In June 2002, Rajesh Hukku, chairman and managing director of i-flex solutions, went ahead with an initial public offering of the company’s shares. At the height of the Indo-Pakistan military standoff, when the world feared a war between the two nuclear weapons-armed states, i-flex shares launched at Rs.530 a share and quickly took off. A little more than a year later, the Mumbai-based company declared a bonus of one share for every share owned — in effect, a two-for-one split.
Since Oracle bought out Citicorp’s 42% interest in August 2005, boosting its ownership to 83%, the shares have rocketed up further, to a recent Rs.2,020 ($47.11) — an almost eight-fold increase over its split-adjusted offer price — in less than five years. The company now has a market capitalization of about $3.6 billion. In a December 2006 article, The Hindu newspaper recommended investors accept Oracle’s Rs.2,100-per-share ($48.97) offer to buy i-flex shares, pointing out that, based on an earnings estimate of Rs.45 ($1.04) per share for the just-completed 2006-2007 year (which ended March 31), the offer was 46 times earnings, compared with a price-to-earnings ratio of 33 times for Infosys.
In the second half of a two-part interview with India Knowledge at Wharton, Hukku, 49, spoke about i-flex’s competitive strengths and what he hopes for from the Oracle purchase with Ravi Aron, a senior fellow at Wharton’s Mack Center for Technological Innovation. (To read the first part of the interview, please click: i-flex solutions’ Rajesh Hukku: ‘No One Dreamed That $400,000 Would Become Almost $600 Million in 13 Years’ .)
Aron: Why is there no Indian company with the global stature of an IBM or a Citicorp?
Hukku: IBM and Citicorp have a size and time-to-evolve factor. I believe that in another ten years you will see true multinationals from India. The signs of this can be seen even today. We have 18 nationalities represented in our employees. A lot of other companies are setting up centers around the world and hiring foreign nationals.
However, I agree that we have a long way to go to emulate true globalization as a country. We need a change in the mind-set to be able to integrate the Indian way with the way of other nations, the different work-styles, different cultural nuances, and a lot more. The culture, work ethic and style are very different between a European or American person versus an Asian. Both sides have to trust each other and respect their individual styles, learn from each other and complement each other’s strengths, rather than getting upset about the differences. It is difficult and it takes time to do this assimilation.
But the good news is that a lot of good Indian companies understand this. I was quoted in Business Week, four or five years ago, that we have a dream to be a global company that manufactures in India, rather than an Indian company which sells around the world. Many CEOs are saying similar things and working on making this happen. Indian companies buying foreign companies and vice-versa will also help in building the global organizations of the future.
The reverse is also true with foreign employees who are set to integrate with the Indian ways. Indian companies today are hiring people — Americans, from American universities — and taking them at the lower level, and integrating them. Maybe that is the way it will work better.
Aron: Would you do that?
Hukku: We are beginning to do that, in a very small way. People want to come to India now. An American wants to go and live in India because he thinks he will learn something new and it’s going to improve his resume.
Aron: I have an MBA student who’s going to India to take up a permanent position. He’s not going there for his resume. He’s actually going there because this is a company that he’s excited about and he’s going to make his career with.
Hukku: When you start fresh and small, then it’s very easy.
Aron: When will we see TCS, Wipro, Infosys, regularly make standard career paths that terminate in the CEO’s oak-paneled office for Americans from Wharton, Stanford, Harvard, places like that?
Hukku: I think it will happen sooner than later. Sooner than you expect. Most likely, it will be led by the large Indian companies, because when somebody wants to go to India, they look at a company that is already a brand, listed with NASDAQ, $10 billion dollar market capitalization, it’s an easy proposition.
I personally think that both sides are ready for it. The fact that you are talking to me means that we are meaningful to somebody from Wharton. Recently, I was at seminars at Wharton, Yale, Columbia, Harvard and Michigan, so people here are also very meaningful to us. I don’t have a budget to hire 100 students from the U.S. today, but obviously there is a thought process behind it. I think it’s important for students at these universities to know our story. And maybe a few of them will get excited and come to us, and maybe we’ll formally start going to them in future.
