Assisting XYZ Ltd. for valuation of intangible assets relating to its acquisition of Infologistics India Pvt. Ltd. Purchase Price Allocation Report August 2010
Purchase Price Allocation of Infologistics India Pvt. Ltd. – Transmittal letter • The Directors • XYZ Limited • Delhi - 110009 • 6 August 2010 • Valuation report of Infologistics India Pvt. Ltd. • Dear Sir, • This is in accordance with the terms of reference set out in our engagement letter dated 17 July 2010 (“LoE”), wherein VVSS & Co. (“VVSS”) has been appointed by XYZ Limited (“XYZ” or the “Client”) to act as financial advisor in relation to carrying out a Purchase Price Allocation (“PPA”) on account of the acquisition of controlling stake in Infologistics India Pvt. Ltd. (referred to as ‘IIPL’ or ‘Company’). • VVSS is to undertake a Purchase Price Allocation of consideration paid to acquire a controlling stake in IIPL (“the PPA Valuation”) as at 3 July 2010 (“Valuation Date”). The Valuation is to be used for the purpose of allocation of consideration paid towards tangible and intangible assets. • The Report sets out the factual information, assumptions which are to form the basis of the Valuation and VVSS’s’s conclusions on the Purchase Price Allocation. It has been prepared in accordance with our Letter of Engagement (LoE). • This Report is based on the information which was provided to VVSS by the management of XYZ. • In arriving at our conclusions, VVSS applied generally accepted valuation methodologies as on the Valuation date. We have based our analysis on the historical financial statements of the Business for the period 1 January 2008 to 30 June 2010. • Additionally, our analysis is based on the Management Business Plan for the period 4 July 2010 to 31 December 2015. Any changes in the assumptions or methodology used to consolidate the financial statements may significantly impact our analysis and therefore the valuation. For our analysis, we have relied on published and secondary sources of data, whether or not made available by the Client. • Yours faithfully, • Sd/- • For VVSS & Co. • Chartered Accountants
Introduction • Terms of Engagement • VVSS &Co. (“VVSS”) has been appointed by XYZ Limited (“XYZ” or “the Client”) to act as financial advisor in relation to carrying out a Purchase Price Allocation on account of the acquisition of controlling stake in Infologistics India Pvt. Ltd. (“IIPL” or “Target” or “the Business” or “the Company”). • VVSS is to undertake a Purchase Price Allocation of consideration paid to acquire a controlling stake in IIPL (“the PPA Valuation”) as at 3 July 2010 (“Valuation Date”). The Valuation is to be used for the purpose of allocation of consideration paid towards tangible and intangible assets. • The terms of the engagement are set out in our Letter of Engagement dated 17 July 2010 (“LoE”). • The Purchase Price Allocation Report (“Report”) is prepared for internal use and regulatory purposes by the Client and must not be copied, disclosed or circulated or referred to in correspondence or discussion with any person including potential investors. The Report is confidential to the Client and it is given on the express understanding that it is not communicated, in whole or in part, to any third party without VVSS’s prior written consent. Neither the Report nor its content may be used for any other purpose without prior written consent of VVSS. The Report has a limited scope as specified in it. Scope and limitations • VVSS has carried out a desktop analysis of the financial information and underlying management assumptions provided by the Management of XYZ (“Management”) for the Valuation Analysis. This information has been solely relied upon by VVSS for the valuation of the Company. • The Report sets out the factual information and assumptions which are to form the basis of the Valuation along with the valuation details prepared in accordance with LoE. • This Report is based on and relies solely on the Management Business Plan for IIPL provided by the Management of XYZ ("Management Business Plan") for the period 4 July 2010 to 31 December 2015. VVSS has analysed but not independently verified the financial projections and underlying data and assumptions and accordingly provided no opinion on the factual basis of the same. If there were any omissions, inaccuracies or misrepresentations of the information provided by the Management of XYZ, this may have a material effect on our findings. • Our work did not constitute an audit of the financial statements and accordingly, we do not express any opinion on the truth and fairness of the financial position as indicated in this Report. Our work did not constitute a validation of the financial statements of IIPL, and accordingly, we do not express any opinion on the same. • The realization of the projections in the Management Business Plan provided by XYZ Management will be dependent on the continuing validity of assumptions on which it is based. Our analysis therefore will not and cannot be directed to providing any assurance about the achievability of the future plans. Since the projections relate to the future, actual results are likely to be different from the projected results because events and circumstances do not occur as expected and the differences may be material.
Introduction • Scope and limitations (cont’d) • For our analysis, we have relied on published and secondary sources of data, whether or not made available by the Client. We have not independently verified the accuracy or timeliness of the same. • Neither VVSS nor any of its affiliates are responsible for updating this Report because of events or transactions occurring subsequent to the date of this report. Any updates or second opinions in this Report cannot be sought by the Management from external agencies without the prior written permission of VVSS. • VVSS has not considered any finding made by other external agencies in carrying out analysis of the Management Business Plan. • We have based our analysis on the audited financial statements of IIPL for the period 1 January 2008 to 31 December 2009 prepared under Indian GAAP and unaudited financials for the six months period ending 30 June 2010. We have also been provided with unaudited balance sheet of IIPL on 3 July 2010. Additionally, our analysis is based on Management projections for the period 4 July 2010 to 31 December 2015. Any changes in the assumptions or methodology used to consolidate the financial statements may significantly impact our analysis and therefore the valuation. • We have not independently conducted a business valuation of IIPL and our Purchase Price Allocation has been carried out on the basis of business valuation of IIPL conducted by the Client. • We have not independently conducted a valuation of fixed assets of IIPL acquired by XYZ and considered for the Purchase Price Allocation. Book value of fixed assets on 3 July 2010, as provided by the Management, has been considered. Management representation • This Report is prepared on the basis of the sources of information listed in Appendix 1. VVSS has relied upon written representation provided by the Management that the information contained in the Report is materially accurate and complete, fair in its manner of portrayal and therefore forms a reliable basis for the Valuation.
