Code of health?

Insight

Firstsource (formerly ICICI onesource), a Rs 840 crore company is engaged in providing business process outsourcing (BPO) services to clients in BFSI, telecommunications, media and healthcare industries, has announced the acquisition of MedAssist Holding, which provides revenue cycle management services in the healthcare space in US for $330 million.

Revenue cycle management services include billing, post-default collections and receivables management services. The stock of Firstsource reacted positively to the news and ended 10% up to Rs 79.40.

MedAssist, a profitable company, enjoys earnings before interest, tax and depreciation margins of 20-22% on reported revenues of $99 million for year ended December 2006. It brings with itself strong management, good service portfolio and a large base of a 1,000 customers.

At present, the healthcare industry in US is estimated to be around $700 billion and administrative costs work out to 14% of that, suggesting that the outsourcing potential for companies like Firstsource in the administrative space itself is an opportunity worth $100 billion.

The acquisition will also provide a scope for Firstsource to expand its reach in US by cross selling its services to MedAssist's clients. The acquisition will be financed by way of debt ($275 million) plus internal accruals. Post acquisition, Firstsource's debt equity ratio will be 1:1, which is on the higher side and is a concern. This may restrict the company from undertaking further acquisitions without diluting its equity.

The acquisition is expected to add $50-55 million to the revenues in FY 2008, equivalent to half year's revenues. The same will provide further boost to revenue growth in 2007-08, which are expected to grow by 50% (excluding MedAssist). Firstsource expects to complete the integration process soon and anticipates that it will be EPS accretive in 2009, which seems difficult unless the company can improve margins of MedAssist and lower the debt-levels (taken for acquiring MedAssist).

Meanwhile, for the quarter ended June 2007 (Q1), like all companies which derive a good portion of their revenues in terms of dollars, Firstsource was affected by dollar depreciation. While the number of clients moved to 75 from 62 a year ago, revenues were down 2% to Rs 290 crore compared to March 2007 quarter. Firstsource's BFSI business performed poorly in Q1 due to seasonality in collections (collections peak in Q4 and then register a drop in Q1).

Positively, net profit was up 27% on a quarter-on-quarter basis to Rs 44.31 crore thanks to forex gains worth Rs 9 crore, excluding which profits would have been flat. At Rs 79.40, the stock trades at 20 times its annualised earnings for 2007-08. Analysts consider the stock attractive in the space.

Gap in logistics

The Logistics space saw two major listings - Gateway Distriparks (GDL) and Allcargo Global Logistics in the last few years. But, over the last one year, the two stocks have performed quite differently-Gateway's stock price has risen by around 16% whereas Allcargo's has appreciated by 26%.

That's quite contrary to their respective performance, at least in terms of margins. GDL consolidated margins have hovered around 45% at the operating level and net profit margins at around 28%. Comparable figures for Allcargo are 6% and 5%, respectively.

A peep into the business models, the recent acquisitions and synergies may explain this gap in performance as well as in valuations.

GDL is India's largest container freight station (CFS) / inland container depot (ICD) operator and the first private sector player in container rail haulage service. It has also acquired Snowman, a cold storage chain operator. GDL's CFS business, which is heavily dependent on Mumbai CFS (contributing over 80% to profits) has stagnated and seen contraction in margins due to rising competition in the JNPT area. Besides, the rail and the cold storage businesses will contribute to the profits in the long run and how long that is, remains anyone's guess. Also, the asset-to-turnover (sales generated for each unit of asset) needs to be monitored here.

Allcargo is primarily a multi-modal transport operator (MTO) offering end-to-end freight service for export/import cargo. The acquisition of ECU Line last year, greatly boosted the company's sales and, it is into non-vessel operating common carriers (NVOCC). This led to significant fall in the Allcargo's consolidated margins to 8.9% (9 months ended December 2006), which prior to the acquisition stood at 21.5% in 2005-06.

However, the company has taken restructuring initiatives like setting up an office in Hong Kong leading to better negotiation power for freight rates with shipping lines, which will improve this situation, Also CFS and ICD expansion plans are on track with land acquisition at 5 locations for rail/road linked ICD's, already done. The business model is more synergistic as freight buying will be done from shipping lines for NVOCC/ MTO services and this in turn will drive import volumes for CFS services.

Allcargo has been extremely proactive, with its investments both in organic and inorganic growth fructifying into revenues. Moreover, it has the scope of low cost scalability as they will move up the value chain with greater contribution from CFS/ICD business. This will get reflected in the form of margin expansion, which at the current high base would be difficult in the case of Gateway.

Clearly, most of the positives appear to have been factored in into the stock prices at present for GDL and it appears to lack triggers in the medium term. For Allcargo, too, while the near-term prospects are reflecting in stock valuations, its prospects do appear promising going forward.

Contributed by Pallavi Pengonda & Devangi Bhuta