Aron: You have spread from Africa to Europe, the U.S. and Latin America. What gives i-flex its brand strength?
Hukku: A brand’s strength is directly proportional to who uses it, what capabilities it brings, how it benefits its users, and what the experts think of it. FLEXCUBE, our flagship product, has been adopted by more than 300 banks in 100-plus countries, since its launch in November 1997. For a product that comes out of India, or anywhere, which addresses a very mission critical operation of a financial institution, to be adopted by banks in 100-plus countries within a period of 10 years, is a very unique thing. I personally do not know of any examples of a brand new product, capable of running the whole bank, which has geographically spread so rapidly.
We support transaction processing, analytics and risk & compliance for financial institutions. We handle all internet banks to very conventional banks, where we are replacing legacy systems. If you look around the world today, there are probably more than a hundred software companies in the financial services domain, but i-flex, with its global applicability and end-to-end functional coverage, is unique.
Aron: It is obviously a product with a great deal of versatility. How do you customize the features that need to be built in, and how they need to work, in each of these countries in your major markets?
Hukku: It takes in a lot of hard work on many fronts to be able to do this. We are proactively and constantly looking at what new things are happening, how needs are changing. So our first effort is to absorb these changes, and we have a structured method of assimilating the needs that will arise in the future.
Once you understand what is required, then it is a matter of hiring the right people, getting consulting help, and taking it through the whole cycle of creating a new or enhanced product. The product is also constantly improving as we install it in Tier-1 banks. As they use FLEXCUBE, they want more features, always pushing the envelope. As they replace their old systems, their wish lists come into play.
Another way is through acquisitions. We are constantly looking at either acquiring complementary product companies or acquiring the rights to their products. Our biggest acquisition so far was of a U.S. company called Mantas, a thought leader in anti-money-laundering and behavior detection. Mantas complements our Reveleus product extremely well, and together they cover almost the entire area of risk and compliance for financial institutions.
Aron: Rajesh, tell us a little bit about the acquisitions in the consumer finance and insurance areas.
Hukku: FLEXCUBE handles lending, but as you go into very specific areas, like the U.S. auto-finance industry, or commercial real estate, they have their own requirements. About two and a half years ago, we understood we had to enrich FLEXCUBE with those requirements. After we took the conventional build-or-buy decision, we realized that it would be better to look for a very well thought out, conceived, and architected product, and to integrate it with FLEXCUBE rather than spending years building all that expertise.
We identified a company called Super Solutions in the U.S. and we went for a total acquisition of that company. In the last two years that we have been working with Super Solutions, we have done two or three things. As their software was directed more to non-bank lending institutions, we took the relevant pieces of their software and integrated them with FLEXCUBE, which is normally sold to a bank that also does this kind of lending. And we have had some success in selling FLEXCUBE to more banks where this requirement was part of their overall core banking needs.
Secondly, we are continuing to sell their product independently, as well. They were a smaller company, and they were only focusing in the U.S. We are taking their product to other geographies and other customers that they did not have access to. We have had some success in Japan and in Europe already, selling their package as is.
Now, insurance is the next frontier for us. We believe that legacy systems in the insurance domain also need to be changed for the required operating efficiencies. A huge amount of improvement can be done on insurance systems, and obviously you have to start from somewhere. So in this particular case, we initially started by creating a center of excellence for insurance within India by hiring some domain experts who had worked with international companies, and had a good understanding of the market and domain.
Aron: Where did you find these experts?
Hukku: The lady who is handling the Center of Excellence for us has worked for insurance companies in Europe and US, and technology companies like Microsoft. You start with one and then two, and then build a team of 15 to 20 people, and then you create a strategy.