Executive summary Infologistics India Pvt. Ltd. (Target) • Incorporated in 2006, Infologistics India Pvt. Ltd.was established as a captive BPO for group companies of the Infologistics Group. Infologistics UAE has 100 per cent stake in the Company. • The Company provides freight audit, logistics carrier and customer services for key customers of the Infologistics Group all over the world. • The Company recorded a revenue of around INR 480 million in 2009 and around INR 180 million for the four month period ended April 2010. XYZ Limited (Acquirer) • XYZ Limited is an end-to-end business process outsourcing solutions provider. XYZ operates in five business areas: Business process outsourcing, research and analytics, risk advisory services, process advisory, etc. • The Company recorded a revenue of INR 1820 million in 2009. Infologistics Group (Seller) • Founded in 1965 and headquartered in the United States, the Infologistics Group is a logistics services provider. The Group operates in three business areas: • Truckload services • Intermodal services • Logistics services • The group has an estimated revenue of INR 37,000 million and conducts business in around 28 countries across North America, Europe, Africa and Asia. Consideration and equity value • XYZ acquired the stake of Infologistics UAE in IIPL on 3 July 2010 for around INR 310 million. • We have not independently conducted a business valuation of IIPL and our Purchase Price Allocation has been carried out on the basis of business valuation of IIPL conducted by the Client.
Executive summary Acquired Assets • XYZ incurred around INR 309 million for 100 per cent of the share capital of IIPL. Based on the cash and marketable securities of around INR 83 million and zero debt balance as on 3 July 2010, the fair value of Business is around INR 226 million. • As of 3 July 2010, IIPL had net assets of around INR 51 million consisting of: • Fixed Assets: around INR 46 million • Net Working Capital: around INR 5 million • Hence, the value to be allocated to goodwill and intangible assets is around INR 175 million as of 3 July 2010, based on 100 per cent equity of IIPL. Identified intangibles • Based on discussions with management of XYZ, the following intangible asset has been identified and considered for the Purchase Price Allocation: • Order book (Master Service Agreement with Infologistics Group) • Key points • Purchase consideration of around INR 309 million for 100 per cent stake in IIPL. • Value of goodwill and intangibles to be allocated is around INR 175 million. • Master Service Agreement between IIPL and Infologistics Group identified as intangible (Order book).
Transaction background Before acquisition After acquisition Dubai India Infologistics UAE XYZ Limited 100% 100% 100% buy out India India Infologistics India Pvt. Ltd. Infologistics India Pvt. Ltd. • The Company’s name has now been changed to XYZ Logistics India Pvt. Ltd. Source: Management Transaction background • UAE based Infologistics Group Company held 100% per cent stake in India based Infologistics India Pvt. Ltd. (IIPL). • XYZ Limited and Infologistics UAE entered into a share purchase agreement on 3 July 2010 wherein XYZ acquired 100 per cent equity stake in IIPL. • From 3 July 2010, effective control of IIPL was transferred to XYZ. Hence, we have considered 3 July 2010 as the date of acquisition. • Key points • XYZ Limited acquired 100 per cent stake in IIPL on 3 July 2010.
Industry overview – Global Sourcing Trend Banking, Financial Services and Utilities and Others Insurance (BFSI) Construction 15% 17% 4% Transportation 3% Healthcare 2% Manufacturing Services 17% 8% Government Retail 12% 9% Communication 13% • Global technology spending • Growth Drivers • Worldwide technology related spending has been estimated to cross INR 72 trillion in 2009. • Software products, IT and BPO services accounted for over INR 43 trillion – nearly 61 per cent of the total spend. • Since technology remained critical to the achievement of efficiency and productivity gains, worldwide IT spending continued to grow in 2009, though spending patterns were impacted for hardware, software and services markets. • The growth was driven by the following factors: • Increased need to reduce costs and remain competitive in pricing; • More corporations trying to adapt to a global services oriented business model; • Access to world markets; and • Addressing skill shortages. Industry sector wise global technology related spending in 2009 Source: IDC, NASSCOM • Key points • Global technology related spends has been estimated to have crossed INR 72 trillion in 2009. While overall spending moderated in 2009 on account of recessive market conditions, spends on outsourcing grew, despite decline in developed markets, which was offset by increasing spends in emerging economies.
