IPO Analysis: Genpact Offer Price Extremely High

Jul.31.07 | About: Genpact Limited (G)

Genpact (NYSE:G) is primarily a business process management company, providing business process outsourcing [BPO] and software implementation solutions to its clients worldwide. It began in 1997 as the India-based captive business process services operation for General Electric Capital Corporation, or GE Capital, GE’s financial services business, and became an independent company at the beginning of 2005.

Prior to December 30, 2004, the business of the Company was conducted through various entities and divisions of the General Electric Company (‘‘GE’’). In ‘‘2004 Reorganization’’ when company's all operations brought under single entity, the valuation of company was determined at $779,859,000 which include $485,234,000 as Goodwill. And if this offering got through the valuation of company will comes out at nearly $3,508,894,979.

Company earns most of its revenue from offshore BPO solutions, with operations in India contribute nearly 80% of total revenue.

To date, the company has 26,731 employees and 27 delivery centers in various parts of world:

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Business/Company Outlook

In the offshore BPO business, the companies in developed countries with high labour cost shift some or most of their business processes like data entry, inquiry handling, documentation, tele marketing, customer care help lines, data analysis etc (which can be done and deliver through electronic medium) to other countries with cheap & skilled labour.

The mail reason behind the evolution of offshore BPO business is the cost advantage due to availably of cheap and skilled labour in various developing countries. With time, this cost advantage has been reduced to some extent due to rising economic conditions that has lead to hefty pay rises in developing countries.

Moreover, recent declines in the dollar puts extra pressure on margins of these offshore BPO companies that are already working with thin margins. As most of these companies earn in dollars but spend in local currency, every 1% decline in the dollar can easily hit the company's margins by 0.5%. The effect of this exchange difference is not fully evident as of yet due to currency hedge done by most of the companies, but as we go forward if the dollar doesn't rise, the effect will be much more evident and hard on offshore BPO companies.

The industry in dollar terms will keep growing with time, but if dollar stay at these levels, the advantage of offshore BPO business will be decline.

All in all, the future of offshore BPO depends on economic advantage it can deliver as compare to onsite and in-house business process units, which currently is on decline.

With long-term big deals in hand, Genpact's revenue is expected to rise in the future, but due to geographic mix of its earning and spending, margins remain uncertain.

Financials ($ in million)

Company's financial year ends on December 31.

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Company has shown revenue growth of nearly 25% and 33% in FY 2006 and Q1FY2007 as compared to corresponding periods last year.

Cash flows can just satisfy its current needs.

Cash on books is low and can't support any big acquisition.

Valuation/Offer value ($ In million)

(Company may not be able to perform this well - chances of company performing this well: 40%)

Assuming that nothing negative happens with the company and it performs exceptionally well and without considering effect of declining dollar:

1. 25% rise in revenue year on year in FY 2007 and FY 2008 from $631 million in FY 2006 to $766 million in FY 2007 and $958 million in FY 2008.

2. Gross margins rise by 1% to 42%

3. Net margins rise by 3% to 10%

This leaves the company with operating profit of $77 million and $96 million in FY 2007 and FY 2008 respectively and after detecting interest cost of nearly $12 and $15 and income tax cost of $8 & $9, this leave company with net profit of $57 million and $73 million, that is EPS of $ 0.28 and $ 0.35 for FY 07 and FY 08 respectively.

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This means that even if the company performs exceptionally well, at an offer price of $17 the company's share is selling at one year forward PE of nearly 61 and two year forward PE of nearly 49.

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We rate this IPO 1- on scale of "1 to 5" (5 is best)

Negatives

* Offer price is extremely high.
* High dependence on one client i.e. GE.
* Currently company enjoy tax benefits for majority of its operations although by March 31 2009 profit from all of its current delivery centers in India, from which company derived 66% of its revenues in 2006 will be charged income tax @33.6%. Also in China the rate of income tax applicable on company's business is expected to rise by 10% from 15% to 25%.
* Dollar has shown steep decline against other currencies. Due to geographical mix of company's business this decline can hit company very hard.
* Competition is rising in its business and most tough competition is expected to come from software development companies which increasingly offering their existing clients with supplement BPO services.
* Cash flows can just fulfill its current needs.
* Due to high number of employees in BPO industry the dilution of equity capital due to employ stock options plan is much higher in BPO industry than in other industries.
* Cash in company's books is low and can't support any big acquisition, which is a major way of growth in BPO industry. Company has to raise extra debt for any big acquisition.
* In ‘2004 Reorganization, when company's all operations brought under single entity, the valuation of company was determined at $779,859,000 which include $485,234,000 as Goodwill. And now after nearly two and haft years the owners sees company's valuations at $3,508,894,979. Despite the fact that the company's profit has declined since than (due to amortization of intangibles), so as its future outlook.
* In 2004 Reorganization, company was valued at:

Nearly 4.7 times its gross profit
And if one uses the same basis, the company's present valuations will comes out at nearly $1188 million that is $5.8 per share.

Nearly 1.8 times its revenue
And if one uses the same basis, the company's present valuations will comes out at nearly $1115 million that is $5.4 per share.

Nearly 9.5 times its operating profit
And if one uses the same basis, the company's present valuations will comes out at nearly $412 million that is $2.0 per share.

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Positives

* Long-term contract with GE
* Global presence
* Rich in experience
* Deep insight in various industries like banking and financial services, insurance, manufacturing, transportation and healthcare.
* Global delivery model.