My Best Pick 2013

Winning return

eClerx not only generates excellent cash flow, but also deploys it in accretive acquisitions

Vishal Koul

Investing in the equity markets gives every individual a chance to partner with a great management team or business owner and profit from their vision, passion and business acumen. If you choose wisely, you can sit in your living room and while relaxing over a cup of tea and a newspaper, listen to the cash counter whirr away as the company you have invested in keeps delivering its numbers. As far as choosing management partners go, it would be tough to find better ones than the folks at eClerx. 

The word “clerk” conjures up image of someone who does a repetitive and un-sexy job, and retires with a gold watch as reward for a career of drudgery. So while the name eClerx is underwhelming, under that toad lies a prince. 

eClerx is a knowledge process outsourcing (KPO) company with a strongly differentiated model, and the work it does for global corporate customers is anything but mundane. In financial services, the company provides support for financial transactions across the trading lifecycle, including research support, trade order management, confirmations, clearing, settlement, invoicing, accounting, custody and reconciliations. In sales and marketing support (SMS), eClerx’s offerings span web analytics, data management, competitor benchmark pricing, CRM, business intelligence, quality and compliance, and business process consulting. In short, it is a classic high-end KPO.

PD Mundhra and Anjan Malik, the founders of eClerx, both graduates of the Wharton Business School, were successful professionals at bulge-bracket investment banks before the entrepreneurial bug bit them. In a span of 12 years, they have built a company that will likely do around $120 million of revenue in FY13 with profitability and margin profile that Infosys would probably give an arm for. Achieving success at a relatively young age hasn’t changed the dedication and sincerity shown by the founding promoters. Both of them continue to be hands-on involved in running the business even today. You will not see them on the Page 3 circuit celebrating their newfound wealth or business success. They are likely out there hunting for the next client or thinking about how to make their processes more efficient. 

Industry overview

Evalueserve estimates the global KPO industry will touch $17 billion by 2014, and India will be a dominant player with revenues of $10 billion. Within the KPO space, business and market research & analytics has been the largest sub-segment contributing to 26% of total Indian KPO revenues. This is also the fastest-growing segment with enterprises increasingly focusing on data analytics for critical business decisions. eClerx has developed its domain expertise in this area with meaningful scale. 

Another long-term driver that benefits them is that over the next 20 years, India will be among the few countries with stable fertility rates and a young population even as the world ages and the size of the labour force declines everywhere. Hence, India will be a net labour supplier to the world and eClerx is building a business that exploits this mega-trend.  

Stand-out business practices

Here’s what differentiates them:

eClerx focuses on segments of the KPO market that are relatively scalable, rather than the highest-end of the KPO market, which suffers from lack of scalability. You have to draw a fine line between scalability and margins in this business. What that means in simple English is that you are likely to make more money selling Maruti Swifts to a million consumers than selling BMW 7 series to a thousand people. 

Sitting pretty

Capital efficiency is clearly visible in the strong return ratios

Every April, when eClerx starts a financial year, it knows that a large part of last year’s revenues will recur this year too and so most of the new clients that Anjan and PD go out and hunt down will count towards growth. eClerx has managed to do this by targeting the operating, support and marketing research budgets of clients. These involve two to three-year rolling contracts for a fixed number of full-time equivalent staff and tend to be stable year after year. It is worth noting that even during 2009, when many of eClerx’s financial services customers went through unprecedented crisis, the company grew revenues at 39% in dollar terms.

eClerx has used innovation and technology very smartly and, therefore, has been able to maintain its relevance and avoid getting commoditised. This also helps it manage wage cost inflation admirably. 

It recently acquired Agilyst, a back-office operational and analytics firm focused on the cable and broadband community in North America, in an all-cash deal. Given the strong cash flow generated by eClerx, it’s reasonable to assume that such acquisitions will continue in future. This strategy of inorganic growth funded through internal cash accruals of the company will further enhance its growth profile. 

Cash utilisation at eClerx deserves special mention. Not only does it generate excellent cash flow from operations, it either deploys it in accretive acquisitions or pays it out to shareholders as dividends. It is unlikely to use it for buying fancy offices, personal jets or MF Hussain paintings.  

Investment case

It’s reasonable to assume that eClerx will continue to grow its earnings organically at about 20% per annum for the next three years and likely beyond. This would take EPS to ₹93 from the current level of ₹54 in the next three years. Add on a dividend yield of around 4-5% over the next three years annually and absent any multiple expansions, and you can expect to double invested capital over three years. The company is expected to generate significant cash over the next three years, enabling strategic acquisitions to extend service offerings or enter new markets. Should management be successful in making accretive acquisitions, earnings could reasonably be expected to be higher by around 15-20%. 

The company’s stock is currently trading at 12 times forward earnings. Assuming this multiple sustains, we would expect the stock to trade at almost twice its current level by FY15. However, it is highly likely that the stock will earn a higher P/E multiple over the next three-four years, as projected growth is realised and the company achieves scale. If the stock trades more in line with its earnings growth rate of 25% and commands a 20-times earnings multiple, we would expect the shares to trade four times higher than the current price.

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