Industry overview – Global IT Services and BPO 7.2% 5.1% 3.6% 10.8% 12.4% 11.8% 20.4% 15.7% INR Billion Growth • Global BPO service • Worldwide spending on BPO services touched INR 5,175 billion in 2009, a growth or around 12 per cent over previous year. The growth was driven by increasing realization among corporations that BPO was a strategic business dynamic that helped them focus on their core activities, while leveraging external expertise to manage their non-core activities. • BPO services matured as buyers adopted an a bottom-up approach wherein companies focused initially on transitioning less-complex administrative processes, that can be supported by off-shore delivery and underpinned by tried and tested applications. • The developed economies of North America and Western Europe accounted for over 80per cent of total BPO spends in 2009. • BPO spending in Americas in 2009 accounted to INR 3,260 billion, while Europe, Middle East and Africa (“EMEA”) contributed INR 983 billion in 2009. • The acceptance of BPO and related processing services continued to grow among businesses in Europe, spreading from its traditional stronghold in U.K. • Segmental break-up of worldwide spending on BPO services in 2009 • Global IT services • IT services forms the single largest segment of the global spend on technology related services. The total spend on IT services grew by 5.5 per cent in 2009 and is estimated to be over INR 25,065 billion. IT outsourcing spend increased by 7.2 per cent in 2009 from 2008, with corporations across the world continuing to opt for external service provisioning as a means of managing their own businesses more effectively and efficiently. • North America and Western Europe together accounted for over 76per cent of the total worldwide spends on IT services in 2009, with U.S. alone contributing around 36 per cent of the total IT spend. • While past couple of years have seen a decline in U.S.’s share as a percentage of the total worldwide IT spend, its large size of the market coupled with the magnitude of technology adoption still makes it the hub for IT service spending. • In 2010, a decline is expected in spending leading to delays in additional technology investments. These delays will have a corresponding impact on the consulting and implementation projects related to those investments. • Segmental break-up of worldwide spending on IT services in 2009 2008 INR Billion 2009 Source: IDC, NASSCOM 10
Industry overview – Indian IT-BPO sector • Indian IT-BPO sector • Indian IT-BPO sector is expected to reach INR 3226.5 billion in 2010, a growth of 12 per cent from 2009. As a proportion of GDP, the sector revenues have grown from 1.2 per cent in 1998 and is estimated to grow to 5.8 per cent in 2010. • Net value-added by IT-BPO sector to the economy is estimated to be 3.5 – 4.1 per cent for 2009. • Its share of total Indian exports (merchandise and services) has increased from less than 4 per cent in 1998 to almost 16 per cent in 2009. • India remains and integral part of the global sourcing strategy accounting for approximately 51 per cent of the addressable offshore IT-BPO market. • Alignment to the larger global strategy, enhancing efficiencies and domestic shortage of qualified personnel are emerging as strategic drivers for off shoring apart from the traditional labor arbitrage. • Exports form the backbone of the sector, generating two-thirds of total revenues. • Increase in the number of players offering higher value and project based services such as system integration, IT consulting and software testing services is expected to increase exports by about 16 per cent in 2010 to reach INR 2128.50 billion from 2009. • The domestic market has also been increasingly adopting information technology in a bid to improve its competitiveness through increased process automation and higher utilization levels. Growth in Indian IT-BPO sector Break up of Domestic and Export by service line, 2009 Domestic Export Source: NASSCOM Source: NASSCOM • Key points • IT-BPO industry revenue as a percentage of India’s GDP is expected to reach 5.8 per cent in 2010, of which value added contribution is estimated at 60-70 per cent. Slowdown in IT spending in 2010 is expected to lead to demand side challenges. However, the resilience of the sector and its fundamental value proposition for customers is expected to drive the growth in the medium and long term. 11
Group overview – XYZ Limited (Acquirer) • Group Overview • Established in 1999 in the India, XYZ Limited is an end to end business process outsourcing solution provider. The company operates in five business areas: • Business Process Outsourcing: Structured around industry focused services such as insurance, banking and financial services and cross-industry services such as finance and accounting, collections, transaction processing, exception processing and customer services. • Research and Analytics: Provides custom made data driven solutions to a variety of business applications. • Risk Advisory Services: Provides compliance, technology and risk management services. • Process Advisory: Provides solutions for reducing costs and improving effectiveness of processes. • Value Added Services: Service offerings include finance strategy and operations improvement, performance measurement, cost and activity based management and enterprise risk services. • With a revenue of INR 1820 million in 2009, XYZ employs around 9,000 people. • The company is listed on Bombay Stock Exchange and has a market capitalization of around INR 3,750 million on 31 March 2010. Note : Year ending December Source: XYZ Ltd. Annual Reports Source: Public information
Group overview – Infologistics Group (Seller) • Group Overview • Founded in 1965 and headquartered in United States, the Infologistics Group is a logistics services provider. • The Group operates in three business areas: • Truckload services – With a fleet of around 22,000 trailers and 9,000 drivers in America, the Infologistics Group provides truck services. • Intermodal services – Intermodal services provided by the Infologistics Group consist of truck services and value added services such as load securement and border crossing. • Logistics services – Infologistics Group logistics services include transportation management, freight forwarding and customs house brokerage, transloading and distribution, supply chain management and supply chain advisory services. • The group’s solutions include one way, intermodal, dedicated, bulk, transportation management, transloading services, logistics and payment services. • With an estimated revenue of INR 37,000 million, the Group conducts business in more than 28 countries across North America, Europe, Africa and Asia. • The Infologistics Group has adopted an inorganic growth strategy over the last few years. It has made large acquisitions in similar business to attain business synergies. OPERATIONS IN ASIA TRANSPORTATION MANAGEMENT FREIGHT AUDIT AND PAYMENT FREIGHT FORWARDING AND CUSTOMS BROKERAGE SUPPLY CHAIN ADVISORY SERVICES • Transportation Management • Planning and optimization • Slot time management • Carrier selection • Order management • Transportation • Pan- European Carrier network covering diverse range of modes: rail, sea and air. • Shipment visibility with tracking and tracing • Freight audit and payment • Audit of carrier invoices of all modes against agreed contracts • Detailed analytics and web tools • Payment solutions for freight cost control. • Freight forwarding and custom brokerage • With major offices in Rotterdam the Company has the infrastructure to provide freight forwarding services by truck, train or barge. • Custom House Brokerage • Standard custom clearance for all commodities. • Drawback- import duty drawback entry process • Custom Bond – Single entry and continuous bond applications • Supply Chain Advisory Services • Designing supply chain networks • Reducing transportation inefficiencies
Company overview – Infologistics India Pvt. Ltd. (Target) • Key financials • Business summary • Incorporated in 2005, IIPL was established as a captive BPO centre for group companies of the Infologistics Group. Infologistics UAE holds 100 per cent stake in the Company. • The Company was engaged in the business of conducting freight audit, logistics carrier and customer services for key customers of the Infologistics Group in Europe and the United States. • The Company recorded a revenue of around INR 487 million in 2009 and INR 180 million for the four month period ended April 2010. • Headquartered at Gurgaon in India, the Company employed around 217 people in June 2010. This consisted of 205 billable employees and 12 employees in management and support. • Note: Year ending 31 December, YTD 2010 refers to January – April 2010 • Source: Management • Key points • India based IIPL provides BPO services to Europe and US based customers of the Infologistics Group. • The Company enters into service contracts with Infologistics Group companies, who ultimately enter into contracts with end customers such as Ford etc.
