eClerx Services: Avoid

Investors can give the initial public offering of eClerx Services a miss, considering uncertainties surrounding the macro environment for this business and key business risks. eClerx is a knowledge process outsourcing (KPO) company that provides services to clients in the manufacturing, retail and financial services space. At Rs 315 (upper end of price band) the offer price values the company at over 18 times its annualised current year earnings on the post-offer equity base. This appears a bit stiff, especially in the IT/ITES space, where most players command low double-digit valuations.
Client and service spread

For retail and manufacturing clients, eClerx offers product price benchmarking, analysis of customer feedback on products and catalogue analysis under the data analytics services umbrella. It also develops technical content for clients’ Web sites, Web stores and product brochures.

For financial services clients, eClerx has a more elaborate portfolio of services catering to the investment banking, capital markets and asset management divisions of financial companies.

sThis includes portfolio matching, reconciliation of financial data, analysis of price fluctuation of asset classes, and so on.

In terms of service offerings, the major portion of the company’s offerings (except certain data analytics services) cannot be termed as high-end back-office services. But the company works predominantly on multi-year deals which may provide more stable long-term revenue streams.
Financials

Not being a voice-based player has been a plus for the company and it has managed to capitalise on a strong wave of outsourcing from the US over the last five years. The company’s revenues have grown at a compounded annual growth rate of 58 per cent between 2004 and 2007 and its profits after tax at 131 per cent during the same period.

But operating profit and net profit margins have been falling steadily over the past couple of years, with an actual decline in net profit in the first six months of this fiscal. This decline may be explained by steep increases in employee costs and a spike in general administrative expenses for its US and UK subsidiaries.
Risks and Concerns

Competition risks: Increasingly, outsourcing deals from the US and elsewhere are awarded on a multi-service basis which includes a KPO/BPO component. Top-tier and even some second-tier players are able to cater to multiple requirements.

This takes away a chunk of business from pure KPO or BPO players. This apart, in the segments where eClerx operates, players such as Office Tiger, Genpact, WNS and Firstsource are more integrated, with strong parental backing and deep pockets. This may not be the case with eClerx.

US slowdown concerns: eClerx has significant presence in the financial services apace. Also, it derives over 73 per cent of its revenues from clients in the US. With the sub-prime lending issue affecting top financial services players such as Citibank, Merrill Lynch, and HSBC, a clear picture on the enormity or otherwise of the sub-prime problem is awaited. Concerns about whether outsourcing contracts to IT/ITES will continue, and at what levels, may be clear only over the next several months.

The possibility of a US slowdown, which has been reinforced by recent economic data, is also a concern. The company is trying to diversify geographically, but may take time to broad-base its revenues from the current levels. The appreciating rupee may also affect margins.

The company derives over 85 per cent of its revenues from its top five clients, making for a fairly concentrated profile. The employee expenses are going up steadily and, if sustained, could hurt margins in the long run. Employee costs stood at 34 per cent of the revenues for the half year. Attrition at 37 per cent, though not unusual for ITES players, is also an execution risk.

Offer details: The company plans to raise Rs 101 crore from this issue, in the price band Rs 270-315.