Acquiring Growth

The excitement around staffing firm Quess Corp was palpable in 2016, when it announced its intention to list on the bourses. The Bengaluru-based company’s initial public offering (IPO) was oversubscribed 144x — the most successful issue in the past nine years. Even on July 12, 2016, when it made its touched a high of Rs.509 before closing at Rs.503. The stock listed up 59% from its offer price of Rs.317.

Since its stellar debut, the stock has continued its upward movement, reaching a record high of Rs.1,300 on June 13, 2018. The reason for such enthusiasm around one of India’s leading integrated service providers is its exceptional growth in revenue and net profit. These have increased at a CAGR of 44% and 79% respectively between FY13 and FY18. 

Quess has been an outlier because of its inorganic growth strategy — a path few companies dare to tread. The staffing firm has made 23 acquisitions and investments in the past 11 years, gaining around 1,900 clients. 

Despite the company’s inorganic play, its debt-to-equity ratio is just 0.4x. It has been able to keep its debt under control by funding its expansion drive through equity. The company had raised  Rs.4 billion through the IPO route and another Rs.8.74 billion through institutional placement programme (IPP). Some portion of “the cash generated from IPP is still lying with them, which is also a big asset for the company,” says Sumit Pokharna, deputy vice president, Kotak Securities. 

Turnaround Kings

Founded by Ajit Isaac and now promoted by him and Fairfax Financial Holdings through its Indian subsidiary, Thomas Cook India, Quess operates in ten countries — across North America, the Middle East and South East Asia. With employee strength of 284,000, it offers a range of services in staffing, skilling and company infrastructure management.

Quess keeps on offering more services every year, which helps it bag new clients and retain older ones. “This has helped the company grow with clients’ needs and reduce revenue uncertainty associated with the short-term nature of most client contracts,” says Kushal Rughani, research analyst, HDFC Securities. 

The company states that its acquisitions are services focused. On the costing end, Isaac, chairman and managing director, says the company goes for buys that have “minimal asset requirement, and need low maintenance and capex”. On the return end, the buys should have “a minimum internal rate of return (IRR) profile”, which factors in margin, competitive intensity and growth opportunities. 

Analysts say the method Quess follows is pretty simple. It buys small and medium-sized firms such as Monster India at an attractive level, and then scripts a turnaround story. The deal for acquiring Monster’s business arms in India, South-East Asia and the Middle East was executed in January 2018 at a low valuation of 0.6x EV/trailing revenue. Quess managed to bag the Indian arm of one of the leading e-recruitment platforms for $7.5 million and even acquired the firm’s business in South East Asia and the Middle East for $6.5 million. “They discovered that Monster, which was bleeding, was available at a cheap valuation,” says Pokharna.

Isaac says that they are currently streamlining Monster’s systems to optimise the turnaround time of its queries. Post the product revamp, Monster India will focus on building the brand. It also plans on expanding its reach in Tier-2 and - 3 cities, where online penetration is nascent.

The company applied similar investment rationale while acquiring loss-making firms such as Brainhunter, an IT staffing firm in North America  and MFX, a US based systems integrator for insurance companies. Pokharna says, “The management identified the key issues such as high spending on selling and administration, big teams onsite and other operational inefficiencies with Brainhunter and MFX, and fixed them. They optimised costs, tweaked the business model and increased offshoring.”

Rughani states that the company also aligns its acquisitions perfectly with its bouquet of offerings. “A few quarters ago, apart from Monster, the company acquired Conneqt for Rs.1.53 billion. While Monster is a strong brand in e-recruitment, Conneqt helps Quess tap into business process outsourcing (BPO) market,” he says.

Monster and Conneqt join a long list of acquisitions made by the company over the last four quarters: Vedang Cellular Services, which provides services such as network planning and installations; Manipal Integrated Services, a facility management firm; Greenpiece Landscapes India, end-to-end design and landscaping firm; and Digicare, an after-sales service provider of Mobile and Consumer durables. “Acquisitions made in the last two to three quarters would start witnessing better results in all likelihood by Q3 or Q4 in FY19,” says Rughani. 

Quess is a sensible shopper then, but Isaac adds that inorganic growth is only a smaller part of their story. “Two-thirds of our growth has come from organic route and the balance from inorganic acquisitions,” he says. 

Long Legs, Short Steps

Despite the company’s high growth numbers, its margins – which improved from 4.4% in FY16 to 5.7% in FY18 — have not expanded at the same pace. This is largely due to the company’s dependence on its people and services management or general staffing segment, which faces high competitive pressure because it has low cost of entry and is crowded with many unorganised players (See: Growth fuel). 