Identification and description of intangible assets Identification and description of intangible assets • The purpose of a PPA in connection with the business combination described above is to restate the acquiree‘s identifiable assets, liabilities and contingent liabilities to their fair value at the transaction date so as to determine the amount of goodwill associated with the transaction. The transaction meets the definition of a business combination and therefore AS-26 (Accounting Standard of ICAI), is applicable and a PPA is required. • The first step in a PPA is to identify all acquired tangible and intangible assets, liabilities and contingencies. Therefore the closing accounts and the business model along with its planning and value drivers has to be analyzed. • According to Management, the book value of the tangible assets acquired as part of the acquisition is representative of the fair value of the tangible assets and hence the tangible assets acquired have not been valued separately. • According to AS 26, an intangible asset should be recognised as an asset apart from goodwill if it meets either of the following criteria: • It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the acquired entity or from other rights and obligations; or • If an intangible asset does not arise from contractual or other legal rights, it shall be recognized as an asset apart from goodwill only if it is separable, that is, it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged, regardless of whether there is an intent to do so. • An enterprise controls an asset if the enterprise has the power to obtain the future economic benefits generated by the underlying resource, and if it can also restrict the access of others to those benefits. The capacity of an enterprise to control the future economic benefit from an intangible asset would normally stem from legal rights that are enforceable in a court of law. In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for control since an enterprise may be able to control the future economic benefits in some other way . • Intangible assets that meet the recognition criterion are measured at their fair values at the Valuation Date. For financial reporting purposes, the standard of value is fair value, and is defined in AS 26 as follows: • “The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale”. • The specific, identifiable intangibles of a business enterprise depend largely upon the nature of its operations. The approach to the valuation of each intangible asset will vary depending upon the nature of the asset, the business in which it is utilized, and the economic returns it is generating or is expected to generate.
Identification and description of intangible assets (Cont’d) Identification and description of intangible assets • The following are examples of intangible assets that meet the criteria for recognition as an asset apart from goodwill as per accounting standards: • Intangible asset classification as per Accounting Standards • Marketing- related • Customer-related • Artistic related • Contract-based • Technology-based • Trademarks, tradenames • Service marks, collective marks, certificiation marks; • Trade dress; • Newspapers mastheads; • Internet domain names; • Non competition agreements • Customer names; • Order or production backlogs; • Customer contracts and related customer relationships; • Non contractual customer relationships • Plays, operas, ballets; • Books, magazines, newspapers, other literary works; • Musical works such as compositions, song lyrics, advertising jingles; • Pictures, photographs; • Video and audio visual material, including motion pictures, music videos, television programs • Licensing, royalty, standstill agreements; • Advertising, construction, management, service or supply contracts; • Lease agreements; • Construction permits; • Franchise agreements; • Operating and broadcast rights; • Use rights such as drilling, water, air, mineral, timber cutting and route authorities; • Servicing contracts; • Employment contracts • Patented technology; • Computer software and mask works; • Unpatented technology; • Databases, including title plants; • Trade secrets, such as secret formulas, processes, recipes
Identification and description of intangible assets (Cont’d) • Master Service Agreement (MSA) between XYZ Limited and Infologistics Group • As a part of the Transaction, XYZ Limited and Infologistics Group entered into a Master Services Agreement (MSA) dated 3 July 2010. Key terms of the MSA are enumerated below: • IIPL will provide BPO services to Infologistics Group in the capacity of an independent contractor for a period of 3 years commencing 4 July 2010. Such services would be provided to Infologistics Group directly or to their customers, as directed by Infologistics Group. • During such period, Infologistics Group will provide the Company a minimum volume of business that shall require services of FTEs equal to ‘Applicable Minimum FTE Volume’. • Applicable Minimum FTE Volume has been considered as follows: • 4 July 2010 – 31 December 2010 : 193 • 1 January 2011 – 30 June 2012 : 180 • 1 July 2012 – 3 July 2013 : 76 • The Company would be remunerated by the Infologistics Group on cost plus margin per FTE basis. • Costs would consist of expenses incurred towards provision of services by IIPL to Infologistics Group. These would include both direct and indirect expenses. • For the first 3 months of the MSA, margin will be calculated as 10 per cent of cost incurred. For the remaining term of the MSA, it will be calculated on the basis of average of margin per FTE in USD for the first 3 months. • The Company shall invoice Infologistics Group for the services rendered during the preceding month. Infologistics shall pay each invoice promptly and no later than 45 days from the date of delivery of such invoice to Infologistics Group. • The term of the MSA is three years ending 3 July 2013. The MSA can be extended for a further period of 2 years in case both parties mutually agree to the same. However, as per discussion with the Management, XYZ does not expect the MSA to be extended.
Identification and description of intangible assets (Cont’d) • Share Purchase Agreement (SPA) between XYZ and Infologistics Group Key terms of the agreement are summarised below: • The SPA was consummated on 3 July 2010, effective control of IIPL being passed on to XYZ with effect from 4 July 2010. Post Transaction, XYZ holds a stake of 100 per cent in IIPL. • The purchase consideration was considered as around INR 309 million. The purchase consideration consisted of two components: • Fixed price of around INR 220 million • Subsequent to preparation of the Company’s balance sheet on 3 July 2010 (Closing Date of the Transaction), a working capital adjustment of around INR 89 million was made to the purchase consideration. • For a period of 3 years commencing 4 July 2010, the Infologistics Group will not perform BPO Services in India. • Further, during the three year period commencing 4 July 2010, the Infologistics Group will not hire any employees of the Company.
