Firstsource Solutions -Valuation in favor; Buy - BofA ML

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Firstsource Solutions Ltd.
Valuation in favor; Retain Buy
􀂄 Cut PO on delays in vol ramp; Retain Buy on valn comfort
Q2 operating profits for Firstsource grew 5% qoq (2% ahead of our estimates)
helped by improvement in Asia business unit. However, delays in volume ramp
from existing telecom clients moderate our sharp rev growth expectations for H2.
We cut our FY11-13 earnings estimates by 7-9% to factor the delay and
incorporate sale of Pipal (51% subsidiary). Lower PO to Rs35 at 0.5xEV/EBITDA
to 2-yr growth, implying 10x FY12 adj EPS but retain Buy on valuation comfort.
More deal wins like the recent Barclays deal are critical for sustained
improvement, in our view.
Q2: in-line, modest quarter
Revs grew 3% qoq while EBIT margins expanded 25bps sequentially as Asia
business unit nears breakeven helped by recent win in banking vertical. Co.
signed an agreement to sell its 51% stake in Pipal (a research service provider).
Attrition rates remain high while DSO & unbilled days increased in the quarter due
to client specific situation. This has already been reversed by the company.
Ramp delays in telecom moderate H2 growth trajectory
We moderate our rev growth forecast for H2 over H1 to 8% (vs. 14% earlier) as
vol ramps expected from vendor consolidation in the telecom vertical are delayed.
Normalizing may take up to 2/3 qrtrs. In fact, slow pipeline conversion / transitions
have been reported across BPO sector given short term return focus of clients.
Pipeline adds remain strong
Additions to deal pipeline remains robust with the pipeline having grown in quarter
despite the large deal conversions. Healthcare remains a strong medium term
opportunity for the company on the back of recent healthcare reforms in US. We
think the pipeline in telecom is also attractive but closures remain the key issue.






Valuation in favor; Retain Buy
Q2 operating profits for Firstsource grew 5% qoq (2% ahead of our estimates)
helped by improvement in Asia business unit.
However, delays in volume ramp from existing telecom clients moderate our
sharp rev growth expectations for H2.
We cut our FY11-13 earnings estimates by 7-9% to factor the delay and
incorporate sale of Pipal (51% subsidiary).
Lower PO to Rs35 at 0.5xEV/EBITDA to 2-yr growth, implying 10x FY12 adj EPS
but retain Buy on valuation comfort. Our adjusted EPS imputes interest on FCCB,
given we treat FCCB as debt.
More deal wins like the recent Barclays deal critical for sustained improvement, in
our view.


Delays in vol ramp expected in telecom
􀂄 Revs in telecom were expected to see a sharp pick-up in H2 arising out of
vendor consolidation benefits for Firstsource. This has, however, been
delayed with decisions on consolidation being postponed. We moderate our
rev growth forecast for H2 over H1 to 8% (vs. 14% earlier) as normalizing
may take up to 2/3 qrtrs.
􀂄 In fact, slow pipeline conversion / transitions have been reported across BPO
sector given short term return focus of clients. Recently, sector leader
Genpact cut its CY10 rev guidance from 14-17% growth to 12-13% growth
citing similar concerns.
􀂄 That said, additions to deal pipeline remains robust with the pipeline having
grown in quarter despite the large deal conversions.
􀂄 Healthcare remains a strong medium term opportunity for the company on
the back of recent healthcare reforms in US. Pipeline in telecom is also
attractive but closures remain the key issue.