Firstsource Solutions - DoCuRi

Initiating Coverage December 3, 2013 Rating matrix

Firstsource Solutions (FIRSOU)

Rating

:

Buy

Target

:

| 29

Target Period

:

15-18 months

Potential Upside

:

34%

El Clasico!

YoY Growth (%) FY12 Net Sales

FY13

FY14E

FY15E

9.7

25.0

7.5

8.7

EBITDA

-36.1

51.0

32.2

27.4

Net Profit

-55.2

136.3

33.4

53.4

[

Current & target multiple

FY12

FY13

FY14E

FY15E

PE (x)

15.0

7.6

7.4

4.8

EV to EBITDA(x)

12.7

8.4

6.4

5.0

Price to book (x) Target PE

1.0 20.2

0.8 10.2

0.7 9.9

0.6 6.5

Target EV/EBITDA

15.4

10.2

7.7

6.1

1.4

1.1

0.9

0.8

Target P/BV [

Stock Data Bloomberg/Reuters Code

FSOL IN EQUITY / FISO.NS

Sensex

20855

Average Volumes (yearly) Market cap (| crore)

629433 | 1447 crore

Debt (Sep-13)

| 1060 crore

Cash (Sep-13)

| 150 crore

52 week H/L (|)

24 / 9

Equity capital

| 670 crore

Face value

10

DII Holding (%)

5.0

FII Holding (%)

1.1

Comparative return matrix (%) Returns (%) FSOL HGS EXL Genpact

1M 3.9 12.4 -10.7 -9.3

3M 75.5 83.7 -3.5 -6.1

| 22

6M 96.3 48.8 -12.3 -7.7

12M 79.9 37.9 -4.2 12.9

[

Price movement

200 150 100

Firstsource Solutions (FSL) scripted an ideal turnaround narrative, from reeling under FCCB weight to successfully repaying it along with a change in management. Operationally, FSL appears to be doing everything right from 1) consolidating facilities, 2) eliminating operational silos, 3) realigning sales function, 4) renegotiating unviable service agreements (SLAs), 5) repaying debt and 6) trimming excess flab for margin expansion, to aligning itself to capture the impending healthcare opportunities. Though FY14E revenue growth could be soft (7% in constant currency vs. 15% in FY13), we believe growth could return in FY15E (10% in CC) led by top client mining, demand uptick for customer management services for providers and likely improvement in offshoring for UK BFSI piece. Though valuations have doubled since May 2013, they continue to be reasonable, relative to global peers, given the debt repayment and margin improvement roadmap. This makes FSL an attractive story for value investors. We initiate coverage with a TP of | 29. ObamaCare induced spends may be key drivers for healthcare vertical ObamaCare, as it is popularly known, mandates that Americans purchase health insurance in 2014 or else face penalties. This could bring ~30 million Americans into the insurance net and implies incremental volumes for both hospitals and insurers. Broadly, we believe, regulations could drive spends to reduce costs, raise member enrolments, billings, claims administration and data analytics. Net debt neutral by FY16E end, plausible At the current repayment rate, FSL would repay $135 million of its debt by FY16E and end with ~$50 million of cash, resulting in a net debt of $12-13 million assuming no accelerated payments. However, back of the envelope EBITDA calculations suggest accelerated repayments are plausible if FSL manages to improve the EBITDA to FCF conversion ratio to an average ~85% vs. 57% in FY13. Debt repayment may translate to Mcap gains FSL continues to be an attractive story for value investors given the debt repayment roadmap, which itself could translate to Mcap gains even if the enterprise value were to remain the same. We value the stock at | 29 i.e. at 5x FY15E EV/EBITDA multiple. The target multiple implies a 34% discount to its five-year historical (FY08-13) average multiple of 7.6x. The discount is warranted, despite debt repayment schedule, as revenue growth and margins have moderated relative to the historical average and are inferior relative to the peers. Exhibit 1: Key financials

50 0

FY11

FY12

FY13

FY14E

FY15E

2055

2255

2819

3029

3292

EBITDA (| crore)

290

185

280

370

471

Net profit (| crore) EPS (|) - diluted

139 2.9

62 1.4

147 2.8

195 2.9

300 4.5

Nifty

Nov-13

Jul-13

Sep-13

Mar-13

May-13

Jan-13

Nov-12

Jul-12

Sep-12

May-12

Jan-12

Mar-12

Sep-11

Nov-11

Income from operations (| crore)

Firstsource

PE (x)

7.4

15.0

7.6

7.4

4.8

Analyst’s name Abhishek Shindadkar [email protected]

EV to EBITDA(x) Price to book (x)

8.1 1.0

12.7 1.0

8.4 0.8

6.4 0.7

5.0 0.6

RoNW (%)

9.7

4.3

9.3

10.1

13.0

Hardik Varma [email protected]

RoCE (%)

7.0

3.6

7.5

10.5

13.3

ICICI Securities Ltd | Retail Equity Research

[

Source: Company, ICICIdirect.com Research

Company background

Shareholding pattern (Q2FY14) Shareholder Promoters FII DII Others

Holding (%) 56.8 1.1 5.0 37.1

24

Firstsource Solutions (FSL), incorporated in December 2001, is a leading global provider of business process management (BPM) services and is among India’s top three pure play BPM companies. FSL offers the full suite of BPM services across the customer life cycle – customer acquisition, customer care, transaction processing, billing & collections as well as business research & analytics – and has over 30,000 employees. Its 75+ clients include six Fortune Global 500 banks, two Fortune Global 500 telecommunication companies and three Fortune 100 healthcare companies. FSL provides services to companies in the healthcare, telecom & media, banking & financial services and insurance verticals from its 47+ facilities spread across the US, UK, Europe, Philippines, India and Sri Lanka.

12

Business description

FII & DII holding trend (%) 60 48

49.5 7.3

56.9 7.6

56.8 7.9

56.8 6.1

0

49.5 7.3

%

36

Q2FY13

Q3FY13

Q4FY13

Q1FY14

Q2FY14

Promoters

FII & DII

Premier

Partnership

FSL’s current business structure has been realigned taking into account the three dimensions of vertical market across geographies, horizontal services and delivery, with sales and marketing, client engagement aligned to verticals. The company primarily focuses on four business units (BU) viz. healthcare payer BU, healthcare provider BU, collections BU, and customer management BU.

Healthcare provider Solutions

offered:

MedAssist®

Eligibility

Services,

Program, Receivables

Management, Member Enrolment Services, Innovative Staffing Solutions, Patient Financing (Map™), Physical Enrolment and Contact Centre Solutions

Exhibit 2: Provider business overview

FSL provides revenue cycle management solutions including eligibility services (80% of provider), enrolment and other recovery solutions to over 730 hospitals and health systems across 35 states and helps maximise reimbursement systems, increase cash flow and reduce bad debt. The provider business generates about two-third of FSL’s healthcare BU revenues and has ~1600 employees (100% US delivery) spread across 13 US regional service centres. Generally, pricing is outcome based as FSL earns commissions while the order book as on Q2FY14 end stood at ~$105 million. Major competitors include Emdeon, Accretive, Conifer and Parallon Solutions.