Identification and description of intangible assets (Cont’d) Intangibles identified • Based on the above criteria and discussion with Management, the following intangible assets have been identified and considered as acquired by XYZ as part of the acquisition of Infologistics Logistics UAE. • All future revenue accruing from Infologistics Group is based on the MSA entered between XYZ and Infologistics Group and accordingly has been identified as an intangible (order book). With an original term of 3 years, the MSA is extendable by a period of 2 years. However, the Management does not expect the agreement to be extended. Accordingly, no intangibles have been allocated to customer relationship (non contractual) with the Infologistics Group. • Further, since IIPL was providing services only to Infologistics Group in Europe and US, no intangibles have been allocated to customer relationship (non contractual). • Under the share purchase agreement, XYZ enjoys non compete rights from Infologistics Group for 3 years. As the Infologistics Group has committed a minimum level of services from IIPL over this time period, the Management has not considered non compete as an intangible asset. • IIPL currently has leased facilities. According to the Management, all these leases have been entered into at market rates and there are no favorable lease terms that could have been recognized as an intangible asset. • Further, based on discussions with the Management, no other intangible asset could be identified and allocated as per AS 26. • Intangible Asset • Basis • Order Book • Infologistics Logistics UAE has entered into a MSA with the Infologistics Group of companies under which the Group has committed BPO services equivalent to a minimum FTE volume over a period of next 3 years. The order book is considered as an intangible asset for the purpose of the Valuation Analysis.
Historical financial information - Profit and loss account • Key points • Revenue increased from INR 453 million in 2008 to INR 487 million in 2009, growth of 8 per cent. This was primarily due to increase in business volumes. For the four month period of January – April 2010, the Company recorded a revenue of around INR 180 million. • Revenue from net brokerage is attributable to transport services provided by the Company. The same have been discontinued since July 2010. • In 2009, INR appreciated by 10 per cent against the USD. On the other hand, the Company’s charge out rates were not revised. Accordingly, gross margin as well as EBITDA margins reduced. • Gross margin reduced from 52 per cent in 2007 to 43 per cent in 2008. This was on account of INR appreciation as well as higher salary costs. With revision of billable rates per FTE in 2010, gross margin increased to 48 per cent in January – April 2010 period. • EBITDA margin reduced from 21 per cent in 2008 to 14 per cent in 2009. With indirect costs being absorbed over a larger revenue base, EBITDA margins improved to 24 per cent in January – April 2010.
Historical financial information – Balance Sheet • Key points • The balance sheet of the Company on 31 December 2008 and 31 December 2009 is enumerated in the adjoining table. These have been represented as per India GAAP. • The shareholders funds were INR 264 million on 31 December 2009. This consisted of share capital of INR 54 million and retained earnings of INR 210 million. • The net block of property, plant and equipment was INR 70 million. This primarily consisted of office equipment and computers. • Incentive receivable of INR 166 million was attributable to capital subsidy accrued to the Company from the Government. Infologistics group will have the right to received the full incentive subsequent to the transaction. • The current assets were INR 46 million on 31 December 2009, primarily consisting of cash amounting to INR 39 million and accounts receivables of INR 5 million. • The current liabilities were INR 69 million, consisting of accounts payable of INR 10 million, other liabilities of INR 27 million and accrued taxes of INR 32 million.
Historical financial information – Balance Sheet (3rd July 2010) • Key points • With acquisition of the Company by XYZ, the balance sheet of the Company on 3 July 2010 has been enumerated in the adjoining table as per Indian GAAP reporting standards. • Shareholders’ funds were around INR 134 million on 3 July 2010. • Recent decline in shareholders’ funds is attributable to distribution of dividend amounting to around INR 90 million over the last few months. • Fixed assets primarily consist of office equipment and computers. • Cash balance of the Company was around INR 83 million and other current assets comprising of receivables and prepaid expenses were around INR 45 million. • Current liabilities of around INR 40 million primarily consist of payables to vendors and employees as well as outstanding tax dues.
