I know that this is sort of a cliché topic, but I haven’t seen much interesting news during the past week.  In the absence of anything really noteworthy to comment on, I’ll take the easy way out.  Several of my clients have asked me to comment on where the China software outsourcing industry is heading, so I thought that I’d go out on a limb and make some predictions.  In no particular order:

• We’ll see a true leader emerge with the scale and the management sophistication to set the tone for the industry.  Some of the possible contenders include: VanceInfo (VIT), NeuSoft, iSoftStone, FreeBorders, hiSoft and Longtop.  FreeBorders has brought in some smart new executive management and is definitely moving in the right direction.  VanceInfo (VIT) and Longtop Financial (LFT) were able to raise capital from the public markets and clearly have the clout to step up.  NeuSoft certainly has the scale, and they’ve done a great job of working with Japan.  If they ever start to focus on the west, they will be a serious competitor.
• A small group of the companies will become very serious about winning western business and will make the investment necessary to have a credible sales team and world class delivery capability for mainstream western clients.  Longtop Financial (LFT), though their affiliated company Longtop International is already making inroads, as are some of the early leaders like hiSoft, FreeBorders and Augmentum.  iSoftStone is also rumored to be adding skilled senior management and staff in the U.S. for a major push into this market.
• Consolidation will accelerate with combinations that include some of the early leaders.  It seems inappropriate to name names, right now, but there are rumors that a couple of the pioneers will not be independent by the end of the year.  Of course, I’ll be happy to speculate off the record with anyone who wants to contact me.
• The industry will see a number of serious new players emerge as more ventures are established by Indian and western companies.  At least a couple of these will finally get it right and very quickly become leaders.  This prediction includes my guess that we’ll see western companies entering the market based on their strength in complementary industries.  I’ve spoken with some of these folks and they are really sharp.  If they make the commitment, they will be able to build businesses quickly (most likely though acquisitions, which ties into the prediction above).
• A couple more Chinese software outsourcing companies will tap the public markets in the U.S. for capital.  My bet is on hiSoft and DarwinSuzsoft.
• At least one of the Chinese companies listing in the U.S. will prove to be a big disappointment.  Again, I probably shouldn’t spout off about this in public, but I’d be happy to trade rumors privately.
• The yuan will continue to appreciate relative to the U.S. dollar, but it won’t move by enough to significantly impact any of the stronger software outsourcing companies.  The move could start causing problems for companies that are only competing on low hourly rates, or that haven’t managed their businesses well enough to achieve healthy margins.
• The recent concerns regarding the safety of products imported from China will have no negative impact on the software / IT outsourcing business in China.

I’ll try to remember to review these predictions a couple of times during 2008 to see how well I did.

Is anyone planning to attend the Olympics in Beijing? I intend to avoid the whole country during the time around the events.

Technorati Tags:  China, China Outsourcing

VanceInfo(VIT) announced that their underwriters had exercised the option to buy the shares set aside for over-allotment.  According to their press release:

…the over-allotment option granted by the Company to the underwriters for the purchase of 1,147,500 additional American Depositary Shares (ADSs) was exercised in full on December 17, 2007 by the underwriters Citi and Merrill Lynch & Co.

The sale complements the initial public offering by the Company on December 11[sic], 2007. As a result of the initial public offering and the over-allotment option, 8,797,500 ADSs are now held publicly and the aggregate offering amount is US$74,778,750.

I don’t know why the press release gives the date of the offering as “December 11, 2007″.  I believe that the offering actually took place on December 12, 2007.

Of course, VanceInfo didn’t actually add $75M to their war chest.  According to their filing:

(…collectively, the “Selling Shareholders”) propose to sell to the several Underwriters 1,350,000 Ordinary Shares

If we subtract the proceeds that went directly to the “Selling Shareholders”, the company actually brought in $63,303,750 (before expenses related to the offering).

As we reported earlier, the company priced at $8.50/ADS, but the stock jumped to $9.50 almost immediately upon opening on December 12, 2007.  It reached $10.95 a couple of days later (Friday, December 14, 2007).  Unfortunately, this hasn’t been such a good week.  The stock closed today at $8.51.