Provider

Patient services

Eligibility service

Receivables management

Collections services

Hospitals

• Patient contact and registration

• Medicaid review and management - Assisting patients with secondary Medicaid coverage

• Ongoing and clean-up projects for all Payor classes - Initial billing, follow-up & denials management

• Custom Telephone Collection Campaign

• Charity assistance - Handling all aspects of providing charity assistance

• Self-Pay “Early-Out” Cash Acceleration - Management of patient interaction to ensure maximum recovery

• Skip-tracing Services

Physician Groups

• Insurance verification and certification • Patient visit management

• Self pay conversion • MedAssist Advantage Plan (MAP) - Innovative hospital credit card in conjunction with US Bank

• Management of provider enrolment and billing for Outof-Primary-State Medicaid Receivables

• Small Balance Collections

• Cash Acceleration Services • Attorney Services

• Credit Balance Resolution



Page 2

Healthcare payer The payer business provides BPM solutions to the insurance industry and accounts for about a third of the healthcare business. With ~2500 employees, FSL processes claims for leading healthcare payers including many Blue Cross & Blue Shield plans, third-party administrators and primarily provides 1) front-end office & mailroom solutions, 2) data conversion, 3) claims processing/adjudication, 4) claims auditing & 5) member enrolment & eligibility services solutions. Delivery generally is a combination of onsite & offshore while pricing is output based. Major competitors include ACS, Xerox, CSC, HOV Services, Hinduja Global Services (HGS) & BPO divisions of Indian vendors like Wipro & Cognizant.

Exhibit 3: Payer business overview Payer

Mail room

Data conversion

Member enrolment

Claims Processing & adjudication

Client support

IT support

Insurance Companies

• Mail handling & document management

• Workflow enabled image management

• Entry in system

• Member & provider eligibility

• Member service

• Database design

• Data “EHelp”

• Database maintenance

• Provider Services

• Data cleansing System design and support

Third Party Administrators

Managed Care Organisations

• Scanning and reject handling • Indexing • Archival • Printing

• OCR/ICR Technology •Capture data with integrated database validations

• Data base maintenance • Calls to validate information

• Customized output generation (ANSI837, NS, etc.)

• Service line verification • Allocation of benefits • Earner liability processing • Bundling & duplicate analysis

• HIPAA compliance support

• Maintenance and support

• Claims repricing


Customer management Firstsource delivers innovative and value-added BPM services across the customer lifecycle. The company offers a comprehensive suite of customer relationship management services – customer acquisition, customer care, complaints management – through a combination of deep domain knowledge, strategic alliances and internal competencies backed by the right technology.

Collections management Firstsource offers innovative collections and recovery solutions providing end-to-end solutions encompassing the entire collections life-cycle from pre-collections delinquency (welcoming calls, reaching delinquent or likely to become delinquent customers), early stage collections (pre charge off first party and third party), late stage collections (post charge off recoveries), legal (pre-legal, litigation, post judgement), to collections support (skip tracing, letters, process excellence).

Transaction processing FSL offers a range of data processing services including transaction processing outsourcing, back office outsourcing, document management, mailroom services and transaction processing services to the banking & financial services, insurance, telecommunications and healthcare industries.


Page 3

Exhibit 4: Company History Date 2001

Event Established as ICICI Infotech Upstream Ltd by ICICI Bank, India

2002

Renamed to ICICI Onesource. Acquires Customer Asset in UK.

2003

Acquires FirstRing, a global BPM player, in the US.

2003

WestBridge (now managed by Sequoia Capital) invests in the company.

2004

Acquires majority stake in Pipal Research and Accounts Solutions group in the US.

2004

Strategic investment by Temasek in the company

2005

Enters Heatlhcare and Publishing Industries through the acquisition of RevIT India

2006

Inks strategic partnership with Metavante & acquired Business Process Management Inc. US

2006 2007

Name changed to Firstsource Solutions Ltd. Starts operations in Northern Ireland and Argentina Initial offering in India. Acquires MedAssist to strengthen its presence in Healthcare provider space. Raises FCCB worth $ 275 million.

2008

Signs a 5-year, $ 80 million outsourcing deal with BarclayCard US

2011

Enters into a joint venture (JV) with Dialog Axiata and enters Sri Lanka. RPG led CESC acquires 56% stake in the company. Repays FCCB obligation worth $ 237 million in December 2012.

2012


24 12.7

4.3

9.7

1000 FY08

FY09

FY10

Net Sales

FY11

FY12

Growth, YoY



FY13

240

8.2

200

12

160

0

120

9.9

FY08

FY09

FY10

FY11

FY12

FY13

Operating EBITDA

12 %

36

16

14.1

279.6

1400

1298.8

25.0

14.2

13.2

185.1

1800

1970.8 2055.3

280

289.6

1749.4

48

280.5

2200

2255.0

20

18.0

231.1

34.7

320

| crores

| crores

2600

60

%

2818.5

3000

Exhibit 6: …while average EBITDA margin were 12.9%

233.9

Exhibit 5: Revenues have grow at 16.8% CAGR during FY08-13

8 4 0

EBITDA Margin, %


Page 4

Management Profile Rajesh Subramaniam, Managing Director and CEO: Mr Subramaniam is responsible for driving the company’s strategic and corporate initiatives globally and evolving the company’s business model towards achieving long term growth, profitability and industry leadership of the organisation. Prior to joining Firstsource in 2011 as Deputy Managing Director and Chief Financial Officer (CFO), he was the Managing Director of Walden India Advisors Pvt Ltd. He was also the CFO of Firstsource between November 2002 to June 2008. He earned his MBA from Richmond College, London and is a commerce graduate from Madras University, India Dinesh Jain, Chief Financial Officer: Mr Jain oversees the company’s global finance, banking, accounting and corporate taxation functions. He has been with FSL since inception and was instrumental in consolidating the commercial and finance functions globally. Prior to joining FSL, he was with ICICI Bank, responsible for US GAAP financials and played an important role in the US listing of ICICI and ICICI Bank as well as in the merger of ICICI and ICICI Bank. He holds a bachelors degree in commerce from Jodhpur University, and is also a Chartered Accountant from the Institute of Chartered Accountants of India and a Cost Accountant from The Institute of Cost and Works Accountants of India. Mr Sanjay Venkataraman, President, Customer Management: Venkataraman is the head of Customer Management at Firstsource and focuses on enhancing customer management initiatives. Prior to joining Firstsource, he worked with companies including Mahindra Satyam (as Head of South Asia) and Dell (as Country Manager). He holds a Bachelors degree in Electrical Engineering from Bharathiar University, Coimbatore. David Strickler, President and CEO – Healthcare Provider: Mr Strickler is the President and CEO – Healthcare Provider Solutions for North America. Prior to Firstsource, he was the SVP-Operations at Accretive Health and also worked with leading corporations in the US including The Advisory Board Company, McKinsey & Company Inc. and Westinghouse Electric Corp. Mr Strickler holds an MBA and a Masters degree in Arts from Cornell University. Stephanie Wilson, Executive Vice-President, European Operations: Ms Wilson is responsible for client engagement and operations in Europe. She has several years of experience in the contact centre industry and has worked with companies such as Teleperformance, TSYS Managed Services and Convergys prior to joining the company. Shalabh Jain, Executive Vice-President, Customer Management Domestic Business: Mr Jain heads the Indian domestic and South East Asia BPO business. Prior to Firstsource, he worked with various organisations including Wipro, Compaq/HP, GE, IBM Daksh and MphasiS. Mr Jain holds a Bachelors in Mechanical Engineering degree from the Indian Institute of Technology, Kanpur, and also holds an MBA (Finance) from the Institute of Management Technology, Ghaziabad. Venkat Raman, Executive Vice-President, Healthcare Payer and Publishing: Mr. Raman is in charge of Firstsource’s Healthcare Payer and Publishing businesses including P&L responsibilities. Prior to Firstsource, he served with Lason Inc. He is a graduate in Physics and also holds a Certificate in Management Development from the Indian Institute of Management, Ahmedabad, India.