Forecast financial information – Basis for considerations • Management Business Plan • The Management Business Plan (“Management Business Plan”) is projected for the period 4 July 2010 to 31 December 2015 (“Forecast Period”). The Management Business Plan is prepared by the Management based on their estimations/projections considering market trends and envisioned changes in the business model. • We have held discussions with the Management on the Business Plan and its assumptions and the following sections incorporate inter-alia the information provided to us during these discussions. • During the initial years of forecast period, revenues are mainly derived from Infologistics Group contract. As per the agreement, Infologistics Group will provide the Company a minimum volume of business that shall require services of FTEs equal to ‘Applicable Minimum FTE Volume’. Applicable Minimum FTE Volume has been considered as follows: • 4 July 2010 – 31 December 2010 : 193 • 1 January 2011 – 30 June 2012 : 180 • 1 July 2012 – 3 July 2013 : 76 • With an original term of 3 years, the MSA is extendable by a period of 2 years. However, the Management does not expect an extension of the agreement and accordingly projections for Infologistics Business have been considered only till 3 July 2012. • Further to the above, the Management Business Plan has also considered projections for New Business attributable to clients other than the Infologistics Group. FTEs released from the Infologistics Business have been considered to be deployed in the New Business. Projections from 4 July 2013 – 31 December 2015 are attributable to the New Business only. • The Management Business Plan has also taken into consideration new costs expected to be incurred in IIPL. These are primarily attributable to quality control initiatives. • Management Business Plan has considered an average maintenance capex of around 3 per cent of revenue over the projection period. This translates into cumulative capex of around INR 82 million over the projection period. As per Management inputs, tax depreciation has been considered at 22 per cent and book depreciation has been considered at 25 per cent. • Other key assumptions include: • Corporate tax rate of 33.99% per cent in 2009 and 33.22 per cent there after. • Debtors equivalent to 60 days of revenue and creditors equivalent to 60 days of operating expenses
Forecast financial information – Basis for revenue projections Basis for revenue and expense projections • The Company has considered a per FTE cost plus margin model for revenue projections. • In line with the agreement between Infologistics Group and XYZ, revenue per FTE for the first three months of the contract, i.e. 4 July 2010 – 3 October 2010 has been considered as cost per FTE plus a margin of 10 per cent. • Cost per FTE has been considered on the basis of actual costs incurred for full year period of 2009. • For capex incurred till 3 July 2010, depreciation has been considered for various asset classes on SLM basis. For capex incurred from 4 July 2010 onwards, book depreciation has been considered on SLM basis at a rate of 25 per cent. • Further to the above, revenue per FTE has been considered as INR 2.545 million per annum for the first three months of the agreement. • As per Management inputs and in line with the contract with Infologistics Group, subsequent to 3 Oct 2010, margin per FTE has been fixed at INR 0.231 million per FTE. This margin is added to the actual costs incurred by the Company during a period to arrive at revenue per FTE. • Projections for New Business have been considered on the same basis as those for Infologistics Business described above. Source: Management • Key points • Cost plus margin model has been considered for the financial projections of the Company. • For the first three months of the agreement, margin has been considered at 10 per cent of costs. Subsequently, margin has been considered as an absolute amount in INR million per FTE equal to average of margins earned in INR million per FTE during the first three months. • Projections for New Business have been considered on the same basis as projections for Infologistics Business.
Forecast Financial Statements - IIPL • Revenue break up • Revenue attributable to Infologistics Business reduces from 87 per cent in 2010 to nil in 2014 as the contract with the Infologistics Group expires on 3 July 2013. Source: Management Forecast financial information - IIPL • Negative revenue growth of 16 per cent and 28 per cent in 2012 and 2013 respectively is primarily attributable to rationalisation of FTEs. • Gross margin has been considered to be around 36 per cent over the projection period. • While lower EBITDA margins in 2011 and 2014 are attributable to cost of recruitment of additional FTEs. • Key points • Revenue is driven primarily by the Infologistics Business till 2012, subsequent to which share of New Business increases. • Gross margins are constant at 36 per cent. EBITDA margins fluctuate due to costs associated with idle resources or recruitment of new FTEs. Note : *Period from 4 July 2010 – 31 December 2010 Source: Management
Forecast financial information – Intangible asset : Order book Forecast financial information – Order book • Revenue from order book reduces from around INR 244 million in 2010 (4 July 2010 to 31 December 2010) to around INR 98 million in 2013. This is due to decrease in FTEs serving the Infologistics Business as per the agreement. • FTEs serving the Infologistics Business have been considered equivalent to Applicable Minimum FTE Volume guaranteed by the agreement as follows : • 4 July 2010 – 31 December 2010 : 193 • 1 January 2011 – 30 June 2012 : 180 • 1 July 2012 – 3 July 2013 : 76 • Though FTEs at the end of 2013 are nil, 76 FTEs cater to the Infologistics Business from 1 Jan 2013 to 3 July 2013. Projections for 2013 have been considered on this basis. • Gross margins have been considered to be around 36 per cent and net margins have been considered to be 14 per cent throughout the projection period. • As compared to the historical financial statements, the Company has reclassified facility operating cost, travel and entertainment expenses under direct expenses in the projections. Accordingly, gross margin is 36 per cent vis-à-vis 43 per cent in 2008. • Key points • Revenue from order book is driven by Applicable Minimum FTE volume specified in the MSA. • While gross margins have been considered to remain constant at 36 per cent, EBITDA margins are around 14 per cent over the projection period. Note : *Period from 4 July 2010 – 31 December 2010 Source: Management
Methodology and approach • Basis of valuation • This PPA Valuation has been prepared on the basis of Income approach and allocates purchase price paid by XYZ on account of acquisition of a controlling stake in IIPL. • Valuation methodology • Market approach • The market approach determines the fair value by comparing recent sales of similar assets. The information is adjusted based on factors like age, condition or type of sale, to reflect the specific characteristics of the intangible asset. In the market approach, a variety of factors is considered by the market. However, the market does not necessarily value the contribution of the specific intangible asset to the value of an ongoing enterprise. The market approach reflects current market perceptions, conditions and transactions. However, sales or market prices of intangible assets are seldom available. This is due to the fact that intangible assets typically are transferred only as part of a business, and not in a single transaction. A comparison between intangible assets is difficult and thus a market approach is seldom feasible, because intangible assets are rather unique to an enterprise. Since the details of recent sales of similar assets is not available, we have not used this approach. • Income approach • The income approach determines the fair value from the future cash flows the intangible asset will generate over its remaining useful life. The application of this approach involves projecting the cash flows which the intangible assets are generating, based on current expectations and assumptions about future states. It should be noted though, that synergistic or strategic benefits in excess of those to be realized by market participants have to be removed from the projected cash flows. Then, these cash flows generated by the asset have to be converted to a present value by discounting them with the appropriate discount rate. The discount rate reflects the time value of money and the relevant risk associated with the cash flows and the intangible asset. • The income approach can be further distinguished according to the way cash flows generated by the intangible asset are calculated. The most important methods are : • multi period excess earnings method; • relief from royalty method; and • incremental cash flow method.
