Sell rating on Wipro: Taking baby steps into BPaaS, the future of BPO

Wipro has announced the acquisition of Viteos, a niche Business-Process-as-a-Service (BPaaS) for the Alternative Investment Management industry. The rationale is sensible, but the acquisition size is too small (<0.5% of Wipro’s FY15 revenues) to matter. Wipro has a good track record of identifying emerging trends, but has so far failed to capitalise on them due to a flawed culture and high management churn. There are some signs of improvement (e.g. organisation structure has been verticalised) and valuations are tempting (trades at 14x 1-year forward earnings). However, we think its performance could worsen before it improves and there is now increased value in large peers. We retain our SELL stance.

Target and deal details

Viteos was founded in 2003, and is headquartered in the US. It is a leader in shadowaccounting services. It delivered revenues of $27m in FY15, growing at 35% CAGR over the past two years. Wipro has paid $130m for the acquisition. The high employee productivity (revenue/employee) of ~$66,000 p.a. vs $45,000-$50,000 p.a. for a typical IT services company and $20,000 p.a. for eClerx, proves that a significant part of its operations have been automated. Wipro has acquired 100% of the equity which was majority-owned by employees. The sellers decided to sell in order to expand their reach globally.

Sensible rationale

As we had highlighted in our 16th September 2014 note, BPaaS offerings such as by Viteos are the future of BPOs. In this model, the client does not have to buy hardware, software and services separately, and is charged on a per-transaction basis.

This also adds niche capabilities in a large addressable market. As per a PwC report, incremental revenue opportunity for the fund administration industry is $660m-$880m on an undiscounted basis for the period of 2014-2018.

Where do we go from here?

Wipro has a good track record of identifying new opportunities. For instance, it acquired Infocrossing, an infrastructure management services company in 2007, well before any Indian IT services company, except HCLT, was taking this opportunity seriously. However, weaknesses in account mining and inconsistent delivery have prevented it from capitalising fully on these opportunities.

The company has recently started taking steps to fix these, such as by hiring Abid Neemuchwala, a veteran at TCS, as the chief operating officer in February 2015. Abid has recently verticalised the organisation structure, which we think can help.

Current valuation of 14x one-year forward earnings is also appealing given that the company can grow earnings sustainably in the mid-teens over five years, if it gets its act together. The company has made an over 20% return on equity in each of the last fifteen years.

However, we think things are likely to get worse before they get better. For instance, Sangita Singh, the head of Wipro’s healthcare and life sciences division (11.4% of revenue, Sep-15) has quit to pursue a career outside the firm. This marks the second senior executive departure after the head of the media and telecom business left last month.

Also, our recent primary checks with industry stakeholders indicate that there are permanent problems in Wipro’s culture that would prevent a turnaround. With clearer BUYs in HCLT, TechM, TCS and Infosys, we retain SELL on Wipro for now.