STRATCAP SECURITIES

(INDIA) PRIVATE LIMITED

Equity Research India

Nimesh Chandan
nimesh@strategicindia.net
91-22-56503761
Parul Patel
parul@strategicindia.net
91-22-56503757

14 December 2004 Company Visit Note

Shareholding pattern
(Sep 2004)
%
Hello and Namaste
Promoters 35.80
FIIs Spanco Telesystems has moved ahead from being only a
Banks/FI/MFs
Pvt. Corporate Bodies
64.20 Telecom equipment player to an emerging player in the ITES
Public (incl others) arena. The company is targeting opportunities in both the
Total 100.0
domestic and the international market to provide voice based
BPO services

CMP (Rs) 67 Telecom integration being the mainstay of the company’s revenue is slowly
52 Week H/L (Rs) 72.5/26 giving way to the upcoming call centre business division. Currently the call
3M Avg daily vol 63491.1 centre division contributes 40%, to revenues. By 2006, 57% of revenues would
FV (Rs) 10 come from this business.
Equity (Rs. mn) 169.9
Market Cap (Rs mn) 1138.3
EPS (Rs)-FY05E 5.0 Spanco is in the process of augmenting its call centre capacity both Domestic
P/E –FY05E EPS 13.4 and International. To fund the Rs 39.35 crore project, the company recently
raised a composite issue of Rs 25 crores from the capital markets. Project is
slated to be completed by end of December 2004. Post completion, Spanco’s
capacity would increase from 1370 to 2280 seats.

Sparsh, the company’s domestic call centre would be the growth driver in the
near term. We believe that with capacity addition of 400 seats, Sparsh would
register growth rate of 170% by FY05 (y-o-y). While Respondez, the
international call centre would deliver a modest 28.8% growth in revenues this
year. By FY06, Respondez would register 100% growth in revenues

As per Gartner, India’s constitutes a mere 3% of the $ 124 bn Global Offshore

BPO pie. However, it is expected to touch to $17 bn by 2008, implying a
galloping growth rate of 70% p.a. In addition to this as Indian companies
increase their spending on IT and ITES, players like Spanco stand to benefit.

Notwithstanding the growth in the BPO space, stiff competition is likely to

depress margins in the near term. Nonetheless, margins are likely to firm up as
the company caters to more private sector clients and offers higher value
added services.

Valuations
At a CMP of Rs 67, the company is trading at EV/Sales of 1.6 on FY05 and 1x
on FY06E. Spanco is available at P/E of 13.4x on FY 05 EPS of Rs 5.0 and a
P/E of 8.1x FY06E EPS of Rs 8.3.
Spanco Telesystems and Solutions Ltd.

Background
Incorporated in 1984 “Kadambari Leasing and Hiring Company”, bought over
the telecommunication business of Spanco in 1999 and re-christened itself to
Spanco Telesytems Ltd. During its formative years, Spanco was engaged in
providing networking infrastructure for utilities like the Railways, Defense, Oil
and other PSU’s. By setting up access network, Spanco catered to the carrier
requirements of these utilities. As time went by, Spanco widened its clientele
and product offerings. The company began by addressing the Wide Area
Network (WAN) requirements of upcoming customer contact centre and soon
started offering multi-services to include ACD (Automatic Call Distribution),
Switch, CTI (computer technology integration), Predictive Dialer and Monitoring
systems. With this, Spanco emerged as an end-to-end service provider for call
centre architecture. Having established itself, in telecom integration, Spanco
diversified in the BPO space in the year 2002. In this segment, the company
began operations by setting up a domestic call centre, “Sparsh”, and later
established “Respondez”, the company’s international call centre division.