Methodology and approach • The multi period excess earnings method calculates the cash flows based on a detailed forecast of cash inflows, cash outflows and pro forma charges for economic returns of and on tangible and intangible assets employed. The cash inflows and outflows are in general derived from projected financial information. Since normally intangible assets only generate cash flows in combination with other tangible or intangible assets, notional payments for these contributory assets are taken into consideration for the determination of the relevant cash flows. The charges for the economic returns are computed based on the assets utilized by the intangible asset. The resulting net cash flows are also termed multi period excess earnings. We have used this approach to value the Order Book (IIPL MSA). • It is presumed that the contributory assets were leased from a third party in that scope necessary for the generation of cash flows. All considerations refer to the attributable fair value of the relevant contributory asset. The applied contributory asset charges take into account the return of the asset (wear and tear) and the return on asset (a reasonable interest on the capital invested). Asset charges have to be calculated for the value of assembled workforce, although this itself cannot be recognized as an independent asset apart from goodwill. • Finally, the tax amortization benefit (“TAB”) is added to the discounted after-tax value of the identified asset. The TAB reflects the additional value accruing to the intangible asset because of the ability to deduct the amortization of the asset over its useful life for tax purposes. According to current practice and literature the TAB is an element of the fair value of all intangible assets that are deductible for tax purposes even if there is no actual deduction in this specific case because the acquisition was executed as a share deal (and not an assets purchase). • The relief from royalty method assumes that the intangible asset has a fair value based on royalty income attributable to it. This royalty income represents the cost savings of the owner of the asset – the owner does not have to pay royalties to a third party for the license to use the intangible asset. The derivation of the royalty income consists of two steps: the determination of revenues attributable to the asset and the determination of the appropriate royalty rate. • The TAB is also a component of the fair value which is derived from a relief from royalty method. • The incremental cash flow method compares the future estimated cash flows from the enterprise including the intangible asset being valued with the cash flows from a fictitious comparable company excluding the asset. • The difference in the cash flows per period between the two companies is reflected in the incremental cash flow attributable to the intangible asset to be valued. To calculate the fair value of the asset, these additional cash flows are discounted to the valuation date using the weighted cost of capital rate specific to the asset (post-tax calculation). These additional cash flows may arise if additional cash receipts are generated by the intangible asset concerned or cash payments are saved. • The application of the incremental cash flow method presupposes that the future cash flows of the fictitious comparable enterprise can be reliably estimated without this asset. • Cost approach • The cost approach estimates the value of an asset based on the current cost to purchase or replace that asset. The cost approach reflects the idea that the fair value of an asset should not exceed the cost to obtain a substitute asset of comparable features and functionality. However, there may be little correlation between the cost incurred and the fair value created by an intangible asset. We have not used this approach to value the intangibles.
Discount rate – general In order to determine the discount rate, we have used the WACC methodology as set out below: WACC = Ke * ( E/(D + E)) + Kd * (1-T) * ( D/(D + E)) Where: Ke = cost of equity E = market value of equity Kd = cost of debt D = market value of debt T = corporate taxation rate Valuation analysis - Discount rate • The cost of equity is derived using the Capital Asset Pricing Model (“CAPM”) as follows: Ke = Rf + ß * (Rm – Rf) + • Where: Rf = the current return on risk-free assets Rm = the expected average return of the market (Rm – Rf) = the average risk premium above the risk-free rate that a “market” portfolio of assets is earning ß = the beta factor, being the measure of the systematic risk of a particular asset relative to the risk of a portfolio of all risky assets = company specific risk factor (alpha) • Cost of equity • Risk free rate • The risk-free rate is derived by reference to the bond yield on the long term 10 year Government base rate, which at the Valuation Date was 4.3% (Source: Ministry of Finance) • Market risk premium • The Equity Risk Premium considered in our analysis is 1.9%, based on expected long term returns in the Stock Exchange. (Source: 10 year return on index on Stock Exchange)
Valuation analysis - Discount rate • Beta • In order to determine the appropriate beta factor for IIPL, consideration has been given to betas of comparable quoted companies in the global BPO sector. • Since there are no listed captive BPOs, we have considered third party BPOs in our analysis. • Though IIPL caters to the logistics sector only, due to lack of close comparables, third party BPOs catering to multiple sectors have been considered. • Keeping in view the small size of IIPL’s business, only companies with annual revenue of less than USD 500 million have been considered. • Further to the above, the comparable company beta factor is enumerated in the table below. • Observed betas in the market reflect actual financing structures. In undertaking a DCF analysis of a target company it is necessary therefore to unlever the beta observed in the market for the impact of financing structures and then relever this asset beta based on the target debt to equity ratio. • A review of data for comparable quoted companies indicated 0.5 level of debt financing being used by businesses in the same sector. • Based on the specific characteristics of IIPL and based on current capital structure of IIPL and discussion with the management, we have considered a capital structure of 100 per cent equity, for the purposes of our analysis, which results in a relevered beta of 1.1 • Company specific risk factor • In estimating the Cost of Equity of IIPL, consideration has been given to the size of the business, single customer focus, single industry focus and illiquidity associated with investment in IIPL. Since the business has a high level of dependence on a single customer i.e. Infologistics Group and it is not listed on any recognized stock exchanges, we have considered a company specific risk premium of 3 per cent in estimating the Cost of Equity for IIPL. • Conclusion • Applying the above factors results in CAPM derived a cost of equity of approximately 9.4% Note : All figures in USD million. Source: Industry database