Page 5

Satish M, Executive Vice-President, Human Resources: Mr Satish has over 19 years of experience and is responsible for driving the HR strategies. He has been associated with companies like Medall (where he headed the HR and process excellence function), Accenture (where he lead the recruitment for the BPO division), LG Soft India Ltd and Siemens Public Communication Ltd. Mr Satish has done his MBA (HR) from New Port University and Accelerated Management Program from ISB, Hyderabad. Iain Regan, Executive Vice-President, Sales and Client Services: Mr Regan is responsible for global Sales, Marketing and Account Management at Firstsource’s Telecommunications and Financial Services verticals. He holds an honours degree from Kingston University in Geography and Environmental Science.


Page 6

Investment Rationale Firstsource Solutions scripted an ideal turnaround narrative, from reeling under FCCB weight to successfully repaying it along with a change in management. Operationally, FSL appears to be doing everything right from 1) consolidating facilities, 2) eliminating operational silos, 3) realigning sales function, 4) renegotiating unviable SLAs, 5) repaying debt, 6) trimming excess flab, which aids margin expansion, to aligning itself to capture impending healthcare opportunities. Though FY14E revenue growth could be soft (7% in constant currency vs. 15% in FY13), we believe growth could return in FY15E (~10% in CC) led by top client mining, demand uptick for customer management services for providers and likely improvement in offshoring for the UK BFSI piece. We model revenues to grow 7.5%, 8.7% YoY in FY14E and FY15E, respectively, along with 228 bps, 210 bps expansion in margin to 12.2%, 14.3%, respectively. Though valuations have doubled since May 2013, they continue to be reasonable, relative to global peers, given the debt repayment and margin improvement roadmap and hence makes FSL an attractive story for value investors. We are initiating coverage on FSL with a target price of | 29.

Key drivers for healthcare vertical: spends driven by new regulations BPM spends induced by the significant regulatory overhaul of the US healthcare system could be a key driver for the healthcare vertical. ObamaCare, as it is popularly known, mandates that its citizens purchase health insurance in 2014 or else face penalties. This could bring ~30 million Americans into the insurance net and implies incremental volumes for both hospitals and insurers. Note that creation of health insurance exchanges (HIX) in each state, offering a marketplace to compare policies, could create IT-BPM opportunities. Broadly, the changes that aim to a) increase the quality and affordability of health care, b) reduce the number of uninsured through public and private coverage and c) reduce the cost of healthcare could create spending opportunities in 1) IT implementation and support for Electronic Health Record (EHR), 2) business process outsourcing (BPO) to reduce costs, raise member enrolments, billings, claims administration and data analytics services to support fact-based decision-making throughout the healthcare system. Exhibit 7: Healthcare BPO contracts both in volume and value have risen in 9MCY13 200

$ billion

160

15 22.8

149.7

12

120

9 9.3

80 6.3

40 0

11.7

10

CY07

CY08

2 CY09

Healthcare contracts awarded

3

8.6

6 11

3

4

CY10

CY11

2 CY12

6

6

0

9MCY13

Annual contract value (ACV), RHS

Source: Bloomberg, ICICIdirect.com Research


Page 7

Healthcare rebates may drive savings in “non-claims” costs for payers The Affordable Care Act’s mandatory medical loss ratio (MLR) threshold for insurance companies could drive cost savings initiatives, through outsourcing, in the healthcare payer market. Note that with the aim of improving the care quality, the Act encourages compliance with MLR threshold – set at 85% for large group market and 80% for small market and individuals vs. marginally lower earlier – and maintenance of uniform rates across states. The threshold ensures insurers spend a certain percentage of premium generated on improving the quality of care. Further, the rebate requirements kicks in – estimated at $2.1 billion in 2012 including savings from lower premiums – if insurers do not set the premium at levels where they would maintain the MLR threshold by paying generated premiums as benefits. Understandably, a higher MLR ratio yields lower profitability for payers and could help drive cost saving initiatives through outsourcing/offshoring to trim commissions and other administrative expenses to become efficient. MedAssist had three main service offerings - eligibility services (60-65% of revenues), collections services (1517%) and receivables management (20-25%). For eligibility services, the company maximises the eligibility of the private-pay patients (uninsured) for federal/state and other financial assistance programmes. It also manages their application and reimbursement process for hospitals

MedAssist acquisition: Bane earlier, boon now! FSL entered the healthcare space through acquisitions. FSL first acquired RevIT, followed by US based BPM Inc. for US$30 million in 2006 and then MedAssist – a pan-American revenue cycle management solution provider – in August 2007, to expand its healthcare provider business. While the BPM acquisition size was relatively small, MedAssist was huge, at $300 million. The acquisition added 1000 customers, including 800 hospitals, to its roster and gave a strong foothold in the US with ~1400 employees spread across 23 delivery centres. However, FSL’s intentions of integrating the payer and provider business, also a reason that drove MedAssist acquisition, never fructified. Further, despite the constructive setup of 1) healthy MedAssist margins (~22-24%), 2) client diversification (top and top 10 contributing 4.3% and 29% of CY06 revenues) - peak cycle valuations (3.3x CY06 revenues and 15x EBITDA), ensuing economic downturn and the corresponding debt [US$275 million line of credit at 250-300 bps above Libor (five-year duration) and remaining US$55 million from internal accruals) overwhelmed FSL. However, this could change with FSL restructuring the top deck at MedAssist by hiring a new CEO, CFO and HR head. David Strickler, the new CEO, worked earlier as SVP Operations at Accretive Health, which had revenues of US$826 million in CY11. At present, the company has a tie-up with 800 out of the 4,500 hospitals (18% marker share) across the US. The company is refocusing on its sales strategy, which could likely yield an improvement in the provider business from Q4FY14E.

A peek into US healthcare landscape Healthcare spending in the US constitutes $2.7 trillion ($8,680/person) or ~18% of its GDP in 2011, up from $2 trillion in 2005. The centre for Medicare and Medicaid Services (CMS) expects healthcare spending to reach $4.4 trillion by 2020 or ~19.2% of the US GDP. Medicare provides healthcare coverage to ~49.5 million Americans aged 65 or above, and accounts for ~3.7% of the 2012 GDP ($580 billion) and is expected to reach $1.1 trillion by FY20. Similarly, Medicaid, which covers ~56 million low-income Americans, stood at ~$417 billion or 2.7% in 2012. Though Medicare and Medicaid spends are expected to grow 4.7% and 6.7% in 2013, respectively, CMS expects spends to rise at a faster – 7.4% and 7.9% to $1.1 trillion and $839 billion, respectively – rate between 20152022 driven by higher enrolments, increasing costs, and focus towards care vs. service earlier. Interestingly, despite being one of the largest healthcare systems in the world, various estimates suggest that the US is an inefficient healthcare system, with annual overages ranging between ~$600 and $850 billion, as discussed in detail below.


