Engineering Services Outsourcing: Shareholder returns wiped out in 2011

- Return on equity of pure-play ESO companies in India slid from 34% in 2007 to -5% in 2011
- With annual growth rates of 30% - 35% between 2007 and 2009, revenue decreased by 21% in 2010
- Debt has become a major concern for medium-sized companies
- Mahindra Engineering came out on top with strong financial credentials across parameters

Compared to outsourcing IT and other business processes, engineering services outsourcing (ESO) on a global scale is a relatively recent trend. ESO is commonly practised in industries such as automotive, telecom and aerospace. It is a means to increase flexibility, reduce fixed R&D costs, and gain efficiency through specialisation and scale effects. Global spending on ESO is estimated to witness a double-digit growth in the years to follow.

Keeping the potential of this segment in mind, ValueNotes analysed the key financial ratios of Indian pure-play service providers in ESO, in a report titled “Engineering Services Outsourcing: Revenue fall necessitates curb in expenses”. While traditionally the total export revenues in India from engineering research and design services include the captives in the market, this study only comprises the pure-play ESO firms. Financial indicators show that the segment was unaffected by the global economic crisis until 2009, but the slowdown in 2010 adversely impacted it, bringing the weaknesses in their financial performance to the forefront.

“In 2011, shareholder returns were wiped out and return on equity had slid to -5%. This is a major cause for concern. In fact, weaknesses in financial performance always existed and had been building up, but high revenue growth had been masking them,” says Arjun Bhuwalka, project manager at ValueNotes. The Indian pure-play ESO segment has seen a fall in performance across several key financial indicators, and is now in a comparatively worse position than other pure-play KPO segments.

The revenue of ESO companies increased from 2007 to 2009, with annual growth rates of 30% - 35%. After the peak in 2009, it began falling, with a 21% decrease in 2010, followed by a marginal increase of 1% in 2011.

While return on equity (ROE) was an impressive 34% in 2007, it slid to -5% in 2011. In 2007, ROE was high across all three segments (small, medium and large sized), with small-sized companies having the best ROE. But by 2011, only large-sized companies had a positive ROE. Medium-sized companies have been the worst hit. They have added to their burden by taking on more debt, leading to difficulties in meeting their interest obligations.

Top-5 service providers in the engineering services outsourcing segment in 2011

Companies like Mahindra Engineering, QuEST Global, Aktis Engineering, Altair India, and ImageGrafix stood out, with Mahindra Engineering topping the ValueNotes Service Provider Evaluation ranking in 2011. They represent the ideal financial performance needed by companies in the industry in the current situation.

If the weak financial performance of the small-and medium-sized ESO companies continues to prevail, we may see some of them having trouble staying afloat in the future. It is critical for these companies to reduce costs given the uncertainty in revival of revenue growth due to the gloomy global economic environment.

ValueNotes is a leading provider of market intelligence and research, with expertise across industries. The company provides a wide range of bespoke business research, competitive intelligence and financial research services about specific markets, industries and companies. Clients include global corporations, consulting firms, research and B2B publishers, PE and VC firms, and money managers.

ValueNotes publishes proprietary market intelligence on the (services) outsourcing industry – in BFSI, e-learning, engineering, healthcare, legal and publishing – with an emphasis on knowledge services or KPO.

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