Spanco’s Business Model

Telecom
Turnkey Network
Solution Integration

Telecom
Integration Enterprise LAN / WAN
Networking solutions

Access network
Support Multi-service WAN
services Satellite Commu.
WAN & DSL sol.
Video conferencing
Spanco

Inbound
International Call services

Outbound
Call Calls
Centre

Domestic CRM

IVRS

Telecom Integration Business

The telecom suite of services comprises:
Setting up of LAN/WAN.
Voice, Data and Video Networking.
Radio, Satellite and Terrestrial Communication Integration.
CRM Integration and Carrier Networking.
This division addresses the networking infrastructure and system integration
requirements of varied customers. For e.g. Spanco caters to Carriers like
BSNL, MTNL, PSU’s like ONGC, NTPC, Utilities like Railways, Airports etc.
Call Centre’s & Enterprise Networks like Intelenet, MsourcE, TCS and the
Ministry of Defense. Since quality is paramount in acquiring customer traction,
Spanco has strategic alliances with seasoned telecom equipment providers like

09 December 2004 Stratcap Securities (India) Pvt Ltd. 2

Spanco Telesystems and Solutions Ltd.

Nortel, Alcatel, Verint etc. From the very beginning, the telecom division has
been the bread and butter of Spanco. Of the company’s total revenue of Rs.612
mn in FY 04, this division contributed Rs.367.6 Mn, constituting 60% of the
revenue pie. Out of this portion, Carrier customer segment accounts for 79%,
Corporates contributes 12%, while Utilities and Defense account for 7% and 2%
respectively.

The management has identified Defense customer segment as the growth

driver. Currently, defense contributes a minuscule portion to revenues.
However, having executed large contracts, Spanco is upbeat on bagging repeat
orders. The Ministry of Defense has earmarked a sizeable portion for IT and
networking activities. Another growth driver would be the Call Centre business,
as Spanco expands its service portfolio to include data redundancy center.

Despite the above-mentioned triggers, the management believes that the

telecom division would register a modest 27% growth in FY 05. As a mid-sized
player, Spanco not only faces competition from Supreme Telecom, TCIL and
Global Telesystems but also from larger players like VSNL. As customers seek
to rationalize vendors, large telecom players would be preferred.

Call Centre Business

The call centre division currently accounts for 40% of revenues. This business is
bifurcated into domestic and international divisions, each contributing 15% and
25% respectively to the revenue pie. Spanco essentially provides Voiced based
BPO services to varied clients. Its bouquet of service offerings includes inbound
& outbound call handling, telemarketing, back office processing, CRM, IVRS,
Fax-on-Demand, etc. Apart from these services, Spanco’s call centre
architecture offers both centralized and distributed formats, catering to the
diverse needs of its customers.

Domestic Call Centre Business – An explicit beginning

The BPO majors in India have been mainly concentrating on the international
market where billing rates and volumes are comparatively higher. In addition to
this, many of the Indian corporates preferred to have their own captive BPO arm
rather than outsourcing the same to third party vendors. As domestic companies
begin to manage more complex businesses, we observe a significant rise of 16-
17 % in IT spending by Indian corporates. With this development outsourcing in
India too, will gain further ground.

Amidst this emerging scenario, Spanco launched “Sparsh”, the domestic BPO
services division in the year 2002.The 1150 seat call centre, spread across five
locales, caters to clients across the telecom, retail, banking and insurance
verticals. Currently the company has a strong foothold in the telecom vertical
with clients like BSNL, MTNL, Hutch and Airtel. In other verticals, the company’s
clients include HLL, Tata AIG, Citigroup etc.

In the highly competitive domestic BPO space, Spanco faces stiff competition
from the likes of Spectramind, IBM-Daksh, WNS, ICICI Onesource, etc. The
company differentiates itself from competitors by its geographic diversity.
Spanco operates from 5 centres across India viz. Mumbai, Delhi, Kolkata,
Bangalore and Pune.

The management has identified the domestic call centre division as a revenue
spinner in the near term (FY05), expecting 170% growth in revenues amounting
to Rs 245.1 Mn. Spanco is already in a process of expanding capacity from
1150 seats to 1550 sets by December end of FY04.The management expects

09 December 2004 Stratcap Securities (India) Pvt Ltd. 3

Spanco Telesystems and Solutions Ltd.

an improvement in billing rates as it widens its customer base to include more

private sector companies. Last year, the company had higher concentration of
PSU work (BSNL), where the average billing rates were lower. Spanco expects
an additional improvement in margins on account of better utilization of spare
capacity by providing data redundancy services to other BPO’s. Spanco
currently addresses the lower end of BPO space where competition continues to
remain high especially with the entry new participants like ESSAR, Godrej etc.
We believe that the margins are likely to face erosion in the near term. Going
forward, the key to margin improvement would lie in catering to more private
sector clients and offering higher value added services