Page 8

Government Accounting Office estimates that the annual healthcare spending overages range between $600 and $850 billion and the “waste” could exhaust a third of US Healthcare Bill. Prominent overages include: •Unnecessary care (~27% of healthcare waste): Excess usage of antibiotics and protection against malpractice exposure through diagnostic lab tests usage, account for ~$190 billion in annual healthcare spending •Fraud (~10%): Fraudulent Medicare claims and kickbacks for referrals for unwanted services costs ~$70 billion each year •Administrative inefficiency (~25%): huge volumes of paperwork involving claim payments, reimbursement and redundant paperwork accounts for annual spending of ~$175 billion •Inefficient delivery of care and inflated prices account for ~31% or $220 billion of healthcare waste while preventive failures account for ~7% or $50 billion Waste reduction through greater use of IT and BPM could reduce healthcare costs without impeding the quality of care given incremental 30 million Americans could be added to insurance net and uninsured percentage falls to 6.9% in 2020 vs. 14.7% in 2011. Finally, the BPM outsourcing opportunity could reach $80 billion vs. $10 billion in 2011. Exhibit 8: Funding under American reinvestment and recovery act (ARRA) Date

Amount

Purpose

Medicare and Medicaid incentives for EHR adoption

$ 17 billion

To provide incentives for the early adoption and use of qualified, certified interoperable HIT and penalties in future years for providers that have not demonstrated meaningful use of EHRs.

ONCHIT Programs

$ 2 billion

To promote the use and exchange of electronic health information in a manner consistent with ONCHIT's strategic plan.

Biomedical Research

$ 8.2 billion

This funding is designed to expand jobs in biomedical research to study diseases.

University research facilities

$ 1.3 billion

For constructing and renovating extramural research facilities and for acquiring shared instrumentation and other capital research equipment

Comparative effectiveness health research $ 1.1 billion

To conduct or support research to evaluate and compare clinical outcomes, effectiveness, risk and benefits of two or more medical treatments and services that address a particular medical condition.

Prevention and wellness

$ 1 billion

To support state and local efforts to fight preventable diseases and conditions.

Community Health

$ 1.5 billion

To be used for construction, renovation, equipment and acquisition of health IT systems for community health centers.

New sites and services grants

To support new sites and service areas, to increase services at existing sites, and to provide supplemental payments for spikes in the $ 500 million uninsured populations.

Workforce training

For training primary health care providers and to pay medical school expenses or repayment of medical school loans for students who $ 300 million agree to practice in underserved communities through the National Health Service Corps.

Other health care professionals

These competitive grants, scholarships and loan repayment programs will be used for all the disciplines trained through the primary $ 200 million care medicine and dentistry program, the public health and preventive medicine program.

Source: Centers for Medicare & Medicaid Services, ICICIdirect.com Research

BFS business may be sluggish; ‘I’ could be a surprise Discussions suggest the BFSI business continues to face multiple headwinds from lower credit card issuances, outstanding loans and a decline in charge off rates. Further, the Credit Card Act includes several provisions on limiting the card company’s ability to charge consumers (but does not include price controls, rate caps and fees). As a reminder, FSL earns a commission depending on its ability to recover bad debt. However, the outstanding credit card portfolio has declined to ~$800 billion vs. $1 trillion before the financial crisis while charge off rates have declined to 2.5% vs. peak rates of 9.9% in March 2010, reflecting an overall improvement in the portfolio quality. We believe BFSI vertical revenue growth could be below the company’s average given collections


Page 9

contribute ~50% of revenues while financial services institutions account for 75% of the collections business and healthcare for the remaining.

Exhibit 9: BFSI business overview Financial Services

Transaction processing

Customer service & fulfilment

• Check, remittance and item processing • Funds transfer and forex transactions • Custody operations & fund service - Portfolio valuation and reconciliations - Contract note generation - Settlements - Corporate actions - Billing support - Performance audit

• Account maintenance - Activation & authorisation - Account closure - Lost and Stolen cards • Query management - Transaction related - Payment related - Product related - Helpdesk activities • Interactive services (Email/Web chat) - Up selling - Cross selling - Disputes & complaint resolution

Credit Cards

Custody

Retail banking

Mortgage

General & life insurance

Collections

• Mortgage - Origination - Loan vault conversion - Collateral review - Underwriting - Loan booking • Insurance - Application processing - Policy amendments - Policy amendment/ cancellation - Data and trend analysis

• Early stage collections - 1st party - Pre-charge off • Late stage collections - 3rd party collections - Skip trace


Exhibit 10: Credit card liabilities and charge-off rates are off their peak 850

12.0

840

10.0 8.0

820

6.0

810

4.0

800

2.0

790 780 Oct-06

%

$ billion

830

0.0 Jul-07

Apr-08 Jan-09 Oct-09

Jul-10

Credit card loans

Apr-11 Jan-12 Oct-12

Jul-13

US Net Charge-off


Exhibit 11: Banking contract ACVs have moderated YoY 220.2

425.6

$ billion

360

280.4 100.2

270 180 90 0

62.2 31

17

10

18

8

CY07

CY08

CY09

CY10

CY11

Banking contracts awarded

100.7

101.8

9

10

35

450

28

360

21

270

14

90

0

0



413.3 366.4

30 24

284.2 142.2

180

7

CY12 9MCY13


$ billion

450

Exhibit 12: But insurance ACVs saw demand uptick relative to CY12

80.4 18

153.2

12 53.5

19

21

10

11

16

CY07

CY08

CY09

CY10

CY11

Insurance contracts awarded

6

14

6 0

CY12 9MCY13



Page 10

FSL recently won the outsourcing partnership award from

Client mining strategy driving telecom and media business

its top customer in the Europe call centre and customer

The telecom and media business continues to be driven by top and top 10 customers. We estimate that seven of the top 10 customers are from this space. This list includes the top customer, to whom FSL provides customer service and technical support for the latter’s 10 million+ customers spread across TV and broadband services. Further, last year, FSL extended its existing 10 year relationship for three years, which could see it expanding its 1000 staff, single location delivery to ~1900 staff spread across three locations. Finally, as a reflection of the success of FSL’s mining strategy, top and top 5 clients’ revenues have grown faster (11.5% and 6.2% CQGR during Q4FY12-Q2FY14) than company average (4.1%) along with 640 bps and 510 bps increase in revenue contribution, respectively.