Valuation analysis - Discount rate Tax • Corporate tax rate of 33.22% has been used in the computation. • Conclusion • The WACC estimated based on the methodology and assumptions set out in the preceding sections was 9.2% for IIPL. 4.5% 33.22% 3% IIPL cost of debt IIPL tax rate IIPL net cost of debt 0% X(1- )= X Cost of debt 9.4% Target capital structure WACC = 3% 4.3% 1.9% 1.1 Alpha Risk-free rate (Market Rate of Return – Risk Free Rate) Beta 100% Cost of equity )+ +( x X • Key points • Cost of equity – 9.4% • DE ratio – 0:1 • WACC – 9.4%
Valuation analysis - Contributory asset charge Contributory asset charge • In order to account for the use of all other tangible and intangible assets to generate the relevant cash flows under consideration, contributory asset charges have to be deducted. Charges to be applied on the respective revenues for the use of contributory assets were calculated for fixed assets, working capital and assembled workforce. • Fixed assets • The derivation of the charge for fixed assets is provided below: • As on date of acquisition IIPL had fixed assets amounting to INR 46 million. Management estimates to incur an average capex of around 3 per cent of revenue over the projection period, cumulative capex being INR 82 million. The fair value of fixed assets enumerated above has been considered on the basis of Company’s capex plan and depreciation of around 25 per cent on SLM basis. • The required return on fixed assets is estimated on the basis of after tax risk free rate of return, considering the nature of asset. • Note : • 1. For 2010, fair value of fixed assets on 3 July 2010 has been considered. Revenue has been considered for the full year on the basis of actual revenue for six month period ending June 2010 and projected revenue for the remaining part of the calendar year. • For subsequent years, fair value of fixed assets at the end of the year and revenue for the full year have been considered. • Fair value refers to net block of fixed assets. • Source: Management, VVSS analysis
Valuation analysis - Contributory asset charge • Working capital • The derivation of the charge for working capital is provided below: • As on date of acquisition, IIPL had net working capital amounting to INR 5 million. Fair value of working capital from 2011 to 2015 has been considered as follows: • Debtors of 60 days of revenue • Creditors of 60 days of operating expenses • As per Management inputs, the prevalent rate of working capital loan in the country is around 4.5 per cent. The required return on working capital is estimated based on post tax cost of working capital loan. • Note : • 1. For 2010, fair value of working capital on 3 July 2010 has been considered. Revenue has been considered for the full year on the basis of actual revenue for six month period ending June 2010 and projected revenue for the remaining part of the calendar year. • For subsequent years, fair value of working capital at the end of the year and revenue for the full year have been considered. • Source: Management, VVSS analysis
Valuation analysis - Contributory asset charge Assembled workforce • The assembled workforce is not an intangible asset that is recognized apart from goodwill when acquired in a business combination. However, the assembled workforce is valued in order to determine the appropriate capital charge, which is a fictional lease payment charged to other intangible assets. • As part of the transaction, XYZ acquired a trained and assembled workforce. This approach determines the price a similar company would pay to replace the workforce. The result is equivalent to the premium a purchaser would pay for a company with an assembled workforce in place. Costs associated with creating an assembled workforce in this industry were estimated to establish the replacement costs to estimate the fair value of the assembled workforce, including recruiting and training time and expenses. • As per inputs received from the Management, the estimated fair value of assembled workforce is enumerated in the table below: • Training cost per employee has been considered equivalent to salary of half a month. • Considering that an employee requires one month to attain 100 per cent efficiency, salary cost of one month has been included in fair value. • Recruitment cost of 8 per cent of annual salary has been considered. • The required return on assembled workforce is estimated on the basis of WACC. • Source: Management • Source: Management, VVSS analysis
Valuation conclusion - Allocation of Purchase Price • Note : Purchase Price Allocation has been conducted on the basis of information provided by the Management. • Source: VVSS analysis • XYZ has incurred INR 309 million as purchase consideration to acquire a stake of 100 per cent in IIPL. • As at the date of acquisition, IIPL had cash and marketable securities of INR 83 million and zero debt. • While net working capital at the date of acquisition stood at INR 5 million, fixed assets were INR 46 million. • Further to the above, value of intangible assets including goodwill and order book is INR 175 million. • Key points • Purchase Price Allocation to intangible assets including order book and goodwill is INR 175 million.
Valuation conclusion - Intangible asset – Order Book Note : *Period from 4 July 2010 – 31 December 2010 Source: VVSS analysis • Present value of cash flows from order book amounts to INR 62.1 million. • Present value of benefits on account of tax amortization amount to INR 19 million. • Key points • Considering cash flows and tax amortisation benefit, fair value of order book is INR 62.1 million Note : *Period from 4 July 2010 – 31 December 2010 Source: Management
Valuation conclusion - Allocation of Purchase Price • Note : Purchase Price Allocation has been conducted on the basis of information provided by the Management. • Source: VVSS analysis • Key points • As per the analysis in the previous section, the value of identified intangible i.e. order book has been reduced from the value of intangibles. • The balance amount is goodwill and is valued at INR 113 million.
Valuation conclusion - Reconciliation of return Source: VVSS analysis • Key points • The weighted average return on assets is given in the above schedule. • As per the analysis, return on goodwill is 11.7 per cent and the overall return on assets is equal to WACC.
Sources of information SOURCE OF INFORMATION • All of the following documents and information are to be regarded as an integral part of the report: • Audited financial statements of Company for the year ended 31 December 2008 and 2009 as per Indian GAAP; • Unaudited financial statements for the six month period of January – June 2010. • Balance sheet of the Company on 3 July 2010; • Share Purchase Agreement entered between XYZ and Infologistics Group; and • Master Service Agreement between XYZ and Infologistics Group. • Due Diligence report dated 11 June 2010 • In addition to reviewing the above information, we also held discussions with key members of management, including: • Vishal Kapur, VP and CFO • Deepak Sharma, VP and Controller • Sandeep Roongta, Assistant Vice President • Relevant information made available to us by the Management at our request; • Publicly available information and secondary information.