International Call Center Business –Responding humbly

Spanco caters to the international call centre segment under the brand
Respondez. This division offers inbound and out-bound tele-calling
programmes for UK and US based clients, catering to the Aviation, Financial,
and Telecommunication and Utilities verticals. In addition to its Mumbai office,
which handles the International operations, Spanco has set up a US based
subsidiary, Global Respondez, to gain visibility in its largest target market.
Currently, the 220-seat call centre contributes 25% to the overall revenues.

The international BPO business is highly competitive with well-established

players. There are not only large third party vendors like Spectramind and WNS
but also captives like GE, e-Serve etc. Many of these captives, as mentioned
earlier, are looking at tapping external business. In the midst of this challenging
milieu, Spanco is in the process of augmenting its capacity to 710 seats by the
end of this fiscal. Spanco’s game plan is to scale up and migrate to high value
added services. As this transition would require time, we expect a modest
contribution of Rs 198.4 Mn in revenues in the near term. However, by the end
of FY 06 this division would register a 100% growth, contributing Rs 399.3 Mn

Indian BPO Opportunity: Story remains attractive

According to Gartner, the global ITES-BPO industry stands $777 bn. North
America accounts for 60% of the outsourcing pie, 22% is contributed by the
European Union, while Asia accounts for the rest. Out of the$777 bn, the global
offshore BPO accounts for $124 bn. India accounts for 2% of this market.
However it is expected to touch USD 17 bn mark by 2008 from the current USD
3 bn, thus implying a galloping growth rate of 70% p.a. Despite an explosion in
growth, offshore outsourcing did witness minor setbacks in the current year.
Burgeoning unemployment in the US, coupled with uncertainty on the mandate
for outsourcing during the presidential elections attenuated the momentum,
forcing most companies in the U.S to withhold their plans on outsourcing. Post
elections, “Doubting Thomas’s” have been put to rest and the outsourcing wave
is expected to gather steam.

Another interesting macro feature of the Global BPO business is its current state
of flux. On one hand we have the Indian BPO outfits acquiring overseas firms
(e.g. ICICI Onesource acquired Illinois based Pipal outsourcing firm) to enhance
their front-end capabilities. While on the other hand global firms are making
transition from captives to third -party vendors in order to improve their back-end
capabilities. (e.g. recent sale of GECIL). Players like Spanco benefit from the
growing market in two ways Firstly they provide telecom equipment and
integration services to BPO companies in India. Secondly they offer their own
call center services.

09 December 2004 Stratcap Securities (India) Pvt Ltd. 4

Spanco Telesystems and Solutions Ltd.

We have highlighted the salient features of Spanco’s initiatives to capture on

the emerging opportunities in the ITES-BPO space.

Spanco’s Gameplan

Spanco aims to emerge as one of the top five call

centre companies, with a capacity of 4000 seats. It
also intends to strengthen is current position, by
offering higher value added services.

Domestic International Telecom

Call Centre Call Centre Integration

Has been identified as the
growth driver in the near
term.
Expected to contribute Rs
245.1 Mn in revenues by FY
05 and Rs 424.1 Mn by
FY06E
Current capacity is 1150
seats. Has already ramped
up capacity to 1550.
CAPEX Rs 39.35 crores
Expected to drive growth
post FY 05.
To contribute Rs 198.4 Mn
in revenues by FY05 and
Rs 399.3 Mn in FY06E
Current capacity is 220
seats. Is in the process of
building capacity to 700
seats by December ’04.
No expansion plans for this
division. Expected to contribute
Rs 468 Mn in FY 05 and Rs
608.9 Mn in FY 06
Defense customer segment to
contribute significantly to
revenues
Going forward, Universities,
Railways, Aviation, and Power
& Oil companies, to generate
business.

Expansion Objective:

“To increase capacity by 910 seats”

The International call centre’s capacity would be increased by 500 seats (from
current 220) at a cost of Rs 27.49 crore.
While the domestic call centre’s capacity would be increased by 410 seats (from
current 1150) at a cost of Rs 11.86 crores.

