Firstsource buy to be a drag on CESC, believe analysts

Say buy will strain CESC's balance sheet as well as future growth prospects

Power and retail giant CESC plans to acquire about 49.5% stake in BPO firm Firstsource Solutions for Rs 400 crore and garner another 26% stake via open offer. The total acquisition cost will be about Rs 650 crore (assuming the open offer is fully subscribed). CESC will fund 30% of the deal value from internal sources and take debt for the remaining 70%. The open offer will take place at a price of Rs 12.20 per share.

While the deal will partly reduce Firstsource's debt, it will strain CESC's balance sheet as well as future growth prospects, believe analysts. Not surprisingly, both CESC and Firstsource were down by 14% and 10% respectively in the morning trade, as against Sensex's loss of 0.50%.

Out of the total proceeds, about Rs 280-290 crore will be utilised towards repayment of Firstsource's outstanding FCCBs. The BPO firm has a cash balance of Rs 680 crore and outstanding FCCB of Rs 1,140 crore and is likely to repay about Rs 1,030 of the FCCBs post this deal.

Even then, the company will be left with net debt of 1,200-1,400 crore, which will impact its margins going forward.

Experts believe the deal valuations are not cheap.

"The deal is valued at Enterprise Value (EV) of Rs 1,900 crore, implying EV/EBITDA of 10.4 times which is at a marginal discount to current EV/EBITDA multiples of peers such as Genpact (11.5 times EV/EBITDA) which operate at an EBITDA margin of 20%. Given the general trend in clubbing IT and BPO together, competitive environment for standalone BPO firms remains tough", believe Amit Rustagi and Rahul Modi of Antique Stock Broking.

Analysts remain skeptical about the benefits of this deal to CESC. The deal will entail an immediate outgo of Rs 640-650 crore for the company, which is almost 3/4th of the company's standalone cash. This will make it resort to additional borrowings to invest in Haldia and Chandrapur expansions. Further, most analysts view this unrelated diversification as totally unnecessary. Also Firstsource has been struggling since the past three years and is operating in the voice BPO business - which is a low-margin business. The company has been struggling to grow in the face of aggressive competition from Philippines-based BPO companies as well as low scalability of its business.

Most analysts have downgraded CESC stock to sell post this deal.

"We Downgrade CESC to Sell from buy as this acquisition is unrelated; past track record of unrelated retail diversification has been poor; and though the BPO business should not guzzle cash like the retail business it could lead to higher leverage in the power business as it has its own needs. We cut target price to Rs 300 (Rs 345 earlier) as we cut target Price/Book Value to 0.85 times (from 1.0 times)", believe Venkatesh Balasubramaniam and Atul Tiwari of Citigroup.