Sunday, 5 October 2008

Xchanging to take control of Indian partner

(By Anthony Miller). In an ironic counterpoint to the recent “Indian buys Brit” brouhaha, “our very own” UK-based, international BPO pure-play, Xchanging, is to take a 75% stake in its Bangalore-based, Mumbai-listed IT/BPO services partner, Cambridge Solutions. Cambridge was founded in ’97 as insurance giant Aon’s Indian captive, but went through a number of transformations before listing in ’05 (as Scandent Solutions – see here for more on Cambridge). Xchanging cemented a £230m/10-year BPO deal with Aon in Aug. ’06.

Cambridge’s FY08 revenues (to Mar. ’08) were in the order of £150m (Xchanging’s were £468m in FY07) but its 4-5% operating margins are shy of Xchanging’s 7%, and well below ex-GE captive Genpact (10-11%) though in line with Indian BPO peer WNS (4%). Cambridge gets around 70% of revenues from the US, 17% from Australia, and the balance from Europe and Asia, whereas Xchanging gets 75% from the UK and almost all the rest from Continental Europe.

At an £83m consideration, the deal values Cambridge at c. £110m. Xchanging will put £45m cash down and offer new shares for the balance, diluting shareholders' equity 7%. Xchanging’s market cap. was c. £550m when the markets closed on Friday. Over 60% of Cambridge’s stock is held by its ‘promoters’ (a quaint term generally applied to the founders/principal shareholders of Indian stocks), Scandent Holdings. Aon’s pension scheme owns 16%.

It’s interesting to compare the relative valuations between this deal and the proposed HCL/Axon bid (see see HCL tosses its hat (and £440m) into the ring for Axon). On my back-of-a-fag-packet calculations, Xchanging will be paying about 0.7x FY08 sales and 16x EBIT for Cambridge. HCL, on the other hand, is offering around 2x sales and 13x EBIT for Axon (which enjoys 14% margins). This is a case where the EV/sales multiple is a better measure of the relative valuations than EV/EBIT, given that Cambridge gets over 70% of its revenues from low margin BPO vs Axon getting 100% of its revenues from high value SAP consulting.

In principle, I would be raising a cheer for a deal like this – and I may very likely do so. Most of you will already know my views on the importance of offshore delivery for UK IT/BPO services companies – i.e. “do or die”. But there are a lot of questions I need answers to first (e.g. how much of Cambridge’s revenues derive from Aon, given it claims to service over 2,000 clients). Much (I hope) will be revealed at tomorrow’s briefing and I will report further then.

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