As Nearshoring has gained prominence in recent years, it has also become a leading region for global mergers and acquisitions (M&A) activity. Offshore service providers are bridging the onshore-offshore divide by offering a truly global delivery model leveraging nearshore capabilities.
Factors like access to bilingual skills, closer time zones, cultural similarities, low employee turnover and ready availability of talent are some value propositions that nearshore locations provide to the integrated service delivery plans of major corporations. Emerging economies in Latin America especially in Brazil, Colombia and Chile are also driving demand for outsourcing services. Hence global and offshore service providers are looking at Latin America as a region to diversify and for driving a higher growth rate.
While Latin America offers the lure of nearshore, it is a very diverse region with significant differences in the way business operates in various countries. Establishing an operation in these countries requires significant local expertise. In order to accelerate market entry and reduce risk, acquisitions have become the preferred route. Additionally, the growing adoption of Cloud computing and SaaS-based delivery models as well as Web-enabled and Mobile applications has provided nearshore firms an advantage over offshore ones. Software development methodologies like Agile require development teams and users communicating in real time and a constantly iterative development cycle. Nearshore destinations facilitate Agile development due to similar time zones and have also become a good source for software talent in these newer technology platforms.
Nearshore M&A Activity
Over the last few years global M&A activity has continued to grow, reflecting a positive momentum and buoyancy in the world economy. BPO industry valuations have risen with median revenue multiples for M&A deals in the BPO sector around 1.6X (Enterprise Value to Revenue). These valuation levels were last seen before the market crash of 2008. Rising valuations are also spurring M&A activity as buyers swoop in to acquire companies before they become out of reach.
Interestingly, valuations of nearshore providers are comparatively cheaper than offshore ones. Organizations actively look to acquire business interests in locations where the valuation premiums are below that of developed markets. This is another reason why the nearshore region will see increased activity in 2014. Global service providers with a strong nearshore footprint will also see higher buyout interest. Case in point, the recent acquisition of Stream by Convergys, was driven by the former’s strong nearshore presence. Recent investments in Brazil, Argentina, Colombia, Guatemala and Costa Rica are indicative of the growing services maturity in the region. Following are some of the notable nearshore deals that are defining how the industry is evolving:
The above deal activity evinces some nearshore M&A trends:
- Access to bilingual talent and nearshore proximity are still the major reasons for M&A.
- M&A interests in BPO functions like CRM and Analytics have outpaced other traditional functions like HR and F&A.
- Markets in Brazil, Argentina and Colombia are attractive but need to be serviced locally, requiring partnering with or acquiring local firms.
- Strategic deals like Genpact’s acquisition of GE Money in Guatemala indicate that nearshore locations have become as sophisticated as India and Ireland in providing multi-tier and multi-functional services.
- Nearshore providers are now venturing forth to acquire North American as well as Offshore firms. When ICD Group of Jamaica decided to foray into the BPO sector, they acquired ACI of Canada to tap into the North American market.
- Top nearshore destinations for acquisitions are likely to be Brazil, Colombia, Costa Rica and Guatemala. But there is growing activity in other smaller destinations like Jamaica, Dominican Republic, Nicaragua, Peru and El Salvador.
While strategic intent often overshadows quantitative and structural considerations, firms seeking to conduct M&A should keep in mind that an investment or acquisition is judged by the ultimate outcomes. Inadequate planning or a flawed evaluation and diligence process can de-rail the best of deals. Some of the key areas that should be assessed with fair amount of circumspection are:
Integration planning – It is common knowledge that the major reason for failure of M&A deals is post-integration issues. Improper integration planning can result in swift misalignment of objectives and a slippery slope towards failed outcomes. With the added complexities of emerging locations and relative difference in organizational cultures, it becomes even more imperative for firms to carefully discuss integration elements and plan for it prior to culminating a deal. A joint business plan outlining the fit of the nearshore delivery center within the global services supply chain is essential for a successful deal.
Deal terms and Structure – The terms of business conduct vary significantly between countries. One of the key reasons to acquire a firm in a new region is their knowledge of local markets and business operating environment. Hence it is important to ensure that the key executives are retained with sufficient incentives and performance bonuses to ensure continuity. Deal structure which enables the core team to execute upon a pre-determined business plan and realistic target based earn-out schedules help mitigate execution risks.
Valuation Premiums – Due to the frenetic courting activity, nearshore service providers have been expecting a premium on market multiples. Valuation premiums are to be assessed rationally to avoid hidden surprises. It is important to quantify the total cost of ownership (TCO) and business synergy that is expected post acquisition. With TCO and synergy defined, acquirer can then arrive at a realistic valuation premium to pay for the acquisition.
Balanced location footprint assessment – As with any investment, it is important to conduct a thorough location evaluation of the country where an acquirer is planning investments. Factors like currency stability, business culture, tax/regulatory environment, inflation, government support, geo-political risks and skills maturity play an important role in selecting the right location. However given the limited size of labor pool and higher delivery risks in the nearshore region, it is also important to operate across multiple locations. Acquirers should assess the overall footprint of the company across the region and map it to their own business objectives before making an investment decision.
Outlook for 2014
2014 is expected to continue the strong deal flow seen in the past few quarters. Improvement in financial climate, healthier balance sheets and a desire to seek inorganic growth are some of the key drivers. Easier access to financing on the back of low interest rates is also spurring deal activity. Wall Street Analysts are also pushing for offshore service providers to leverage the cash on their balance sheets to make acquisitions as a way to offset slowing growth rates.
Many of the larger BPO/Contact Centers will move beyond their core competencies both in terms of vertical specialization and service delivery expertise by acquiring smaller niche service providers. These acquisitions are expected to provide the much needed ‘value addition’ layer to plain vanilla services in turn helping increase per seat revenue.
Indian service providers are expected to get more active in the M&A space to mitigate flattening of their revenue growth curve, move up the value chain and diversify operations beyond the sub-continent. Above all, in 2014, nearshore locations are expected to benefit from M&A to further align and solidify their role in the globally integrated sourcing ecosystem.