service awards

Exhibit 13: Telecom business overview Telecom & Media

Mobile / Wireless

Sales and marketing

Account setup and activation

Customer service

Billing / Helpdesk support

Manage receivables/ collections

Saves / Win back

• Inbound sales

• Provision

• General enquiries

• Invoice requests and complaints

• Overdue collections

• Dispute resolution

• Credit limit/ expiry

• Increasing customer awareness for chosen plan

• Outbound sales Broadband/ High speed internet

Fixed / Wireline

• Lead generation • Cross sell/up

• Order and returns

• Information requests

• Logistics coordination • Porting support • Credit vetting

• Account management

• Increase tolling

• High usage management

• Billing

• Billing issues

• Billing issues

• Technical support

• Account administration

• Inbound internal handoff calls

• Process queries for charges

• Welcome calls

• Order input

DTH/ Pay TV

• Billing disputes

• Customer service

• Technical support

• Help desk

• Internal actioning requests


Exhibit 14: Telecom ACVs saw healthy demand uptick 300

275.1

100.8

$ billion

240

268.6

16

149.4

180 120

12 116.7

34.9

8 28.0

60 0

20

4

7

18

13

7

6

4

11

CY07

CY08

CY09

CY10

CY11

CY12

9MCY13

Telecom contracts awarded

0




Page 11

Trimming excess flab, good for margins FSL’s EBITDA margin – which declined to 8.2% in FY12 vs. 14.2% in FY10 and 18% in FY08 – performance was impacted by a variety of reasons including the rise in delinquencies, investments in India operations, decentralised corporate functions and timing of big acquisitions. Note, the credit card collections business, which includes student loans, contributes ~7.5% of revenues and had peak operating margins closer to teens. However, increased job losses and subsequent delinquencies reduced the margin to almost mid single digit. FSL also invested ~| 100 crore during FY07-09 to set up ~14 new delivery centres for its domestic business (90% telecom, 10% FSI). Further, excessive verticalisation led to FSL operating as silos with decentralised corporate functions, leading to duplication of work and costs overruns, in turn, impacting margins. However, under its three year restructuring plan FSL has: 1) optimised facility usage through consolidation – project “revival” launched and detailed subsequently, 2) created a centralised organisational structure, 3) realigned its sales strategy and 4) renegotiated unviable service level agreements (SLA) with its clients.

Chugging along its three year strategy Following the revenue deceleration in FY12 led by internal organisational restructuring and FCCB overhang, FSL put in place a three year strategy of recovery in FY13, revenue and margin stability in FY14E and growth in FY15E. Though constant currency revenues grew 15% YoY in FY13 (25% in reported), in H1FY14E they are up a modest 2% led by telecom (13.4% YoY), healthcare (7.5%) and others (6.3%) while BFSI was soft (-1.5%). However, EBITDA margins improved 140 bps to 11.3% in Q2FY14 vs. 9.9% in FY13 led by costs saving initiatives. FSL’s facility optimisation programme likely saved ~$12 million while letting go non-profitable domestic clients and price hikes through renegotiated SLAs for others added another couple. Discussions suggest the India business is operating at low single digit margins led by the India telecom piece and FSL is aggressively pushing customer and employee rationalisation efforts there. For FY15E, growth could return led by top client mining, demand uptick for customer management services for providers (two-third of healthcare, ~22% of total) and likely improvement in offshoring for the UK BFSI piece. We model reported revenues to grow 7.5%, 8.7% and expect margins to improve 228 bps to 12.2% and 210 bps to 14.3% in FY14E, FY15E, respectively. Exhibit 15: Revenues could grow at 8% CAGR of during FY13-15E

3292.4

3500 2818.5

34.7

2500 2000 1500

1749.4

2055.3

1970.8

30

25.0

20

12.7

1298.8

2255.0

40

%

| crores

3000

50

3028.9

4.3

9.7

7.5

8.7 10

1000

0 FY08

FY09

FY10

FY11 Net Sales

FY12

FY13

FY14E

FY15E

Growth, YoY



Page 12

Exhibit 16: EBITDA margins may improve 438 bps during FY13-15E 470

16 14.2

14.1

13.2

369.5

14.3 14

12.2

350 280.5

290 233.9

289.6

231.1

230

12 %

| crores

410

279.6 9.9

10

8.2 185.1

8

170

6 FY08

FY09

FY10

FY11

FY12

Operating EBITDA

FY13

FY14E

FY15E

EBITDA Margin, %


Sales focus is not just offshoring but a combination of

Sales strategy and function has also been realigned

multi-sourcing models (onshoring, near shoring and

FSL realigned its silo business – independent UK and the US sales operation and a common delivery head in India – into four strategic business units with P&L responsibility while the sales engine was realigned along verticals to better client engagement and satisfaction. Further, the management, in conjunction with the sales force now ensures that deals signed meet a certain predefined margin threshold. Finally, overall cost savings initiatives including sales force realignment led to a 471 bps reduction in the other costs as a percentage of revenue ratio to 19.6% in Q2FY14 vs. 24.3% in FY12.

offshoring) albeit with differential pricing

Market sizing of BPM industry Global BPM sourcing contribution has risen 2 percentage points (pp) as the global organisations aim to rationalise costs, access local market and adopt robust business continuity models. Note, the sourcing market could grow at a CAGR of 10.6% during CY10-CY13E vs. 8.1% for global BPM spends. India’s competitive edge over other emerging nations continues to be driven by its cost efficiencies and talent pool and is reflected in the ~2% improvement in its global sourcing market share to 35.4% in FY12 vs. 33.5% in FY10. Exhibit 17: Sourcing now forms ~30% of BPO spends vs. 28% in CY10

186

200

$ billion

160

CAGR 8%

156

147

164

120 80 40 41

CAGR 11%

45

49

56

CY11

CY12

CY13E

0 CY10

Global BPM sourcing

Global BPM spends

Source: NASSCOM, ICICIdirect.com Research


Page 13

Exhibit 18: India's market share has likely risen to 35.4% in FY12 vs. 33.5% in FY10 50 37

$ billion

40

CAGR 11%

49

45

41

30 20 10

CAGR 13%

12.4

14.2

15.9

17.8

FY11

FY12

FY13E

0 FY10

India BPM exports

Global BPM sourcing


Exhibit 19: Indian BPM exports may grow at 13% CAGR during FY13-20E 42.3

45 CAGR - Exports 13%, Domestic 13%

$ billion

36 27

CAGR - Exports 15%, Domestic 19%

18 9

7.6

12.4

11.7

9.9

15.9

14.2

17.8 7.4

1.1

1.6

1.9

FY07

FY08

FY09

2.3

2.8

3.1

3.1

FY10

FY11

FY12

FY13E

0

India BPM exports

13% FY20E

India BPM domestic


Exhibit 20: FSL’s addressable market across verticals 150

160

$ billion

128 96

CAGR 21% CAGR 26%

80

CAGR 7%

64 32

30 10

16

27

0 Healthcare

Telecom & Media CY11

BFSI

CY20E



Page 14

Indian BPM vendors likely focusing on high-end offerings Nasscom estimates a 10% market share loss for Indian vendors in the last five years but predominantly in the voice segment. This could be viewed as a shift by Indian vendors towards higher value business segments or offshoring shift to other low cost destinations such as Philippines or China. Noticeably, Philippine is facing similar challenges as India, be it high attrition, skill staff scarcity and currency fluctuation. Interestingly, cost/FTE in India continues to be the lowest vs. its contemporaries and suggests efficiency gains achieved by Indian vendors.