Insurance is a huge area, but based on recommendations from industry experts, we short-listed system areas that were more amenable to change. Again it was a build-or-buy decision. In this case, since we were starting from scratch, we thought that we should first get hold of a company that had already spent a reasonable time building the expertise. We looked around, and we found a very nice company, called Castek, in Canada — once again, a small company but with a very good product. We did detailed due diligence and then took a controlling stake (now more than 70%) in the company.
We landed a very big initial deal, from the point of view of the size of Castek. It is with Tokyo Marine, which is one of the largest Japanese insurance companies. The deal is for their operations in the United States, and it is a huge project which is going to completely alter their entire policy administration legacy systems. This is a beautiful case of build/buy/ally, with everything happening in one project. We are building some stuff, we have brought the core package, and we are allying with three or four other industry players in the United States, outside of i-flex.
These acquisitions — and there have been several others — signify that we are constantly and proactively going out and trying to complete the whole canvas of the financial industry, but with little steps at a time. It’s not as if something fell into our lap and we said: “Hey this is interesting,” or somebody came and said: “We need to increase our revenue and so why don’t we acquire something?” It’s a very well thought out strategy where we are going out to look for the best, and the best not only means the best technology, but also how to integrate and manage the future.
Aron: This sounds a lot like what, say, Infosys, would do, or what IBM is doing, which is building new applications if the customer wants it, business process outsourcing operations, and consulting. So will i-flex be competing with Infosys and IBM and companies like those?
Hukku: IBM is a great partner for us, though we also compete with them in some cases. IBM’s strategy involves doing all the things you said, and they are a very large and well-resourced organization. But one piece of the strategy is very different between IBM and i-flex. They are not creating intellectual property in the core banking applications area. They’re working with players like i-flex and others.
We have no ambitions on hardware. We have no ambitions on operating systems. We have no ambitions on networking software. We also do not have ambitions for the very large customer outsourcing of data center operations. So IBM and i-flex is a great partnership. We are looking to be that end-to-end solution and there is great scope for i-flex, IBM, Oracle all working together, with some pieces owned by us and some pieces owned by them. For example, at Syndicate Bank in India, where IBM is a system integrator, they are bringing in FLEXCUBE, i-flex consulting, their own program management system integration, and managing the whole end-to-end contract with the bank.
If you look at companies like Infosys, obviously we compete with them in every way, but there are two main differences. One is that the large Indian companies, like Wipro, TCS, Infosys, which are great companies and very capable, are coming from the professional services competency side (around 95%-97% of their revenue base), and have a very miniscule percentage of their revenue coming in from their own Intellectual Property and Packages. We are coming from a very balanced services and products strategy (each around 50% of our revenue base), right from the get-go. FLEXCUBE is in more than 300 banks, so we are far ahead. The services and consulting competency is at about the same level but obviously the size of their outsourcing and BPO is much bigger and they have been at it for 10 to 25 years, before we were even born.
The other difference between large IT companies in India versus i-flex is that they do everything under the sun. But we are 100% focused on the financial services industry. We believe that our domain expertise, if you look at the complete canvas of the financial industry, is a few notches above the generalized large services companies in India.
Aron: IBM has applications instead of packages. Why are they not putting together banking packages, insurance packages, supply-chain packages? It’s a natural fit for them.
Hukku: Well, only IBM can give the best answer for this. Right from Mr. Gerstner’s time, I think the focus has been on providing solutions rather than building application packages, because of the amount of business that they generate by keeping themselves open to any package.
They make a lot of money from selling hardware, selling operating systems, networks, environmental software and system integration services and hosting. In a large deal, if the deal is say $5, I would think that the core banking package would be $1 or $1.50. If they started doing that, they would have to do everything on their own. Today they can make $3 or $3.50 with every package that exists.
Aron: There is a lot of money in providing solutions and services and IBM correctly sees that as the larger opportunity. This ties in with an idea I’ve been working with for the past year and half or so: the idea of revenue and intelligence density. Simply put, the closer you get to functionalities away from the edifice — the edifice being the operating system — the more the amount of intelligent information that can flow increases. The greater the intelligence density, the greater the revenue per unit of work executed.
