for 70 per cent of its revenues, with the top five clients from the ARM segment contributing about 43 per cent. While the client concentration level may be similar across companies of HOV Services' size, this aspect exposes the company to growth risks arising from any loss or reduction of business from these top clients.

As a BPO outfit, HOV Services faces the challenge of managing high attrition. The offer document states that the attrition rate in the ARM business (including voice calls) has averaged 45 per cent. This along with rising salaries and relatively low operating margins, in the 12-13 per cent band, vis-à-vis its established peers can pose a major challenge.

The competition in the IT-enabled services business has also escalated sharply in the past couple of years. Multinationals such as Accenture or IBM are scaling-up their operations in India. Domestic software service companies such as Wipro, HCL Technologies, Infosys, MphasiS BFL (under the EDS umbrella), and NIIT Technologies are also positioning themselves in the voice-cum-transaction processing BPO business. Finally, pure-play BPO companies such as Genpact, WNS or ICICI OneSource with established operations have also enhanced the competition levels within the industry. If consolidation also takes off in some form, it has the potential to exert influence on the pricing front at the lower end of the BPO value chain.

The offer opens on September 4 and closes on 7.