Quess has five key business segments. From that, People Services and Technology Solutions are the most significant contributors to revenue, at 43.6% and 33.8% respectively. Facility Management, Industrials and Internet verticals account for 14.9%, 5.9% and 1.8% respectively.

However, HDFC Securities’ Rughani believes that the company has an edge over smaller players. “More than 10,000 companies in India provide these services. But the ability to scale up is what is important, and there are very few players who have become big. They include Randstad India, Teamlease, Quess Corp and Adecco Staffing,” says Rughani. 

To accelerate margin growth, the company is even expanding in the staffing business inorganically. “The acquisition of Comtel established our IT staffing footprint in Singapore and gave us a market-leading presence in South East Asia, a key geography for our next stage of growth,” the management  had said in its FY17 annual report. Isaac believes further increase in margin is possible through cost optimisation and digitisation.

Diversification, thanks to its buying spree, has helped it to report better margins than its peers.  For instance, Quess‘ staffing business reported an operating margin  of 4.73% in FY18 compared with an industry average of around 2-3%. Thanks to its presence in multiple segments, it has cumulative margin of approximately 6% (and company’s endeavour is to reach ~10% in the next three-five years).

Quess’ only listed peer Teamlease Services also hasn’t been able to maintain high margins. Teamlease reported an Ebitda margin of 2.26% in FY18.

“Through these acquisitions, such as Conneqt, MFX and Manipal Integrated services, the company got exposure to high margin segments such as global technology solutions and integrated facility management,” says Pokharna.  

Hidden Potential

But why has Quess continued to bet on staffing business with a tough climb? The answer is that this business holds much promise as the country’s economy matures. And what works to the advantage of firms such as Quess is the availability of a flexible workforce.

Since around one million people are entering the country’ workforce every year, generating sustainable employment is a focus area for the government. Quess has harnessed that opportunity — by partnering with the central government to provide training and skill development through more than 100 centres spread across 65 cities.

The retail sector, which is expected to witness growth to the tune of 10-12% each year, will also provide a massive boost to staffing firms. The Indian flexi-staffing industry is expected to register 14-16% growth per annum over the next few years, according to India Staffing Federation’s report. The report also adds that the number of temporary workers in the organised sector may increase over the next ten years – from 1.3 million to 9 million.

“In today’s digital world, competitive intensity has increased, the traditional supply chain has been disrupted, and clients are switching to asset-light business models. Companies including start-ups intend to remain flexible to adapt to fast-changing market conditions. As a result, corporates are outsourcing non-core activities to professional service providers such as Quess,” says Pokharna.

Analysts also believe that the company will benefit from the introduction of Goods and Services Tax (GST) and other government policies. While the organised sector accounts for 20-30% of the market in general staffing business, “With the implementation of GST unorganised players are expected to face problems, eventually increasing the share of organised players,” says Rughani. While the Centre has introduced the Wage Code Bill, which proposes universalisation of minimum wages, the three other codes — industrial relations, social security and safety, and working conditions — are expected to be finalised soon. Again, organised players like Quess would be better placed to implement these.

GST has also streamlined and simplified the process of indirect taxation, according to Isaac. “This helped in opening multiple new segments of the economy for our range of service offerings. Companies that traditionally stayed away from the model of outsourcing are reaching out to us for business opportunities,” he says.

Second Look

The company’s management is strategically focusing on client acquisition and offering a wider range of services to existing clients to achieve scale and improve operating level efficiency. “Topline in this business can grow very fast,” says Pokharna. “Hence, the lower margin will get compensated by a very high topline growth. So, even at lower margins, they are making a lot of money,” (See: Accelerating the climb).

And with the stock correcting almost 45% from its all-time high of Rs.1,300 in June, analysts believe the current valuation of 22.19x FY20 estimated earnings is attractive. Along with cheap valuation, the continuous margin improvement led by the turnaround in recently acquired companies and cost rationalisation will help Quess clock higher growth. 

“We have assumed 70 basis points margin expansion over FY18-20. Strong CAGR revenue growth of 27% and superior margin mix would lead to a stellar 38% PAT CAGR over the same period,” says Rughani. He adds that higher contribution from global technology solutions and integrated facility management would drive margin in the coming years. 

Given the management’s track record of ensuring a healthy growth momentum and multiple avenues to grow through organic as well as inorganic routes, analysts expect the company to continue on its upward trajectory. The recent correction only provides a perfect opportunity for investors to get into the game.