WNS Holdings vs. EXL Services: May the Best Indian BPO Player Win

The other day I got a note from an analyst who was researching the Indian BPO sector and wanted my independent opinion as to which stock is better: WNS Holdings (WNS) or EXL services (EXLS). To be honest I have no inclination towards either of them. You must have seen that in my last post where I branded both of these businesses as "What if your customer wants to buy your business?" The contacts they have with their leading customers give them an option to buy back part of the business that caters to their needs.

But I still gave a second look at both the stocks and came up with following observations.

WNS holdings:

1. The unique part of their business is that they handle the financials of the Auto claims for their client's customers. In other words they pay directly to the auto repair shops, and in turn get the claims amount reimbursed by the clients. Their accounts receivable as of Mar-31/2007 were $41mn. I wonder what what percentage of the account receivables is related to the auto claims?

2. The number of employees has increased from 7,176 in Mar-2005 to 15,084 in Mar-2007. (2.1 times increase).The revenues (less auto repair payments) have increased from $99mn to $219mn. (2.21 times increase). This shows around 10% increase in billing rates.

3. Contract with Aviva - This contract gives Aviva the option to buy back the Pune facility which accounted for 8.3% of revenues, which is $18mn (Less of auto repair payments).

4. The billing rates might go down in future - Refer to the following risk factor stated in the 10-k report:

Some of our client contracts contain provisions which, if triggered, could result in lower future revenue and have an adverse effect on our business. If our clients agree to provide us with a specified volume and scale of business or to provide us with business for a specified minimum duration, we may, in return, agree to include certain provisions in our contracts with such clients which provide for downward revision of our prices under certain circumstances.

For example, certain client contracts provide that if during the term of the contract, we were to offer similar services to any other client on terms and conditions more favorable than those provided in the contract, we would be obliged to offer equally favorable terms and conditions to the client. This may result in lower revenue and profits under these contracts.

Certain other contracts allow a client in certain limited circumstances to request a benchmark study comparing our pricing and performance with that of an agreed list of other service providers for comparable services. Based on the results of the study and depending on the reasons for any unfavorable variance, we may be required to make improvements in the service we provide or to reduce the pricing for services to be performed under the remaining term of the contract. Some of our client contracts provide that during the term of the contract and under specified circumstances, we may not provide similar services to their competitors.

Some of our contracts also provide that, during the term of the contract and for a certain period thereafter ranging from six to 12 months; we may not provide similar services to certain or any of their competitors using the same personnel. These restrictions may hamper our ability to compete for and provide services to other clients in the same industry, which may result in lower future revenue and profitability.

5. Sri Lanka - The Company had an offshore center in Sri Lanka which was transferred to Aviva. Nowhere there is any mention about their tax liability in that country.

6. Capital expenditures: The Company has spent $27.5 mn, $14.9mn and $18.3mn as capital expenditures in last 3 years respectively. Totaling around $60mn.The net addition to the employees during this time has been around 8,000. This means the company is spending around $7.5mn per every increase of 1,000 employees in a 2 year span.

7. Exposure to Mortgage industry - They have developed a proprietary system called Digital Loan Management. This is supported by 500 employees who support more than 30 processes including loan origination, underwriting, closing, post-closing and loan administration services. Their clients have benefited through reduced operational costs and a quicker turnaround time on certain transactions. With the present downturn in mortgage industry, more clients might be planning to use Digital Loan Management to reduce costs.

8. Emerging business not that high paying - This is the segment that deals with all the businesses other than airlines and financials. The total number of employees here were 4,800. This represents 24% of their revenues. but represents 31% of employees (4,800 / 15,084). This means that the billing rates for the emerging business are not as high as that of other businesses.

9. Employee attrition and recruitment: The Company recruits around 1,300 employees every month with around 43% attrition rate.

10. Growth is coming from top 5 clients: The percentage of revenues from top 5 clients was 40% in 2005 and was 55% as of Mar-31/2007. The company in total has 150 clients.