Longtop Financial Technologies, Ltd.(LFT) has also experienced some bumps.  After pricing at $17.50 (above the originally expected price range) in October, the stock closed up 85% at $32.40 on it’s first day of trading.  Today the stock closed at $20.49.  It actually traded as low as $19.25 on November 12, 2007.  I hope that the genius market bloggers that pumped this stock based on its early performance have re-evaluated their positions.  Of course, Deutsche Bank started LFT at Buy on December 4, 2007.  Jeffries also started them at Buy on the same day.  Avondale started them at Market Outperform on November 30, 2007.  So maybe I’m just missing something.

I guess that we’re still trying to figure out whether investing in these situations is investing, or gambling…

Technorati Tags:  China, China Outsourcing

VanceInfo used to go by “Worksoft” (a long time ago the company also used the name “Octiga”).  As some of us who attended software test related tradeshows remember, Worksoft was already claimed by a Dallas, TX company that “is a leading provider of testing solutions that automate, accelerate and optimize deployments of SAP® applications.”

The conflict with the aforementioned firm forced the Chinese outsourcing company to re-brand.  They chose the name VanceInfo as a play on “Advanced Information” - get it?  Insiders also tell me that VanceInfo sounds somewhat like the company’s real Chinese name.

They plan to begin trading on the NYSE on December 12, 2007, with the ticker symbol “VIT“.  According to the press release, they’ll be offering 7,650,000 American Depositary Shares at US$8.50 per ADS.  Rumor has it that both the price and the size of the offering are lower than originally hoped.  With these parameters, it looks like they’ll raise roughly US$65M - the chatter earlier this year was that they would be looking to raise something more on the order of $120M.

Their press release indicates that they plan to use the funds raised for “corporate purposes”, which include such things as capital expenditures, new offices and future acquisitions.  The information about book runners and offering managers is covered in the release.

VanceInfo’s Form F-1 for the offering is available online, but I have to confess that I haven’t taken the time to read through it, yet.

The folks at VanceInfo have worked really hard to build one of the leading software outsourcing companies in China and they should be proud of what they accomplished.  While they probably wish that they had been able to get listed before Longtop Financial Technologies (LFT) (see my rant about Longtop), I’m glad that VanceInfo has finally made the leap to the “big time”.  It looks like they may be positioned well to truly break out of the pack.

Technorati Tags:  China, China Outsourcing

According to a recent report, Shanghai Wicresoft, a joint venture between Microsoft and Shanghai Alliance Investment Company, will be merged with Hong Kong based Comtech Global Engineering & Management Services Ltd. to form a new company.  Comtech is a unit of Insigma Technology Company.

Based in Hangzhou, Insigma is closely affiliated with Zhejiang University, and was formerly known as Zheda Innovation Technology Company.  Insigma trades on the Shanghai Stock Exchange under the symbol (600797:SS).

Microsoft owned 49% of Wicresoft, while the government affiliated Shanghai Alliance Investment Company owned the remainder.  Once the transaction with Comtech is complete, the story reports that Comtech will receive 40% of the new company and Wicresoft will receive 60%.  The story also indicates that Insigma will inject US$6.66M into the new company and will become the new company’s largest shareholder.

Wicresoft’s main focus used to be providing support for Microsoft products in Asia.  If I recall correctly, they were a significant resource for both phone and e-mail support.  They also had some capability to do software outsourcing, but we found that their software development outsourcing teams were somewhat challenging to work with.

Zheda Innovation was one of the domestic outsourcing pioneers in China.  While they have been quite successful within China and dealing with MNC’s in the region, they haven’t yet pursued a leadership role in outsourcing to the west.  We tried repeatedly to work with them during the Zheda Innovation days, but we couldn’t match them with any projects from our western clients.  One wonders whether this combination will make Insigma more aggressive in pursuing American & European business.

I’ve long predicted that China’s outsourcing industry would see a major wave of consolidation, so maybe this is one of Insigma’s moves to roll up some nice business.  I think that it’s also a validation for the BPO market in China - at least the smart guys at Insigma appear to believe in it.

Updated: Wicresoft has apparently changed the address of their English language site. The link should be good, now.

