Out of 22 outsourcing stocks, a few have outperformed the S&P to date this year: EXL Service, Global Payments, Star Tek and UEPS. But 18 have underperformed by an average of 9 percent so far. Why is this trend happening?
First, investors are always forward looking, and stock disappointments or exuberance are relative to the prior year. We saw great appreciation in stocks across the industry in 2013. But this year we’re well off that pace. With stocks at full value last year, they have less progress to go.
Several other factors are in play. Protectionist sensitivity to moving work offshore affects several providers. Rising labor costs, attrition and currency fluctuations take another hit. Competition and pricing pressure are intense in some segments. And some providers are dealing with a stepped-up pace of regulatory changes as well as integration challenges of acquisitions.
But I believe the biggest factor is that the global services space is maturing. The strong, robust growth driven by the secular shift to offshoring or labor arbitrage is starting to flatten.
As a result, the industry is in search of the next set of S curves that can drive growth. There are a number of interesting contenders:
- As a service
- New functional areas that companies are willing to contemplate giving to third parties
- Vertical industry plays in healthcare or financial services driven by wrestling with regulations and driving further into compliance and dealing with regulations
All these areas are promising for industry growth. However, these new growth opportunities are not sufficient to offset the declining rate of growth in the broader arbitrage segment. So what does this portend for the future?
I think at least until — and unless — these new areas develop enough scale for robust revenue growth, we’ll see the kind of cyclicality that we’ve experienced over the last few years with the industry’s fortunes tied to economic cycles rather than an underlying growth engine.