The Supreme Court recently ruled, in a case involving Morgan Stanley, that multinationals with captive back-offices in India would have to pay corporate tax in the country on just the local operation and not on that portion of their global income attributable to the local back-office. Rohit Kapoor, president and chief operating officer of ExlService Holdings Inc. told Mint that the judgement still meant that companies would increasingly move business from captive back-offices to third-party service providers such as Exl. He also spoke on how his company plans to work around the rising rupee, and what it means to figure at number 10 on the Indian software lobby’s rankings of tback office companies. Edited Excerpts:
What impact will the Supreme Court’s ruling have on captives and third party back-office operations?
We find that captives are looking to move towards the third party business model and they are doing that for three fundamental reasons—the cost structure which is much higher in their case, the inability to retain middle and senior management talent and, the complexity of dealing with some of the regulations in India, whether it is tax or other regulations. The Morgan Stanley case has demonstrated a further complexity to that.
Can you elaborate on that?
Captives would typically have seconded employees and expatriates who are based here and who take decisions on behalf of the parent organisation. The Supreme Court has clearly ruled that if these employees and expatriates out here are taking active decisions for the local entities, that will have an impact as far as the tax status is concerned. Organisations and captives will have to be very careful as to how they depute people out here, how they retain control over here and what kind of tax (consequences) they are going to pay.
How will the rising rupee your margins this quarter?
The rupee will certainly have a negative impact on our margins and most of the appreciation has happened in the second quarter (ExlService follows the calendar year for accounting purposes). But I can’t divulge more. For this year, we expect revenues between $160-$170 million, which represents a growth of 35-40% over the previous year. Operating margins should be at 12%.
How are you looking at countering the strengthening rupee?
The rising rupee is here to stay. Around 50% of our total revenues ($122 million as on December 2006) is denominated in sterling pounds and 50% of our revenues is in US dollars. Approximately 65% of our cost base is in Indian rupees. We are looking at managing the currency impact by structuring contracts with our customers that allow flexibility in pricing based upon the exchange rate. What we would propose is to have a fixed price with the customer, provided the rupee stays within a narrow trading band (plus or minus 5% of the exchange rate at the time we sign the contract). If the amount goes outside that band, we would share the risk with our customer. If the rupee depreciated, the customer would get the benefit. and if it appreciated, the customer would have to pay more.
Are you looking at operations at other international locations to hedge this risk?
Yes, we are looking at locations such as the Philippines and Eastern Europe to provide services to our customers and are looking at diversifying our cost base even further so that our rupee cost base is brought down. Besides, we are also adding on new business lines that are currency neutral. For us, these are either the domestic Indian BPO businesses or transformation services where you provide analytical skill sets, which have got dollar costs and dollar revenues.
Can you elaborate on your international expansion plans?
Our international expansion will be based on a dual-track model that will look either acquisition of companies that already operate in such locations or setting up something greenfield with our existing clients. We would prefer to do an acquisition of a firm that has domain specific capabilities and revenues of between $25-50 million. In the next 12 months, we will have something in one of these two locations. We will start with 500 people. While Eastern Europe is strong in language capability, Philippines is strong in customer interaction capabilities.
What kind of domain expertise are you looking at? Is there any particular area in which you would like to make an acquisition?
There are always additional areas that we can add to make our existing domain capabilities strong. There are three areas we focus on in ExlService. These are insurance, banking and financial services and finance and accounting. So anything that adds to our capabilities within these industry verticals and horizontals is what we will be looking at.
Nasscom has just released its rankings of third party back office companies in India and you figure at number 10 on that list...
The ranking Nasscom does is primarily on the basis of the absolute amount of revenues. What it doesn’t look into is the quality of business a particular company might be engaged in and the kind of customer relationships it has. What is more important than these rankings is how are we doing in the industry verticals that we have chosen to play in: In the banking, financial services and insurance industry, we are among the top 3 companies.