Hukku: Absolutely. Very well put, Ravi.
Aron: So if consulting services and solutions, the direction in which IBM is going, are obviously the higher intelligence areas, does it not mean the package delivery industry would a) be relegated to lower margin businesses, and b) over time, face commoditization?
Hukku: Here, I differ with you. Operating systems, databases, and some of the environmental software, where domain specific intelligence is not required, could be perceived as cookie-cutter. It is true that here the price you can command over a period of time will not be a factor of how different you are, but of what your market share is and are you continuously improving, so that the user never has to worry about it? If you look at Oracle, their strategy in the database area and Enterprise Resource Planning area is precisely that. They are continuously investing in making their database more and more robust, more and more secure, and more and more open, because that’s what the internet era user demands. On the other hand, they are consolidating their market share.
I disagree with your proposition that a package like FLEXCUBE or Reveleus can become commoditized, and therefore, much less profitable than a pure consulting play in the long run. Of course, it is assumed that there is a constant investment and R&D being put in. Once you have put a package into a financial institution, it’s a very long-term relationship, per customer, the length of your service, and the revenue that comes from it. The continuity of the revenue stream is directly proportional to the benefits that the customer gets and the growth of the customer business. Although consulting is rated higher per unit cost and price, it may be a limited engagement.
Aron: When you say services, you mean…
Hukku: When we say services, we mean doing something specific for the customer. It’s being custom-done for the customer, whether he’s providing all of the specs, part or none. And the intellectual property of the customer belongs to the customer and stays behind Chinese walls. That’s what we call professional services. To that extent, we are very similar to what the good Indian companies do, with probably two differences. One of them is that we do work only in financial applications and the other is that we differentiate and win by domain expertise. Size is mostly a factor, and price is always the factor, in the services business. We are big enough today and comparable to the best companies in price; but generally the winning factor is that we are able to demonstrate that we understand the business better than anyone else. We also have a relatively good edge on the high-end consulting business.
Aron: How difficult is it for you to acquire high-end service capability, consulting, providing solutions, that kind of thing?
Hukku: If you’re looking at domain expertise and high-end solutions capability and consulting, I don’t think anybody has a clear monopoly. So we are at par with most of the Indian companies, simply because we are only focusing on one domain, and they are focusing on 20 different domains. In every deal, our competition is a large Indian or U.S. company. When we win, we win mostly because of domain expertise. It clearly comes out that we know the customers business.
Aron: What percentage of your revenue comes from services, and what is the growth?
Hukku: Services has stayed mostly around 45% to 50% of our total revenues. When I say services, I mean services that are not related to the services on our product. The services business is within the financial services sector only, which includes high-end consulting, process consulting, domain consulting, actual turnkey development of new applications, support of those applications, support of third-party package implementation, system integration, but nothing to do with FLEXCUBE. We have two major high levels: We have project business, and we have product business and that has remained typically the other 50% to 55%.
In terms of growth, it is cyclical, because you’ll have years where services would be growing faster, and years where products would be growing faster. Over a period of last five years the service business has grown at about 30% to 60% year to year.
Aron: How do you compare on profitability with the information technology firms in India, and then with Accenture and IBM?
Hukku: Our profitability has to be split into these two businesses. On the product business, our profitability per employee is significantly higher than the industry majors in India, and the other services players. Our profitability is also much higher than the international application product companies. Here, the license fee helps a lot; the annual maintenance over the years becomes profitable and recurring.
On the pure services segment, our profitability is on par with good global players, but it is significantly lower than the top Indian players. We are not at critical mass yet. The economy of scale is yet to come.
Aron: Will we ever see you entering the pure BPO business for financial services?
Hukku: Yes, we are already there. Our BPO is in fact KPO – Knowledge Process Outsourcing. And we were very selective about entering into an area where we actually could value-add based on domain competency. This way we could differentiate ourselves.