Total Project Cost: Rs 39.35 Crores.

Bank loan: Rs 11.70 crores
Composite Issue: Rights issue Rs 17.46 crores and Public issue Rs 7.50 crores
Internal Accruals: Rs 2.65 crores.

Expected date of Completion:

End of December 2004

09 December 2004 Stratcap Securities (India) Pvt Ltd. 5

Spanco Telesystems and Solutions Ltd.

Summary Financial
(Rs in mn) FY03 FY04 FY05E FY06E
Net Sales 473.6 612.4 911.9 1432.4
Total Expenditure 413.8 501.2 752.8 1188.9
Operating Profit 59.8 111.2 159.1 243.5
Other Income 1.8 7.1 3.3 2.0
PBIDT 61.6 118.4 162.4 245.5
Interest 9.5 13.4 12.4 10.0
PBDT 52.1 105.0 150.0 235.5
Depreciation 16.1 44.5 52.0 59.8
PBT 36 60.4 98.0 175.7
Provision for tax 13.2 -2.4 13.7 35.0
Profit After Tax 22.8 62.8 84.4 140.7
Extra-ordinary Items 0 -1.6 0.0 0.0
Adj Profit After Tax 22.8 61.2 84.4 140.7
EPS (Rs.) 1.3 3.6 5.0 8.3
P/E @ Rs 67 53.8 19.4 13.4 8.1
Market cap 1138.3 1138.3
EV 1440.3 1390.4
EV/Sales 1.6 1.0

Spanco has displayed positive results for the first two quarters of FY05. The
company’s Net sales for the first quarter of FY05 were Rs 165.5 Mn, registering
a 55.98% y-o-y growth. At Rs 202.9 Mn, the second quarter too, witnessed
88.18% growth in revenues. (y-o-y). Even the bottom line grew substantially
contributing Rs 14.1 Mn and Rs 23.9 Mn respectively.

Currently the company enjoys tax credits for its on going expansion program, its
effective tax rate being 14%. Going forward we expect the tax rate to rise to
20%. We also expect margins to depress in the near term. However, going
forward we see margins firming up on account of increased private sector
participation and value added service offerings.

We expect the company’s overall sales to increase by 48.9%, and profits to rise
by 66.70%. Given Spanco’s expansion drive coupled with emerging growth
drivers, our earning target seems plausible.

At a CMP of Rs 67, the company is trading at EV/Sales of 1.6 on FY05 and 1.0x
on FY06E. Spanco is available at P/E of 13.4x on FY 05 EPS of Rs 5.0 and a
P/E of 8.1x FY06E EPS of Rs 8.3.

09 December 2004 Stratcap Securities (India) Pvt Ltd. 6

 Stratcap Securities (India) Private Limited

Equity Research
Analysts Direct Nos Email
Imran Contractor (Head- Research) 91-22-56503760 imran@strategicindia.net
Nimesh Chandan 91-22-56503761 nimesh@strategicindia.net
Siddharth Bhaiya 91-22-56503763 bsiddhartha@strategicindia.net
Rajee Lodha 91-22-56349946 rajee@strategicindia.net
Karthi Keyan 91-22-56503762 karthi@strategicindia.net
Apurva Doshi 91-22-56503756 apurva@strategicindia.net
Parul Patel 91-22-56503757 parul@strategicindia.net
Abhishek Bakshi 91-22-56503764 abhishekb@strategicindia.net

Equity Sales & Dealing

Dealers Direct Nos Email
Shabnam Kapur (Head- Sales) 91-22-56503759 shabnam@strategicindia.net
Rajeev Gupta 91-22-56503765 rajeevg@strategicindia.net
Vikram Babulkar (Head- Dealing) 91-22-56503709 vikram@strategicindia.net
Rajeev Vootla 91-22-56503708 rajeev@strategicindia.net
Chetan Mulani (Private Clients) 91-22-56503710 chetan@strategicindia.net
Chandrakant Ware (F&O) 91-22-56503707 chandrakant@strategicindia.net

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