11. Revenue by geographic location: 50% comes from UK, 11.5% comes from Europe other than UK and 36.8% comes from USA.

12. Management structure - Ramesh Shah who is the chairman of board was recently appointed in 2005 and is based in USA, while Neeraj Bhargava who is the group CEO is the co-founder and is based in India. They together hold around 1.4% of the company. In fact it is interesting to note that J.J. Selvadurai (Group CEO) owns more shares of WNS than Neeraj Bhargava. It is also evident that Chairman of the board is not directly interacting with senior management. All that activity is done by CEO. Because according to the definition of roles and responsibilities (page 57 of 10-k report):

In addition, for fiscal 2006 and 2007, the key performance indicators included the following additional performance targets for the following executive officers:

Group Chief Executive Officer — retention of key managers holding a position of Assistant Vice President and above and the successful completion of our initial public offering;

Chairman of the Board — achievement of specified revenue targets in the US

13. Growing working capital: Current assets increased from $57mn in 2006 to $183mn in 2007. Where as current liabilities just increased from $53mn to $63mn.

14. Great increase in Book value: Increased from $78mn in 2006 to $205mn in 2007. Mainly because of $90mn raised by the IPO. Goodwill and other intangible assets contained around $40mn.

15. Increasing margins. The revenues have increased from $162mn in 2005 to $352mn in 2007. But the gross profit increased from $21mn to $81mn. Plus it is also important to note that the SG&A has just increased from $24.8mn to $52.4mn during this time.

What beats me about WNS is the fact that it is able to slash its revenue costs relative to revenue growth when the infrastructure and employee costs are spiraling. The revenues have increased from $162mn in 2005 to $352mn in 2007. But the gross profit increased from $21mn to $81mn. The revenue has increased by 2.17 times. But the gross profit has increased by 3.85 times.

EXL services:

The total employee strength has grown from 1,800 in Dec-2002 to 8,200 by Dec-2006.

2. The Unique aspect of their business is the analytics wing, which came as part of Inductis acquisition.

3. 150 consultants are dedicated to business process risk services and process excellence services. These consultants get the company's foot in the client's door which further helps the company market its BPO services.

4. New location in Noida was supposed to come up by April-2007. This location will have 1,200 seats.

5. The company has 11 sales and marketing folks in USA and 4 in the UK.

6. Norwich Union and Centrica together contribute around 50% of revenues. They have 50 clients in total.

7. The company has a culture of innovation. They have their own proprietary collections software called ECS. They have a process management software called Prompt. This assists managers in process management and performance evaluation, including tracking individual performance of agents, team leaders and other employees, and they use SOFT to implement process-oriented workforce management for client operations.

8. The attrition rate in 2006 was 38.8%.This has come down from 55% in 2005. In 2006 they hired 6,400 resources by interviewing 50,000

9. The company had 185 certified trainers.

10. Norwich Union's option of buying back the Pune facility: Under one of their agreements with Norwich Union, their largest client, Norwich Union has the option from January 2008 through February 2011 to purchase the shares of our subsidiary that operates one of EXLS's facilities in Pune, India, by paying them an amount approximating the net asset value of that facility on the date of transfer. The affected facility generated 18.9% of EXLS's total revenues in 2006 and 26.7% of our total revenues in 2005. Norwich Union has recently exercised its option to assume the operations of the facilities of one of its third party vendor-contractors and has publicly announced its intention to start exercising its option to assume the operations of the facilities of certain of its other third party vendor-contractors, including one of their facilities in Pune.

11. Management has large stake in he company: Vice Chairman Mr. Talwar and certain trusts for his benefit and that of his family collectively owned 2,130,822 shares (or 7.6%) of the outstanding common stock. CFO Mr. Kapoor and certain trusts for his benefit and that of his family collectively beneficially owned 2,143,572 shares (or 7.6%) of the outstanding common stock. And certain other members of the management beneficially owned 1,970,038 shares (or 6.9%) of the outstanding common stock.

Comparison of Financials

EXL
Market cap : $587mn
Book value (tangible assets) $136mn
Market cap / Book value = 4.312006

profit margin = $13.4mn / 121mn = 11.16%

WNS
Market cap : $758mn
Book value (tangible assets) $161mn
Market cap / Book value = 4.702006
profit margin = $26.5mn / $345.2mn = 7.5%

Conclusion: I guess EXL Services has an edge over WNS:

1. EXLS has a research and analytics division that they acquired when they bought Inductis. Plus the company has 150 high end consultants that work on process re-engineering for their clients.

2. EXLS's management has higher stake in the company. The top management team owns about 20% of the company.

3. EXLS has better profit margin and a lower price / book value compared to WNS.

But I would warn you before jumping on buying any stock. EXLS has lot of chances to go down early 2008 when Norwich Union will have the opportunity to buy back a portion of their company. This will reduce EXLS's revenues in 2008.

So if you are really determined to take a plunge in the Indian BPO sector, then it is good to wait for next few months and get a discounted price on EXLS's stock.