Using our build/buy/ally strategy, we started the BPO line of business with an acquisition of a company, a U.S.-India-based company, called Equinox. The reason we selected them is that their size was manageable, but mostly because they were specializing in only one thing, and that was mortgages. The top management not only possessed expertise from the mortgage industry, but they were also six-sigma black belts. Since we have taken Equinox, we have quadrupled their facilities, so that’s where a lot of our investment has gone, in the last year or so. And the revenues will follow.
Aron: So, are you a product company? Are you a services company? Are you in consulting? BPO? What are you?
Hukku: The answer is simple and goes back to our mission — to make financial institutions excel in their business. And there are different answers at different times for the same bank or financial institution. There are different answers for the same financial institution in different countries. There are the same answers for different banks. You will need to be capable of solving the problem, either by yourself or through your network of alliance partners. And every year, the problem will change, from country to country, from division to division. So you can’t say you are a pure play, and FLEXCUBE is all I should focus on. We value the intimacy and trust of the customer. “Whatever his challenge or opportunity, will he come to us first?”
Aron: You’ve tied it together very nicely. I see strategically how this plays. Do you see the solutions industry becoming specialized, and you have more and more coalitions of, say, five or six companies where one person is the integrator and the deliverer of the solution, and he brings in a strategic alliance of five or six companies?
Hukku: I think in banking solutions, there is a lot of consolidating happening, both in terms of direct mergers and acquisitions, as well as with alliances. The good news is that nobody insists on exclusivity. They are open to getting whatever wallet share of the customer is possible — buying, allying and putting bits and pieces of different players together.
I think that is where the Oracle strategy is really brilliant. Rather than saying, “Look, every banking package anyway works on Oracle, so why do we have to be much closer to i-flex?” They have taken the stand to create an ecosystem where you could go to a very large financial institution and say, “I can transform you. And this is my solution. This works seamlessly with me. I own it. I take the responsibility.” Oracle has taken the first step in that area.
Aron: How did you catch Oracle’s eye?
Hukku: That’s a good question, better answered by them. Over the last 10 years, since FLEXCUBE has become successful, every time we sell it, Oracle gets sold, and that is how they knew of us. They made a decision, while improving their market share on the horizontal enterprise software, to also go beyond ERP and Database into vertical applications — Financial industry; Telecom; Retail, etc. I believe that when they decided on entering the Financial Applications vertical, they did a formal scan of all companies in that domain, and found us to be the most exciting company to partner strategically.
Aron: What are two or three things that you want the Oracle relationship to do in the future?
Hukku: One is that the power of Oracle and the power of i-flex have to continue to synergize in such a way that the resultant power becomes 1 + 1 = 11, rather than just 1 + 1 = 2. There are a lot of areas where Oracle can help us with — Tier 1 relationships, sales, branding, financial stability/funding, infrastructural support, to name the obvious. They have huge amounts of Mergers & Acquisitions expertise and they can guide us in that area too. In the words of Charles Phillips, Oracle’s President, “They are the mother ship that we can tap, when we need,” while essentially continuing to follow our original dream. In turn, they want us to build the biggest and best ecosystem in financial industry vertical working with them.
The other aspect is of providing the synergies of the Oracle/i-flex combination as a direct benefit to customers. Both of us are constantly creating the next generation technologies, and a well-architected and integrated solution based on Oracle’s products and our products will be truly transformational and hugely effective for the customer. Customers have, for the first time, a choice that is rich in content, proven, and with the size and scope that he can depend on.
In a nutshell, our plan is to remain focused on our mission, and focused on our vertical specialization, while accelerating and improving our capabilities with Oracle’s support from outside. It is also clear that while we will integrate our solutions seamlessly with the Oracle application and technology stack, we will continue to partner with other partners and technologies — like IBM. In fact, the coming together of the capabilities of Oracle, IBM, and i-flex to create transformational solutions for the financial industry, as we announced formally sometime back, is an ultimate opportunity for our customers.