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Merill Lynch maintains buy on Firstsource, target Rs 105

Friday, August 31, 2007

Strengthens healthcare offering; EPS accretive in FY09

Firstsource (FS) announced a USD 330 million acquisition of Med Assist (MA), a US BPO vendor providing revenue cycle management to the healthcare industry. It has been valued at 12-13x CY07 EBITDA in line with FS and is being funded by about USD 75 million cash and the rest by debt. We believe the deal will be EPS neutral in FY08 and marginally accretive in FY09, assuming margin expansion and tax shield from debt funded interest cost. We retain our current estimates & Buy rating.

Higher EBITDA margins but high taxes as well

Med Assist had USD 99 million revs in CY06 and high EBITDA margins of between 22% and 24% vs FS EBITDA margin of 19-20%. FS expects to enhance margins further through improved operational (agent utilization) and SG&A efficiency. However, net margins will likely be lower than FS given likely 40% US tax rate.

Significant market expansion; Cross selling opportunities

Med Assist provides FS an entry into the high potential provider (hospitals) segment in the US healthcare BPO industry. FS is a strong player on the payor side (insurance cos) and intends to leverage Med Assist clientele (approx 1000 clients) to cross-sell its services to the provider side. For example, while MA provides eligibility services, receivables management and post default collection for healthcare providers, FS could provide billing and support to its clients.

Retain estimates; Buy

While revenue may grow more slowly than the company average, the acquisition should be at least marginally accretive in FY09 assuming improved efficiencies in delivery and SG&A. We have a Buy on FS, which is trading at 24x FY08E PE and 17x FY09E PE with about 36% 2-yr EPSg forecast


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