CESC shares drop 14%; need for Firstsource deal questioned

Shares in CESC dropped as much as 17.7 percent on Friday as investors questioned why the Indian power utility has agreed to buy a stake in business process outsourcing company Firstsource Solutions .

CESC said on Thursday it would purchase a 49.5 percent stake in Firstsource for Rs 3.95 billion.

Including a mandatory open offer for another 26 percent of Firstsource shares, the total purchase could amount to around 6.5 billion rupees.

CESC said growth opportunities in the power sector were getting challenging, while returns were no longer as lucrative.

Citigroup downgraded CESC to 'sell' from 'buy', saying the acquisition was "unrelated" to its core business, while noting the utility's prior record of diversification into the retail sector "has been poor."

The bank added buying Firstsource would increase CESC's leverage and depress profits, and cut its target price to Rs 300 from Rs 345.

"Although Firstsource is an established player in the Indian BPO industry, it has been struggling to turn around over the last 3 years. Further, we understand that the infusion of Rs. 2.8bn is unlikely to improve Firstsource's debt laden financials significantly (the company will still have a net debt of approximately Rs 15 bn after the infusion). Moreover, the unrelated nature (no identifiable synergies) of the investment is a clear negative," Vijaykumar Bupathy, Senior Research Analyst at Spark Capital Advisors said.

"From CESC's perspective, this means an immediate outflow of Rs 6.4 billion (almost 75% of company's FY12 standalone cash) for acquiring a controlling stake (~80%) in Firstsource. This implies a significant drop in CESC's other income during the remainder of FY13 and FY14. Also, CESC's cash position will likely drop alarmingly by FY14 end, making the company dependent on external capital for funding investments into Haldia and Chandrapur. Downgrade to Sell (from Buy) with a price target of Rs. 255 per share (at a 20% discount to our SoTP valuation given the company's impending dependence on external capital)."

CESC shares were down 14.2 percent to Rs 283.70 as of 10:10 a.m.

With inputs from Reuters

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