India-based Business Process Outsourcing companies are taking away US jobs and are recruiting by the thousands. But why are listed BPO stocks doing badly and what is their long-term future?

The US is reeling under high unemployment, which is often blamed on India's Business Process Outsourcing (BPO) sector, which is accused of pulling out jobs from the US to India.

That should mean great business for BPOs, right? Well, BPOs remain one of the largest employers and highest-paying sectors in the country. But why do their stocks continue to provide dismal returns on investment?

In January 2008, the Sensex was at over 21,000. It then crashed and almost regained its previous peak by October 2010. During this period, Allsec Technologies Ltd is down by a jaw-dropping 72%, Firstsource Solutions Ltd has fallen by 67%, while Tricom India Ltd has plunged by 65%.

Similarly, others like Cambridge Solutions Ltd went down 45% and Spanco fell 33%. On the other hand, the BSE IT Index-which comprises software companies-moved up by 62% in the same period.

What has hurt these BPOs stocks so much? Analysts tracking these stocks say that these BPO companies have no major competitive edge, with the result that their margins are continually being squeezed, especially due to rising employee cost.

The percentage of employee cost to net sales has shown a rise on a year-on-year basis. The employee cost to net sales for Cambridge Solutions rose to 52% in the September 2010 quarter from 37% in September 2009.

Similarly for the relevant periods, the percentage for Firstsource Solutions and Sparsh BPO rose to 52% from 50% and rose to 57% from 54% respectively. However, for Spanco, employee cost to sales percentage remained the same.

Allsec Technologies was the only one among the BPO stock selection whose cost to sales fell to 63% in the September 2010 quarter from 73% in September 2009.

"The BPO business generally comes from the global arena where there is huge competition. The increasing cost of employees and the change in rate of inflation increases the pricing and hence margins are pressured. Earlier the margins were around 18%-20%, but now they have dipped to 13%-14%. In December, due to the festive season, there was a dip in the business. The growth in this sector is muted to only around 2%-2.5%," said a research analyst from a leading brokerage firm, who preferred anonymity.

According to Rohit Anand, senior research analyst at PINC Research, "BPO companies have lagged behind in revenue growth and margins have also been affected due to the appreciation in the rupee, coupled with the high attrition rate in this industry."

Another analyst explains that these stocks are also depressed as various clients of these BPO companies are seeking consolidation of business (outsourcing with allied IT services), which may be a tough ask for a number of these service providers.

Consolidation among BPO companies might help, but even that is not happening. "There is not much of consolidation going on in the BPO industry. Over the past two quarters, fewer contracts were given to these companies. Going forward, these stocks may look up if consolidation takes place," said an analyst tracking IT stocks, requesting anonymity as he is not authorised to speak to the media.

BPO firm eClerx Services Ltd seems to be an exception, with the stock trending upwards. From the Rs269 level on 8 January 2008, the stock was at Rs695.55 in yesterday's trading. "eClerx has given strong returns over the past year," said Mr Anand.

Mr Anand added, "Going ahead, the performance of BPO companies is expected to be better as business volumes pick up. Billing rates have stabilised now, so there are no major headwinds for operating margins. Also, the attrition rate is expected to ease." — Moneylife Digital Team