Increased M&A activity in BPO

While 2008 was a great year for mergers and acquisitions (M&As) within the Indian BPO industry (the industry witnessed 13 M&As including Citigroup Global Services’ acquisition by TCS for $505 million, Quattro’ takeover of RSM McGladrey and Babel Media for $50 million & $125 million respectively, WNS buying Aviva Global Service for $230 million, et al), uncertain economic conditions across the globe perhaps forced several companies to hold on to their cash last year (M&A activity within the industry reduced by 55% in 2009). But the year still saw players like EXL Service Holdings acquiring Schneider National (for $40 million), Cognizant buying UBS BPO Unit (for $75 million), EXL Service Holdings purchasing Am-Ex Travel Services Captive India for $30 million and Infosys BPO taking over McCamish Systems for $38 million.

FY2010 has just started and players like Genpact and Aegis have already announced one acquisition each. While Aegis, the back office company promoted by the Essar Group, has agreed to acquire US-based education and financial service provider Sallie Mae’s customer service centre, India’s largest back-office firm Genpact is taking over US-based analytics and data management services provider Symphony Marketing Solutions. CBay Systems India and Avantha Group too have announced the acquisition of Spheris India and US-based Pyramid Healthcare Solutions respectively. So what is it that has prompted Indian BPO players to go in for the M&A option, one that comes with a huge amount of operational and value destruction risk?

The expectably positive sounding Nasscom-McKinsey report has projected the BPO space to be a $360 billion market opportunity across the globe by 2020. This is one reason why the industry continues to remain a favourite with VC & PE players who accounted for almost over 20% of all deals in 2009. Not to forget, their total investment portfolio for this industry has grown 16 times in the past eight years, at a CAGR of 42%. Even in a year weakened by recession, there has been no let-up in their interest in the BPO sector in India, with a 9% increase in total investment portfolio over 2008. And with the overall global economy recovering in 2010, that concentration is only poised to augment further.

Another thing which has prompted the shift is the fact that the Indian BPO sector has evolved significantly over the last decade, and has matured beyond the pioneer phase to enter the ‘emerging rapid growth’ phase. Players in the BPO industry can now be seen foraying into areas such as business analytics, knowledge-based services apart from transforming clients businesses through a mix of re-engineering skills, technology enabled platforms, new operating models and increased depth of services.

But then there are contrarians who feel that these M&As have nothing to add on to the growth story of Indian BPOs. As per them, it’s actually a fight for survival. Though, at present there are over 110 BPO captives operating out of India, the number is expected to reduce to just half in the next five years. “M&As in the BPO industry, particularly in the voice vertical, are an outcome of the US sub-prime mortgage crisis. It’s the crisis that has made the survival of small players really hard. These players are now allowing bigger players to acquire them as they can no more take the pressure on their balance sheets,” says Anuj Gupta, Angel Trade.

Further, there are many who feel that with time India has lost its price competitiveness that tempted multinationals to offshore their business to India. While Indian BPOs could complete an assignment at one-tenth of the compensation a few years ago as compared to their US counterparts, the difference today is becoming marginal year by year. The major contributor to this rising cost has been the wage inflation, which was hovering over 8% in 2009 and is expected to touch 10.9% by the end of 2010. “With time, India’s price advantage has diminished; it now needs to find a niche and to reinvent the business models, services and enabling technologies,” says Vishal Deep Dhillon, Regional Director-Asia, CSC, to B&E.

That countries like China, Vietnam and Philippines too are emerging as a big threat to India’s dominance in global offshoring industry, is actually old news. But now, as Gartner analyst Diptarup Chakraborty tells B&E, “Destinations like Philippines, Israel are almost coming neck-to-neck with India as they are offering cheaper rates to the outsourcers.” Then there is the slated withdrawal of STPI scheme in FY2011. The sunset clause u/s 10A and 10B of the Income Tax Act gives a tax holiday to IT-BPO companies operating under an STPI, where the tax rate works out to be 20% for a BPO at present. This is expected to go up to 33% if the scheme is withdrawn.

Considering the fact that there have been many domestic entrepreneurial ventures, not particularly backed by large scale IT organisations, that ventured into setting up BPO outfits in an attempt to become bigger simply on the basis of the boom that was, in case the government withdraws tax-holiday sops or increases the tax rates, that surely would put these newbie BPOs on the selloff block, if not immediately bankruptcy. Worse would be the case with Indian BPOs that, hoping for a sudden revival in the US economy (which accounts for clost to 60% of all global BPO projects), have attempted to invest in buying out American BPO units to leverage their physical US presence to get more BPO projects. Deeply submerged on loans and funding from financial institutions, such BPOs will have no option but to themselves be sold off to large scale buyers.

The lessons from all this is that it is inevitable that M&As in the Indian BPO sector would continue to rise; but what would also happen is that the likes of CSC, Infosys, Convergys, Accenture, Genpact, would only go on to become much larger entities than they are now.