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Home > Business > Special

The next big outsourcing story?

Sreejiraj Eluvangal | March 27, 2006

Outsourced product development company R Systems has the potential to post explosive growth, as this business segment is estimated to grow 20 times over the next couple of years.

Going by the valuations of similar companies in the market, the IPO of the Gurgaon-based outsourced product development company R Systems International seems to be priced at a discount and promises an attractive investment option for anyone willing to trust the management's ability to stay focused.

The company, which in the past ran into turbulent times on the financial front as it lacked focus in its business model, seems to have learnt its lessons. It has now decided to stick to OPD services in the future.

With nearly all its growth coming from product-development services rendered by the main company, R Systems plans to double the headcount engaged in this activity from the present 1,000, using nearly Rs 80-100 crore (Rs 800 million - 1 billion) that it expects to raise from the market. Because of the rise in capital-base, the issue will also see the promoter's stake go down from 50.27 per cent to 38.30 per cent.

At Rs 210-250 a share, the issue is valued at 18-21 times the earnings for the past four quarters and compares well with a valuation of 42 times for Aztec Software, a prestigious OPD company of comparable size.

Unlike Aztec, nearly half of R System's turnover comes from its two subsidiaries, which contribute almost nothing to its bottom line and whose businesses are not in line with the company's declared thrust on strengthening its position in the outsourced product development business.

However, the performance of the parent company alone is enough to justify the price of the issue, as it has grown aggressively in its business of helping other software companies design their products through long-term engagement.

The market for such services in India is estimated at anywhere between $500 million and $2 billion and has been predicted to grow nearly 20 times to $8-11 billion by 2008-end by a Nasscom-McKinsey study.

Though the target for the industry looks ambitious, almost all of the eight-ten big players in the sector have been growing at almost 100 per cent a year for the last two years.

Another positive factor: the company does not have any big rivals in this arena. The threat of new entrants is also limited by the fact that relationships take time to mature as they involve sharing of business intelligence. So, the company's decision to focus on OPD is likely to pay good dividends in the long run.

Its experience in providing assistance to software firms in the IPTV and internet music business is also likely to prove an asset, as most other OPD providers in India are focused on telecom, data management and embedded-systems.

Another factor in its favour is the high 'trust' barrier to the industry in which both new entrants and companies, which have their own products, find it difficult to gain a foothold.

Besides, its decision to specialise in OPD activities stems from its earlier not-so-successful attempts to move from services to products.

R Systems, originally founded in 1991 in Sacramento, California, by Rekhi Singh, an Indian software engineer working in the US, kicked off by providing on-site software services for US companies during the first six years.

In 1997, it established a small office in Noida to provide software back-up to the US company, which, by then, had grown five-fold to nearly 40 engineers.

Subsequently, during the dot-com bust of 2000, the company relocated most of its development work - mainly banking and supply chain software services - to its Noida centre, where it also increased the workforce to around 150.

The company's next bold move came two years later, when it acquired two loss-making companies, one based in Pune and the other in Singapore, to try to foray into the products market.

The first of the two companies, Indus Systems, which owned products in the banking and finance sector, brought with it two offices - one in Chennai with 75 engineers and another in Pune with 175 engineers. The other acquisition, of ECnet Ltd - a Singapore-based company, brought in another 40 workers with experience in developing supply chain management software.

However, the company, which has just about finished absorbing and balancing the two subsidiaries, seems to have already realised the difficulties of doing the products business. "We will not be acquiring any more product companies," said Rekhi Singh, president of R Systems, "as we have decided to focus only on OPD services for future growth".

Tellingly, the company made losses of Rs 3.67 crore (Rs 36.7 million) on revenues of Rs 122 crore (Rs 1.22 billion) in 2003, the year after the takeovers. An 'exceptional item' of Rs 2.26 crore (Rs 2.6 million) and a write-off of nearly Rs 6.4 crore (Rs 64 million) in the form of amortisation expenses ate away a portion of its profits.

Since then, the company has managed to overcome most of its 'swallowing issues' and has managed to achieve a net profit margin of 8 per cent this year on its consolidated income of Rs 158 crores (Rs 1.58 billion).

Nearly all the profits, however, are from its parent company, which still accounts for only 51.6 per cent of the overall revenues. The standalone company, as a result, has a healthy 15 per cent margin - only 1 per cent below Aztec's.

The management is of the opinion that the product companies, though indirectly, contribute to the profits.

"By their acquisition, we were able to get insight into the workings of a product company, which stands us in good stead when we are working with other product companies to try to develop products for them. Besides, they also increase our reach considerably as those who buy these products sometimes hire our services arm to do some other work in the domain," Singh said.

However, it is hands-off the products space for now. "We don't have the kind of resources needed to successfully market a product and keep it on the shelves. Therefore, since we already have product experience, we can design products for others," Singh explains his theory of how to make the most of what he has got.

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Number of User Comments: 4

Sub: R- Systems IPO

The story seems to be a publicity stunt to gather subscriptions for there IPO. It seems to be an overvalued offering......

Posted by DK

Sub: R-Systems and OPD

This story on R systems lacks authenticity, and fair play. There are far better, far larger companies doing outsourced software product development for ages, my ...

Posted by vivek

Sub: was it an ad

Wht this,, a type of ad for an company...or ..

Posted by Vijay

Sub: About the story-new Outsourcing

This is an r-systems planted story.... it was as if this was comming out from the r-system ceo/head... trying to get some mileage before its ...

Posted by priya



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