83.2 80.1 34.5 25.7 20.4 18.8

84.4 68.7 28.5 25.0 18.6 14.3

85.5 68.6 32.6 25.1 19.7 15.7

89.7 72.2 33.3 27.7 19.0 16.5

89.7 73.1 33.2 29.2 19.7 14.6

100 90 80 70 60 50 40 30 20 10 0

81.9 79.7 38.5 22.7 17.7 17.9

$ thousand

Exhibit 21: India continues to be cost-effective destination

CY07

CY08

CY09

CY10

CY11

CY12

U.S.

U.K.

Mexico

China

Philippines

India


Net debt neutral by FY16E end, plausible Recall that FSL repaid its outstanding FCCB obligation worth $237 million in December 2012 through a combination of working capital loan (US$15 million), external commercial borrowings ($20 million) and capital infusion ($50 million). As of Q2FY14, FSL had debt of ~$177 million vs. $200 million at March 2013 and $22 million cash. At the current repayment rate, FSL would repay $135 million of its debt by FY16E and end with ~$50 million of cash, resulting in a net debt of $12-13 million assuming no accelerated payments. Debt repayment could be supported by healthy FCF generation of | 355 crore and | 409 crore in FY14E, FY15E, respectively. However, back of the envelope EBITDA calculations suggest, possible accelerated repayments if FSL manages to improve the EBITDA to FCF conversion ratio. To illustrate, FSL could generate cumulative EBITDA of ~$230 million between FY14 and FY16E and could be adequate to repay entire debt ($200 million) along with interest ($27-28 million) assuming average 85% EBTIDA conversion to FCF vs. 57% in FY13.


Page 15

Exhibit 22: FCCB repayment schedule Internal cash accruals | 810 crore ($150 million)

Issue fresh equity

Repayment of FCCB

Raise new ECB loan

| 275 crore ($50 million)



Working capital adjustment |81 crore ($15 million)


Exhibit 23: Debt repayment to be supported by healthy FCF generation 480

409.0

420

355.0

360 | crores

300 202.6

240 180 120

159.7

115.1 -46.9

60 0 -60 FY10

FY11

FY12

FY13

FY14E

FY15E

Free Cash Flow


Exhibit 24: Net debt neutral, plausible by FY16E 200

200 155

$ million

160 120

110

183 134

80

76

40 0

17

21

34

FY13

FY14E

FY15E

Outstanding Cash

65 12 53 FY16E

Net debt



Page 16

Key Financials Modelling FY14E, FY15E revenues to grow 7.5%, 8.7%, respectively We expect FY14E and FY15E rupee revenues to grow 7.5% and 8.7% YoY to | 3,029 crore and | 3,292 crore, respectively. Growth would be driven by top client mining, demand uptick for customer management services for providers and likely improvement in offshoring for UK BFSI piece. Exhibit 25: Revenues may grow at 8% CAGR during FY12-15E

3292.4

3500 2818.5

34.7

2500 2000 1500

1749.4

2055.3

1970.8

30

25.0

20

12.7

1298.8

2255.0

40

%

| crores

3000

50

3028.9

4.3

9.7

7.5

8.7 10

1000

0 FY08

FY09

FY10

FY11 Net Sales

FY12

FY13

FY14E

FY15E

Growth, YoY

[


Modelling average 13.3% EBITDA margins in FY14E, FY15E For FY14E, we expect EBITDA margins to improve 228 bps led by 1) cost rationalisation initiatives, 2) reduction in non-profitable clients and 3) price hikes from other existing domestic customers. For FY15E, we expect EBITDA margins to increase 210 bps primarily led by pick-up in healthcare provider business & margins (~100 bps), rupee depreciation, higher overall revenue growth and full year impact of cost optimisation efforts. Exhibit 26: EBITDA margins may improve 228 bps, 210 bps in FY14E, FY15E, respectively 16

470 14.2 13.2

14.1

369.5

14.3 14

12.2

350 280.5

290 233.9 230

289.6

231.1

12 %

| crores

410

279.6 9.9

10

8.2 185.1

8 6

170 FY08

FY09

FY10

FY11

Operating EBITDA

FY12

FY13

FY14E

FY15E

EBITDA Margin, %

[


Modelling average 7.8% PAT margins in FY14E, FY15E We are modelling average PAT margins of 7.8% between FY13 and FY15E (FY08-13 average PAT margins of 5.7%) that translates to a CAGR of 43% during FY13-15E. Improvement in PAT margins could be led by EBITDA margin expansion, lower interest outgo partially offset by rising tax rates. We expect RoEs to improve 371 bps during FY13-15E to 13% vs. 9.3% led by improving profitability.


Page 17

Exhibit 27: PAT margins to improve led by EBITDA margin beat 299.8 10.1

| crores

240 180

6.9 136.1

131.6

9.1 9

195.5

6.7 146.6

138.5

7

6.5

5.2

120

11

%

300

5

62.0 60

30.7

3

2.8 1.8

0 FY08

FY09

1 FY10

FY11

FY12

Operating PAT

FY13

FY14E

FY15E

PAT Margin, %


Exhibit 28: Expect RoE uptick going into FY14E and FY15E 15 13.0

12 9.7

9.7

9.3

10.1

%

9 6 3

4.3 2.2

0 FY09

FY10

FY11

FY12

FY13

FY14E

FY15E

RoE


Balance sheet health improving At Q2FY14 end, cash balance stood at | 150 crore vs. | 687 crore in Q2FY13, as FSL repaid the outstanding FCCB. Receivables (13.5% CAGR during FY08-13) have grown slower than revenue (16.8%) while unbilled has grown faster (27.8%). Days sales outstanding (DSO) have improved to 44 days in Q2FY14 vs. 54 in Q1FY12. Generally, balance sheet metric has improved. We expect FSL to end FY15E with cash balance in the range of ~$28-34 million.


Page 18

Exhibit 29: FCCB repayment drives cash balance lower 682.9

700

| crores

560 420

324.4

280 140

102.5

96.7

121.8

FY08

FY09

FY10

166.6 90.1

91.1

FY13

FY14E

0 FY11

FY12

FY15E

Cash


Exhibit 30: Receivables have grown slower than revenue growth 386.6 351.5 47.1

| crores

360

240

40

34.7

320 280

60

15.9 237.9

261.112.7 9.7

25.0

9.7

4.3 238.9

20

10.0 -8.5

200 FY09

FY10

FY11

Accounts Receivables

0 -20

FY12

A/R growth, YoY

%

400

FY13 Net Sales growth, YoY


Exhibit 31: While unbilled have grown faster…

| crores

120 90 60

67.3

31.0 25.0

30

FY10

Unbilled revenues

24 12

4.3

11.2

0

36

9.7

12.7

FY09

48

104.2

103.7 34.7 60.5

60

136.4

54.0

51.2

%

150

FY11 Unbilled growth, YoY

0.5 FY12

0 FY13

Net Sales growth, YoY



Page 19

Exhibit 32: DSO improvements likely driven by client rationalisation efforts 54

55

51

52 48

49

52

48

48

47

49

49 46

46

46

44

43 40 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 FY14E FY15E DSO


Scope for improvement in CFO/EBITDA The CFO/EBITDA conversion is significantly lower than its global peers and suggests significant room for improvement. Exhibit 33: CFO to EBITDA conversion may improve CFO/EBITDA

