Acquired health
MedAssist will help Firstsource add to its skills and expand margins.
The key to long-term sustainable growth in the business process outsourcing (BPO) industry is to grow the business either in terms of geographical spread, or in different industry verticals, for instance, banking and financial services (BFSI), healthcare, telecommunications, transport and logistics, and the like.
It is rather easy for a BPO outfit to expand geographically by setting up facilities in different parts of the world on its own. However, the feat that takes enormous effort is to expand into number of industry verticals to which the business serves.
This requires developing a skill-set to the extent of specialisation in the processes concerning the various businesses.
Firstsource Solutions, one of the largest pure play BPO companies of the country, has gobbled up a BPO player in the US in order to expand its footprint in the healthcare vertical of its business.
On August 29, the company announced the acquisition of MedAssist Inc of the US, one of the prominent players in the healthcare outsourcing segment of the industry.
This acquisition will aid the company expand its footprint in the healthcare segment, which was lagging so far, compared to the banking, financial services and insurance, as well as telecommunications verticals, for Firstsource.
The deal
Firstsource paid $330 million (approximately Rs 1,320 crore) in cash for a 100 per cent stake in MedAssist, from RoundTable Healthcare Partners, a private equity firm focused on the healthcare industry.
The fund, which manages $1.1 billion in equity capital, invested in MedAssist in 2004. Founded in 1989, MedAssist is a pan-American player in healthcare revenue management, providing services to hospitals and physician groups.
In 2006, MedAssist clocked $99 million in revenues, thus making the deal worth 3.3 times revenue.
“We have valued the deal at about 12.5 times MedAssist’s estimated 2007 EBITDA (earnings before interest, tax, depreciation and amortisation),” says Rajesh Subramaniam, chief financial officer, Firstsource.
The target business is high in profitability at 22-24 per cent operating profit margins, which is significantly greater than most of its American outsourcing counterparts.
“This is due to the inefficiencies prevailing in the sector in the US,” reasons Ananda Mukerji, managing director and chief executive officer, Firstsource.
“The US healthcare industry amounts to roughly 27 per cent of its gross domestic product (GDP), which translates into an industry size of about $700 billion. The administrative cost for this industry is about 14 per cent, which is around $100 billion,” says Mukerji hinting at the size of the addressable market in the healthcare vertical.
MedAssist is among the top players in the hospital side outsourcing business in the US, with presence in 50 states.
“There are about 5,000 hospitals in the US, of which around 800 are MedAssist’s clients,” claims Farid Kazani, financial controller, Firstsource. It provides eligibility services, receivables management and collection services to hospitals.
The money
To buy MedAssist, Firstsource will raise $275 million by way of debt on the books of the company’s US subsidiary. The rest of the money will come from Firstsource’s cash balances. Firstsource had raised Rs 445 crore in January this year via an initial public offering in order to fund its imminent acquisition drive.
The cost of borrowings is at LIBOR (London interbank offered rate) plus 250-350 basis points. Thus, the interest rate works out to around 7.7-8.7 per cent, or $21.2-$23.9 million a year.
“The deal is likely to have a small impact on the FY08 earnings of Firstsource, while it will be EPS accretive from FY09,” says Kazani.
Dollar doldrums
With the MedAssist acquisition, the contribution from the US to Firstsource top line will increase from 45 per cent to about 55 per cent (See chart: Geography first). This may renew concerns regarding the depreciating dollar and its impact on earnings.
However, Kazani counters this by saying, “Earlier, around 35 per cent of our cost was incurred outside India. Since MedAssist is entirely based in the US, the proportion of cost incurred outside India will rise too.” So far, a 100 basis point (bps) change in the rupee-dollar exchange rates caused about 30 bps change in the net profit margin of Firstsource.
“After the integration of MedAssist, the impact is likely to be muted to the extent of a change of 20-25 bps in the net profit margin owing to the increased size of onsite operations in the US,” adds Kazani.
In its Q1 FY08 results, both the top line and bottom line had remained flat sequentially in spite of the 7 per cent rupee appreciation against the dollar and 5 per cent appreciation vs the pound sequentially.
The company has reiterated its top line growth guidance of 50 per cent for FY08. Over the past four-five years, the company has maintained an excellent track record reporting a consistent top line growth in excess of 50 per cent, y-o-y.
Valuation
Analysts find Firstsource expensive at a price-earning (P/E) ratio of about 20 and 15 times estimated FY08 and FY09 earnings respectively.
ADD IT UP
Rs crore FY07 FY08E FY09E
Revenues 829.80 1445.00 1785.00
Operating profit 178.90 318.00 402.00
OPM (%) 21.60 22.00 22.50
Net profit 97.30 173.40 232.10
NPM (%) 11.70 12.00 13.00
EPS (Rs) 2.30 4.10 5.50
P/E (x) 36.30 20.40 15.00
Its BPO peers such as Allsec Technologies and HOV Services trade at significantly lower P/E ratios. However, investors seem to be offering a premium for the robust management team, strong promoter backing from ICICI and Temasek-owned Aranda Investments, its past track record of accelerating growth at six targets that it acquired in the past, its balanced exposure to the US and the UK, and its much-larger size.
Since investors are worried about the subprime fallout at outsourcing majors, it is important to note that Firstsource does not have any mortgage lending clients in its BFSI segment in the US.
Keeping all this in mind, Firstsource appears to be a good bet from a medium to long term perspective. Conservative investors who are still afraid of the rupee may enter at dips.
