Over the past ten years many companies sold off their ‘captive’ onshore and offshore service centres to the outsourcing marketplace. Following the crash, this stream of service centre sales ground to a halt. However in recent months, it seems there are signs of life once more. What’s behind this new activity and where is it going?

What is happening in the market?

The economic downturn seriously reduced BPO merger and acquisition (M&A) activity. Looking at the combined sales of both captive and outsourcing entities, Grant Thornton estimate that BPO M&A fell from $1.3 billion in January–July 2008, to $616 million for the same period in 2009. Not including the Tech Mahindra-Satyam deal, the total value of cross-border deals (outbound and inbound combined) fell 83% to $156.5 million during January-July last year. Cross-border deal volume in 2009 was a fraction of the 2008 level (13 compared to 47 deals).

However, towards the end of 2009, the number of captive acquisitons started to pick up, including Cognizant-UBS, EXL-Amex Business Travel, NorthgateArinso-CIAN, plus rumours about several players bidding for Target Cooperation’s captive unit. At the time of writing HCL, Capgemini, Infosys, Wipro, Aegis, Patni Computer Services, MindTree, Genpact (to name a few) have all publicly announced that they are in the market for the right buy.

What is driving the market?

Activity is being driven by two factors: suppliers seeking to extend into higher value service areas, and to develop specialised industry verticals:

• Moving to higher value services: With commoditisation, growing competition and the constant pressure on margins, outsourcers need to tap into new and higher value areas, such as the move from commodity IT work to BPO, or ‘mature’ BPO processes such as Accounts Payable work, to Knowledge Process Outsourcing. For example, Cognizant’s recent acquisition of the UBS back office subsidiary diversified its operations away from core IT to a broader set of BPO services.
• Vertical specialisation: At the same time, many BPO players are looking to increase their credentials in the marketplace, by developing deeper expertise and broader scale in specific industry verticals, such as insurance or banking.For example HCL’s acquisition of Liberata Financial services provided a major boost to its insurance vertical; HCL is also reportedly evaluating acquisitions within the $100m range in the media, publishing & entertainment segment. With the acquisition of Citigroup Global Services, TCS added 12,000 staff overnight to its workforce and transformed its presence in the banking and financial services vertical.

One major enabler of this trend is the fact that many outsourcers are cash rich. Due to the booming outsourcing scene of the past decade, solid margins and good cashflow, many outsourcers (particularly the Indian-based outsourcers) have the balance sheets to go on a back office services shopping spree.

What are the valuations?

There is a clear pattern emerging from recent captive sales. A few examples:

• The TCS acquisition of Citigroup GS deal value was 1.8 times Citigroup GS revenues
• The ACS acquisition of E-services group was priced at 1.3 times revenues
• The WNS acquisition of Aviva GS was priced at 1.9 times revenues.

In each case, the revenue multiple is different, based on the quality of the assets and contracts being taken over, and the appetite of the buyer. But in general, the value of these deals range between one and two times the revenues of the acquired company. Captive deal prices may well rise if demand for acquisition continues to exceed supply, and this is certainly Alsbridge’s view. As we continue to talk with clients and outsourcers from across the market, each captive sale is attracting real interest across the industry. Its clear that, for the foreseeable future, it’s a sellers market.

What does the future look like?

As the BPO market matures, providers will continue to feel the pressure to establish themselves as leaders in specific industry sectors, and to rapidly augment their capabilities in high value services. Looking ahead – most BPO providers will remain cash rich, and will continue to seek out acquisition targets. In the meantime the effects of the credit crunch crisis appear to be easing. 2010 should be a great year for the captive acquisition market.