Technorati Tags:  China, China Outsourcing

Two recent news bits caught my attention.  Unfortunately, they also made me a just a touch nervous.  I hope that I’m not being hypocritical.

First, I noticed that United Airlines is currently outsourcing aircraft maintenance…

“Currently, United is outsourcing heavy maintenance of its 747s and 777s to China and South Korea, and is exploring selling off its key San Francisco maintenance facility. The FAA does not require foreign companies to perform drug or criminal background checks on their employees. Foreign companies are also not required to employ FAA-certified mechanics.”

As a long time frequent flier on United (UA889 & UA857 are particular favorites), I was not particularly thrilled to learn this.

Then I saw that Cessna is planning to build a new airplane in China.

“…officials of Cessna and its corporate parent, Textron, Inc., struck an agreement with China’s Shenyang Aircraft Corp. under which the Chinese firm will become the exclusive manufacturer of Cessna’s new Light Sport Aircraft, the Skycatcher. The Skycatcher is a lightweight, high-wing, two-seat aircraft that carried an introductory price of $109,500 when Cessna began taking orders for it at this summer’s Experimental Aircraft Association convention in Oshkosh, Wis. (BA, July 30/44).”

According to Bloomberg.com, Cessna believes that this arrangement will allow them to hit a price point low enough to make private aircraft more broadly available.

“Textron Inc.’s Cessna unit, the world’s biggest maker of business jets, will build its latest aircraft exclusively in China to cut costs, the first plane the 70-year-old company will manufacture outside of Kansas.

Cessna’s new 162 SkyCatcher light sport aircraft will be assembled by China’s Shenyang Aircraft Corp., Textron said in a statement. The $109,500 plane, which has 900 orders, will be made in the northeastern city of Shenyang, said Chen Yongman, senior vice president of the Chinese company.

Cessna has boosted sales in China as the country’s growth rate of at least 11 percent makes private jets, yachts and other luxury goods affordable to more people. Aircraft manufacturers, including Airbus SAS, are also moving some production to Asia’s second-largest economy to cut costs and woo Chinese customers.

“The key to achieving 900 orders within four months of announcing the model is the aircraft’s affordability,” said Jack Pelton, chairman and chief executive officer of Cessna, in a video speech today in Beijing. “The key to achieving that price point is our partnership with Shenyang Aircraft.”‘’

They say that a picture is worth a thousand words.  Here’s an image that comes to me every time that I fly on a domestic airline in China:

`nuff said.

Cyrill Eltschinger’s opinion piece “China Rising” in Forbes.com presents a very interesting take on the current state of the industry.  According to Mr. Eltschinger:

“Outsourcing and offshoring are entering a new phase in their development. With the dollar falling and demand for outsourced talent rising, traditional choices for these services are changing and, as a result, incumbent players are no longer an automatic choice. In fact the shift toward global nearshore is growing strong. So parallel with this approach, the China market is increasing in popularity.”

Cyrill is the founder of I.T. United, and was one of the pioneers among western business people setting up outsourcing operations in China.  He recently sold the company to Softtek, the leading Mexican software outsourcing firm.  I first met Cyrill at an event in Shanghai several years ago.  He has always been a very outspoken advocate for the industry (I’ll never forget the time that Cyrill tried to enlist us to storm the Gartner Outsourcing Summit in Las Vegas to demand that they pay attention to China), and I believe that his decision to sell out to Softtek says a lot about the current state of the Chinese software outsourcing industry.

It appears to me that the market is becoming stratified into three very distinct layers. 

• The organizations that are committed to building global scale, including VanceInfo (formerly WorkSoft), hiSoft and BeyondSoft are examples of the companies in the top level.
• The strong domestic companies including Chinasoft and NeuSoft make up the middle layer.
• Everybody else is in the bottom tier.

As the potential buyers become more sophisticated, and the competition heats up, companies that want to break out of the vast bottom layer will have to explore strategic alternatives, like merging with a leading company from another geography.  I applaud Mr. Eltschinger for recognizing this and making an aggressive move to become a key component of Softtek’s mixed-shore offering.  As usual, Cyrill looks like a visionary.

Technorati Tags:  China, China Outsourcing