CY11

CY12

CY13E

EXL Services

87.4

79.4

NA

NA

Genpact Solutions

90.5

83.4

62.2

69.0

107.2

84.5

91.4

86.2

95.0

82.4

76.8

77.6

FY12

FY13

FY14E

FY15E

81.6

47.9

NA

NA

3.1

71.3

104.2

93.2

WNS Global Average

Hinduja Global Firstsource Solutions

CY14E

Source: Bloomberg estimates, Company, ICICIdirect.com Research

Exhibit 34: Higher EBITDA to FCF conversion, including lower capex, may aid debt repayment FCF/EBITDA

CY11

CY12

CY13E

EXL Services

57.2

56.7

NA

NA

Genpact Solutions

78.3

59.1

48.7

51.9

WNS Global

77.5

56.9

68.7

60.9

Average

71.0

57.6

58.7

56.4 FY15E


CY14E

FY12

FY13

FY14E

(183.6)

(7.4)

NA

NA

(25.4)

57.1

96.1

86.9



Page 20

Valuations Apart from macro headwinds, FSL was impacted by a variety of reasons including acquisition timing, FCCBs and India expansion for telecom clients. However, we are enthused by the considerable success demonstrated by the new management with its three-year restructuring strategy. At current levels, on the EV/revenue metric, the stock is trading at 0.8x and 0.7x its FY14E and FY15E sales, respectively, lower than global peer average of 1.9x and 1.7x but higher than its domestic peer HGS. On EV/EBITDA metric, FSL is trading at 6.4x and 5.0x its FY14E and FY15E EBITDA, also lower than its global peer group average of 9.7x and 8.9x, and higher than 3.5x and 3.2x for HGS, respectively. That said, on P/E metric, FSL is trading at 7.4x and 4.8x its FY14E and FY15E earnings, significantly lower than its global peers (14.7x and 13.9x) and in line/below HGS at 6.8x and 5.9x, respectively). Though the significant discount to global peers was warranted given debt overhang, earnings & margin deceleration, we expect the discount to narrow given the new management has laid the foundation of the rebuilding exercise with likely pay-offs over the longer term. The company plans to 1) repay its outstanding debt through operating cash flows, 2) focus on margin expansion in FY14E and 3) accelerate growth in FY15E. Hence, we believe a likely re-rating is possible as debt repayment alone could translate to Mcap gains even if the enterprise value were to remain the same. We are initiating coverage on the stock with a BUY rating and a target price of | 29. Exhibit 35: Current enterprise value break-up

Net Debt, | 910 crores

Exhibit 36: Likely FY16E enterprise value break up

Potential market cap gain, | 772 crores

39%

61%

61%

Market Cap, | 1447 crores

Market Cap, | 1447 crores

7% Net Debt, | 165 crores

Source: ICICIdirect.com, Research

Source: Company, ICICIdirect.com, Research At current levels, FSL is trading at 7.4x and 4.8x our FY14E

Exhibit 37: One year forward PE(x) chart

and FY15E diluted EPS estimate of | 2.9 and | 4.5,

50

respectively

40

|

30 20 10

Price

11

9

7

5

Sep-13

May-13

Jan-13

Sep-12

May-12

Jan-12

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

0

3



Page 21

Exhibit 38: 60% discount to global peer group average on EV/revenue metric appears unjustified EV/ Revenue

CY11

CY12

CY13E

CY14E

EXL Services

1.8

1.4

1.4

1.3

Genpact Solutions

2.7

2.3

2.0

1.8

WNS Global

2.2

2.2

2.2

1.9

Average

2.2

2.0

1.9

1.7

FY12

FY13

FY14E

FY15E

Hinduja Global

0.6

0.5

0.4

0.4

Firstsource Solutions

1.0

0.8

0.8

0.7

CY14E


Exhibit 39: …and 25% on EV/EBITDA metric too EV/EBITDA

CY11

CY12

CY13E

EXL Services

10.0

7.7

7.0

6.9

Genpact Solutions

14.8

12.7

11.5

10.4

WNS Global

14.3

13.3

10.8

9.4

Average

13.0

11.3

9.7

8.9

FY12

FY13

FY14E

FY15E

5.0

3.6

3.5

3.2

12.7

8.4

6.4

5.0



Exhibit 40: FSL cheaper than HGS on P/E metric Mcap/Profit

CY11

CY12

CY13E

CY14E

EXL Services

22.4

18.6

13.2

13.4

Genpact Solutions

21.9

22.7

16.1

15.4

WNS Global

82.7

48.4

14.8

13.1

Average

42.3

29.9

14.7

13.9

FY12

FY13

FY14E

FY15E

8.2

9.7

6.8

5.9

23.3

9.9

7.4

4.8



We value the stock at 5x FY15E EV/EBITDA multiple. Our

Exhibit 41: EV/EBITDA trend

target multiple implies 44% discount to global peer group average and 34% discount to its five-year historical (FY08-

4000

13) average multiple of 7.6x. The discount is warranted,

3200

despite the debt repayment roadmap, as revenue growth and are inferior relative to peers

2400 |

and margins have moderated relative to historical average

1600 800

EV

11

9

7

5

Sep-13

May-13

Jan-13

Sep-12

May-12

Jan-12

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

0

3



Page 22

Risk & concerns BPO units of IT firms growing faster than standalone BPO firms BPO units of top Indian IT companies grew twice as fast as standalone BPO firms in the last few years and reflect the growing demand for bundled services or integrated offerings. The healthier balance sheet of domestic tier-I vendors, their ability to invest in platforms and ability to offer integrated services could translate into market share gains against traditional BPO vendors. Exhibit 42: Revenue of pure-play BPO companies Revenue ($ million)

CY09

CY10

CY11

CY12

191.0

252.8

360.5

442.9

1,120.1

1,259.0

1,600.4

1,902.0

582.5

616.3

474.1

460.3

EXL Services Genpact Solutions WNS Global (| crores)

FY10

FY11

FY12

FY13

Hinduja Global

892.3

1,073.2

1,554.3

1,983.4

1,970.8

2,011.0

2,254.9

2,844.0


Source: Bloomberg, Company, ICICIdirect.com Research

Exhibit 43: BPO revenues of tier-I companies Revenue (| crores)

FY10

FY11

FY12

FY13

TCS

3,471.9

4,216.2

5,384.2

7,865.8

Infosys

1,391.8

1,471.2

1,760.3

2,570.0

Wipro

2,147.9

2,279.1

2,470.6

2,936.1

995.6

883.1

960.9

1,127.8

HCL Tech

Source: ICICIdirect.com Research

Exhibit 44: BPO units of IT companies growing faster than traditional BPO companies Revenue growth, YoY

CY09

CY10

CY11

EXL Services

5.1

32.3

42.6

CY12 22.9

Genpact Solutions

7.6

12.4

27.1

18.8

WNS Global

8.0

5.8

(23.1)

(2.9)

Average

6.9

16.8

15.6

12.9 FY13

FY10

FY11

FY12

Hinduja Global

11.9

20.3

44.8

27.6


12.7

2.0

12.1

26.1

Source: Bloomberg, Company, ICICIdirect.com Research

Exhibit 45: Tier-I BPO growth likely driven by bundled transformational deals Revenue growth, YoY

FY10

FY11

FY12

FY13

TCS

74.7

21.4

27.7

46.1

Infosys

7.0

5.7

19.7

46.0

Wipro

19.8

6.1

8.4

18.8

HCL Tech

(12.5)

(11.3)

8.8

17.4

Average

22.2

5.5

16.1

32.1

Source: ICICIdirect.com Research


Page 23

Offshoring of ObamaCare related spends may be lower than thought The rollout of ObamaCare has been plagued by problems and could result in delayed spending. Further, breakdown of its main website, Healthcare.gov has already raised concerns over the implementation of the Bill. Finally, offshoring related concerns could result in lower participation by non-US companies in Government IT contracts. That said, FSL’s provider business delivery is 100% from the US.

