Stock Insight: Gate to Wealth

iGate Global Solutions (formerly Mascot Systems) was set up in India in 1993 as an arm of iGate Corp, USA. The company focused on IT services till it acquired BPO and contact centre businesses in 2003. Today, the company is an end-to-end provider of IT and ITeS services spanning technology consulting, enterprise solutions, application development and maintenance, data analytics, independent verification and validation, and infrastructure management services. The company has over 108 active clients and centres across the US, UK, Canada, China, Malaysia and India. Its facilities are certified for CMM Level 5 and follow Six Sigma initiatives.

Its earnings are likely to grow exponentially at a CAGR of 85 per cent over FY07-09E. Here are the key points that make a favourable case for the company.

Robust Business Model
Of late, doubts have been raised over the sustainability of a business model that is based purely on labour arbitrage as the means to have a cost advantage. Any decline in cost advantage due to macro-economic changes is a potential threat, and therefore the advantages have to stretch beyond the cost aspects for the IT companies to remain competitive over long-term. iGATE has addressed this issue with its unique integrated technology and operations (iTOPS) model. Under this model, the service partner is responsible not just for the outsourced business process but also for the underlying technology components. Through this model, iGATE is able to provide substantial and sustainable advantages to clients by way of year-on-year cost savings and efficiency improvements, through a combination of process optimization, technology automation and a globally distributed delivery model. One example of advantages beyond labour arbitrage is a mortgage bank that benefits from sophisticated analytics techniques to ensure that 70 per cent of loans are decisioned automatically.

IT business is becoming a battle of business models, and iGATE's iTOPS offering in the ITeS space is one such differentiating business model that should support a sustained growth in revenues and profitability.

Integrated IT Solutions Provider
iGATE Global Solutions started off as a subsidiary of iGATE Corp with an onshore-centric model. It has undergone a qualitative transformation. The company enjoys a good utilization rates of around 71 per cent. iGate's onshore-offshore mix has improved from 55:45 during Q1FY04 to 27:73 during the Q3FY07, and is better than Infosys' 33:67. Offshore contracts are typically more profitable as lower employee costs and higher productivity in India yield higher margins. We expect the mix to remain stable going forward.

Focus On Fortune 1,000 Clients
The company has embarked on a strategy to focus on Fortune 1000 companies. Since these customers are billed at significantly higher rates, this would boost sales realisations. iGATE currently has 55 Fortune 1,000 clients, which currently account for 85 per cent of revenues. Of these, the top 10 account for 72 per cent of its revenues. This leaves enough room to grow its existing Fortune 1000 client base. The company currently has a total of 108 active clients and some are ramping up very quickly, the most notable being the Royal Bank of Canada.

Higher Billing Rates
Focus on Fortune 1000 customers, coupled with project-consulting assignments has led to higher billing realisations. We expect billing rates to rise steadily over FY07-09E as revenue contribution from customers with higher billing rates increase. Billing rates in the IT sector are increasing and are expected to rise by 3-4 per cent annually due to higher value-added offerings and growing manpower costs. iGATE's offshore billing rates have improved from $18.2 per hour in Q1FY05 to $19.6 in Q3FY07. We expect offshore billing rates to rise to $20.7 by the end of FY09E. Onshore billing rates have gone up from $55 per hour during the Q1FY05 to $62.1 in Q3FY07. We expect onsite billing rates to rise to $64.6 by the end of FY09E. The company plans to increase headcount by 47 per cent in two years to 8,552 from the current 5,821. It currently faces an attrition rate of 20 per cent which is a cause for concern. However, the company is aggressively addressing the issue and we hope to see a robust ramp-up in the number of employees. Moreover, iGATE plans to broaden the base pyramid of employees by hiring more less-experienced people to reduce the impact of rising employee costs. Onshore employee costs have been growing at about 2.5 per cent per annum in dollar terms while offshore employee costs are growing at 13 per cent per annum.

Acquisition to Further Boost Growth
iGATE plans to make an acquisition to add to its domain expertise in the banking, financial services & insurance (BFSI) vertical and create offerings under its iTOPS model. The acquisition of Loan-Pro, a US-based mortgage origination services firm, was one such acquisition through which it acquired domain capabilities in the loan origination and loan servicing areas.

Risks and Concerns
The company's ability to effectively retain its employees and quickly scale-up will be a big challenge. As mentioned earlier, it faces an attrition rate of 20 per cent. Apart from that, a significant appreciation in the value of rupee may also hurt its business.

This article was originally published on April 01, 2007.