KUHN CAPITAL Wednesday, March 21, 2018
Dispatches from the front

BPO, the Way to Go

This month’s Dispatch covers the industries that venture capitalists and leverage buyout groups (private equity investors all) are telling us they like, and why.

BPO, the Way to Go
We’ve spent some time on the road since your last Dispatch talking to private investor groups – some of them clients – about where they think investment opportunity lies today. (Mind that we’re not smart enough to figure out what works in hyper-technical industries like bio-tech and network components. We’re just IT, media and business services guys.)

The word out there among these general business investors is “Business Process Outsourcing”, or BPO, for a number of reasons. In today’s economy of declining or flat sales, cost control rules. BPO vendors convert their clients’ internal fixed costs into external variable costs, and because a highly systemized BPO vendor can deliver its services at substantially lower costs than its clients can, both make money. Investors like this logic.

Other reasons for attraction to BPO investments: rising government regulation is making full-time employees more expensive, spurring demand for ways to cut headcount. Then there’s that pre-requisite for consolidation investor interest – economies of scale. BPO’s are by definition automated or at least efficiently focused. This efficiency requires a fixed investment in infrastructure which – when completed – can be scaled to higher volumes for little incremental cost. Bigger investors even like the fact that these “platforms” can be expensive to build, thereby creating a barrier to entry for less well-funded competitors.

Finally, traditional outsourcing (e.g. staffing) tends to be a leading indicator of economic activity. That is, it is the first to see declines in demand as client sales drop and – the theory goes – the first to see demand return as the economy swings back. Therefore, BPO investors are partly betting that we will see a recovery in the next few years.

Some BPO segments that look particularly strong are staffing (especially nurses and MD‘s, with somewhat lesser momentum in accounting/finance and IT staffing), large-scale financial transaction processing (credit cards, mortgages), insurance process outsourcing (third-party administration, document management, claims management), CRM (end-user technical support, PC installation maintenance, call centers), logistics services and even, at last, higher-education and government administration. As time passes, we expect to see the emergence of outsourcers for other parts of big-company operations. In its ceaseless rhythm, industry is now divesting “non-core” activities after a frantic decade of agglomeration.

Where IT’s OK
Most big-ticket software and technical services vendors continue to search for the bottom. Demand remains depressed as users feel less competitor pressure to innovate, struggle with their own soft sales, and work through the hang-over of 1990’s binge-buying. Making all this worse is the fact that much of what these users bought didn’t work as advertised. As a result, there is a sort of cottage industry of smaller IT shops grown up around fixing what the giant, expensive ERP and tech services vendors like Peoplesoft and Accenture wrought.

Then there are the players with the bad fortune of having specialized in telecom, manufacturing and supply chains apps (SCM), like Manugistics or i2, both areas where demand has tanked. Also faring poorly are undifferentiated tech services players, those who didn’t happen to develop expertise in the applications or technologies that have held up reasonably well.

But every die-off presents opportunities for the strong to grow stronger. As a result, we see active buyers of healthy IT players operating in certain sheltered sub-sectors. While no cake walk, tightly-focused CRM has fared well, perhaps because its users understand how retaining and selling deeper into current clients is cheaper than acquiring new ones. So we have buyers for SAP, Seibel and – perhaps surprisingly – Oracle technical expertise. Interest in these companies is again related to the current strength of CRM and the more effective management of giant customer databases.

Finally, we are seeing investor interest in old-fashioned media properties, business trade and affinity group magazines, and smaller city yellow pages publishers. We believe that this interest is driven both by the capacity of these reliable cash generators to support LBO debt, the fact that they may represent a safe harbor in these turbulent times, and the prospect that such properties may become more available as the exhaustion of the giant media conglomerates like Primedia, AOL Time Warner, Vivendi, and to a lesser extent, Disney, drives spin-offs.

A last industry of interest to investors, perhaps particular to the Midwest, is integrated marketing -- services that fashion media strategy and coordinate multiple media campaigns. Consider it another form of BPO.

Therefore, In Sum
We welcome the opportunity to chat with you about buyers or sellers of healthy BPO’s, CRM technical services vendors, and publishers of periodicals, as well as about our corner of the M&A business.

Ryan Kuhn

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