Attrition continues to be concern Domestic and offshore attrition have risen to 85.6% and 57.3% in Q2FY14 vs. 56.8% and 35.8% in FY09, respectively, led in part by employee rationalisation. Higher attrition continues to be a key concern given it raises employee acquisition and retention cost, which, in turn, impacts margins.

Rupee appreciation may be key margin headwind The rupee has depreciated 14.4% YTD, thus creating margin tailwinds while a significant appreciation could create headwinds. However, 67% onshore delivery ensures a natural hedge to currency fluctuations.

Miss on quarterly debt repayment may jeopardise investor trust Though FSL has a debt repayment roadmap, any miss on the same for unforeseen reasons could jeopardise investor trust and may have repercussions on our estimates and valuation.

Next 12 month hedges reflect lower f/x gains The company has booked forward contracts of $27 million at | 60, ₤46 million at | 94 and AU$5 million at | 59 for the next 12 months. FSL could incur lower f/x gains or f/x losses were the rupee to stay at current levels or depreciate further.

Goodwill impairment, if any, may create P&L headwinds As of Q2FY14, FSL had a goodwill of | 2707 crore largely related to the acquisitions. Impairment, if any, could create P&L headwinds though noncash in nature.


Page 24

Tables and ratios Exhibit 46: Profit & loss account (| crores)

FY11

FY12

FY13

FY14E

FY15E

Total Revenues

2,055

2,255

2,819

3,029

3,292

4.3

9.7

25.0

7.5

8.7

1,766

2,070

2,539

2,659

2,822

290 3.2

185 (36.1)

280 51.0

370 32.2

471 27.4

Growth (%) Total Operating Expenditure EBITDA Growth (%) Depreciation & Amortization

89

89

88

76

83

Other Income Interest

(4) 21

(12) 8

(12) 20

1 80

1 60

PBT before Exceptional Items

175

76

159

214

329

Growth (%)

9.4

(56.7)

109.5

34.7

53.5

Tax PAT before Exceptional Items

35 140

14 62

13 146

19 195

30 300

Exeptional items PAT before MI Minority Int & Pft. from associates

-

-

-

-

-

140

62

146

195

300

2

0

(0)

(0)

(0)

PAT

139

62

147

195

300

Growth (%)

1.8

(55.2)

136.3

33.4

53.4

EPS

2.9

1.4

2.8

2.9

4.5

EPS (Growth %)

2.8

(50.6)

97.2

3.0

53.4

FY15E

Source: Company, ICICIdirect.com Research,

Exhibit 47: Balance sheet (| crores)

FY11

FY12

FY13

FY14E

Equity

431

431

658

658

658

Reserves & Surplus

992

999

1,056

1,492

1,792

Networth

1,423

1,430

1,714

2,150

2,450

Minority Interest Long term Liabilties & provisions

0 1,500

1 1,004

1 934

1 765

1 491

Source of funds

2,923

2,435

2,648

2,916

2,941

Net fixed assets Goodwill

228 2,045

196 2,311

156 2,360

110 2,707

57 2,707

118

162

181

181

181

Loans and advances

Other non current assets

38

37

35

41

44

Current Investments Debtors

132 239

78 351

387

379

415

Cash & Cash equivalents

324

683

90

91

167

Other current assets

118

114

142

176

198

Current liabilities

299

1,468

695

757

815

21

29

9

12

13

2,923

2,435

2,648

2,916

2,941

Provisions Application of funds



Page 25

Exhibit 48: Cash flow statement (| crores)

FY11

FY12

FY13

FY14E

FY15E

175

76

159

214

329

Depreciation & Amortization

89

89

88

76

83

WC changes

(0)

(58)

(72)

34

(3)

Other non cash adju. CF from operations

33 246

(57) 6

43 199

79 385

59 439

Capital expenditure

(43)

(53)

(40)

(30)

(30)

Δ in investments Other investing cash flow

(23) 6

63 (486)

85 538

-

1

1

CF from investing Activities

(29)

Net profit before Tax

(60)

(476)

583

(29)

Issue of equity

2

0

266

-

-

Δ in debt funds Dividends paid

42 -

370 -

(1,081) -

(275) -

(275) -

Other financing cash flow

(27)

(37)

(66)

(80)

(60)

CF from Financial Activities

17

333

-881

-355

-335

Δ in cash and cash bank balance

203

(137)

(99)

1

75

Effect of exchange rate changes

-

-

-

-

-

Opening cash

122

324

187

89

91

Closing cash

324

187

89

91

167

FY12 and FY13 closing cash excludes investments, Source: Company, ICICIdirect.com Research

Exhibit 49: Key ratios (Year-end March)

FY11

FY12

FY13

FY14E

FY15E

EPS-diluted

2.9

1.4

2.8

2.9

4.5

Cash per share

4.8

2.8

1.3

1.4

2.5

21.2 3.0

21.3 1.4

25.6 2.9

32.1 4.4

36.6 5.8

14.1 8.5

8.2 3.4

9.9 5.6

12.2 7.1

14.3 10.0

6.7

2.8

5.2

6.5

9.1

RoNW RoCE

9.7 7.0

4.3 3.6

9.3 7.5

10.1 10.5

13.0 13.3

RoIC

7.8

3.7

8.1

9.6

12.3

Per share data (|)

BV Operating profit per share Operating Ratios (%) EBITDA/Total Revenues PBT/Total Revenues PAT/ Total Revenues Return Ratios (%)

Valuation Ratios (x) P/E

7.4

15.0

7.6

7.4

4.8

EV / EBITDA

8.1

12.7

8.4

6.4

5.0

Price to Book Value

1.0

1.0

0.8

0.7

0.6

EV/Total Revenues

1.1

1.0

0.8

0.8

0.7

MCap/Total Revenues

0.7

0.6

0.5

0.5

0.4

Total Revenues/ Equity Turnover Ratios

1.4

1.6

1.6

1.4

1.3

Debtor days

42

57

50

46

46

Creditors days

27

29

18

19

20

1.0 2.7

0.7 0.8

0.6 0.9

0.4 0.9

0.2 1.0

Solvency Ratios Total Debt / Equity Current Ratio Quick Ratio

2.7

0.8

0.9

0.9

1.0

Debt / EBITDA

5.0

5.2

3.6

2.3

1.2



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RATING RATIONALE

ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: > 10%/ 15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more;

Pankaj Pandey

Head – Research

[email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No. 7, MIDC, Andheri (East) Mumbai – 400 093 [email protected] ANALYST CERTIFICATION We /I, Abhishek Shindadkar MBA, Hardik Varma MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

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