SRT - StarTek Inc

[APG12]

For anyone interested, the best resources to understand the company are the old VIC write-ups (and comment sections):

 

1/17/2012: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/61199

6/10/10: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/34527

2/25/05: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/1724

 

There is also an 'independent analyst' that writes sell-side looking research on the company every quarter. The research is available for free on his website: http://omarsamalotanalysis.com/

 

I don't know who the guy is or anything about him but I've read all of his reports and they're definitely credible in my opinion.

[babysamalot]

very nice job Adam.

[yadayada]

interesting, but how sure are those 20% margins? Have they done this in the past? And what kind of cash do they generate with those margins (sorry im lazy :) ).

 

did a quick one with 18% gross margins - interest - admin exp - taxes. And i get roughly 6.5 mill a year in net income. With a 100 million market cap, that seems pretty much fairly valued?

[babysamalot]

yadayada,

if you look at my matrix in the report (next to last page I think), you will see that I top out my GM assumption to 17%. At a 12mo average of 15% in GM, EBITDA can reach $25m for a 9% EBITDA margin ($9.6m in Net Income).

At a 12mo average of 16.5% in GM, EBITDA can reach $32m for an 11% EBITDA margin ($15.2m in Net Income) (this is my assumption for 2015).

 

Using a 5.5x EV/EBITDA multiple on 2015 estimated EBITDA, you are looking at $13.60/sh.

 

When APAC was bought out back in 07/2011, they were shooting out 18% GMs and were purchased at 8.8x EBITDA.

CVG purchased Stream Global (private co.) last month for 0.8x LTM Revenues.

 

Either of these valuations, once StarTek achieves optimal margin performance, put SRT stock in the mid teens...in my view.

[yadayada]

but when i do 18% OF 58M, - 6m (their admin exp). Assuming they shrink this. - taxes (apparantly interest isnt realy a charge, misread that), x4 I get about 11 million. This is from latest 10q.

 

Then if you want to plant a 15x multiple on this you really have to assume growth. With no growth I honestly dont know how you see 100% upside here. with a 10x multiple, there isn't much upside.

 

Or will they cut more in SG&A?

 

And then you also have to assume they pull it off. And make that 18% happen. There is some risk as well.

 

I do see that their depreciation seems 4-5 million higher then their cap exp tho.

[babysamalot]

oh no, $58m is a thing of the past...the $44m in new annual contract value announced last Q, puts them at a $274m annual clip. And I think we will hear about more new healthcare related business won during Q4. I still have SG&A at around $7.5m/q. And the growth is more profitable given the streamlining already in place among the US facilities and the new IT platform currently in its last stage of implementation.

 

so yes, you have to count on growth...but this is new business already announced, I'm making no assumption of growth outside of what is already contracted. now, the trick here is that there is a lag time between them ramping the facilities, training people and when revenues start showing up. so we will start seeing revenues from that big $44m in contracts signed during Q3'13 in Q2 of 2014, for example.

 

as you say, the risk with this company has always been execution...but this current management is the real deal and they have been showing it.

[yadayada]

ok interesting. What about depreciation higher then cap exp? What % of that is buildings?

 

And 274*0.18 = 50m - 30m in SG&A is 20 *0.65= roughly 12.5 million net income then. I supose I get started reading more about their underlying business then. But certainly looks interesting on the surface if they can increase gross margins to 18%. And tax rate is 35%? Or is that lower?

 

And how does SG&A change if they would add another 50-100 million of revenue in the future?

[babysamalot]

all of the depreciation is mostly buildings, computer equipment and leasehold improvements. they sold 2 buildings during Q4 and we should hear more about that during the call (I got confirmation from the commercial real estate broker that the sales settled on Dec 26th or 27th). As a result from the IT platform improvements, they are taking some accelerated depreciation charges on IT assets that should end in Q1...so the depreciation amount will change a bit over the next couple of quarters. so its hard to break it down for you on a % basis with all the moving parts.

 

The main reason depreciation has been higher than capex is due to previous management preferring to build facilities instead of leasing....so they have had some legacy buildings (current management jokingly calls them the "taj mahals") with excessive build outs and size. However, you will see higher capex going forward as they invest in 3 new facilities (all leashold improvements and equipment) for all of this new business coming online.

 

the tax rate is way lower for a couple of reasons. In the US and Canada, they have a lot of NOLs so they will not pay taxes there for a while. In Honduras, Costa Rica and the Philippines, they have been enjoying tax holidays for the investments they have made. You can check the 10K, but I think the Philippines may have just started charging income tax at the 5% rate (I know they were trying to get an extension to the tax holiday that was ending in late 2012). No taxes in Costa Rica until after 2018 and no taxes in Honduras indefinitely. So I only assume a 15% tax rate for 2014 and 2015....which may prove to be too high.

 

On SG&A, management has told me that they still have some operating leverage at the current level...but they haven't been too specific, But they will try to keep that line at or below 10% of revenues.

[APG12]

very nice job Adam.

 

Thanks Omar! Glad to see you dropped in; your research reports have been incredibly useful. What got you interested in SRT initially? Had you been following it before you started writing your reports?

 

if you look at my matrix in the report (next to last page I think), you will see that I top out my GM assumption to 17%. At a 12mo average of 15% in GM, EBITDA can reach $25m for a 9% EBITDA margin ($9.6m in Net Income).

At a 12mo average of 16.5% in GM, EBITDA can reach $32m for an 11% EBITDA margin ($15.2m in Net Income) (this is my assumption for 2015).

 

So would you say 20% GM is too aggressive (~15% GM from domestic, ~25% from Philippines, ~20% Latin America)?

 

as you say, the risk with this company has always been execution...but this current management is the real deal and they have been showing it.

 

I haven't been in contact with management so I don't put much stock in my opinion on these matters but everything I've seen indicates the same to me. Carlson's demeanor on the conference calls is exactly what I like to see. Totally non-promotional and couldn't care less about the street. I liked the way he handled the issues in the Philippines and he's been phenomenal on SG&A reduction. From $10mm+ a quarter cut down to ~$7mm a quarter is tremendous for a $100mm company. If I remember correctly, when SG&A was over $10mm a quarter that was actually after Jones had implemented his own cost-cutting plans meaning the achievement is that much more impressive. In a recent CC he said something along the lines of "I'm never satisfied with the level of SG&A." It reminds me of that old Buffett/Mungerism that you want to be on board with a management team that is always concerned with low costs rather than a team that implements cost-cutting plans only after costs are out of control. Anyhoo, I can't say much else about the management team so I take that with a grain of salt.

[babysamalot]

I have been following this company since 2009 and at some point I realized I wasn't doing enough research...so I changed that and decided to put it in reports so other value investor can follow the progress easily.

 

an overall 20% GM is achievable especially in a Q4 result, but I always like to err on the side of caution and wait for the company to print that before I make that assumption. your segment GM assumptions are spot on.

 

I agree 100% with your conclusions on management. You should give Chad a call...he is even more impressive in private.

 

One very important fact about his company is the Board composition. There is almost 30% of all shares outstanding directly represented at Board level....talk about shareholder interest aligned with that of the Board, you just don't see that kind of representation often.

[intensityjp]

Should the concentration in sources of revenue between AT&T, T-Mobile and Comcast (~70% of revenues) be a cause of concern?  According to the notes the AT&T contracts expire 2014-2015, the T-Mobile in 2016 and Comcast this year. 

 

Though these contracts have optional extensions, was wondering if anyone has any insight into the stickiness of these relationships and the risk that these customers change providers at the end of the contract period.

 

Thanks in advance.

[babysamalot]

as long as the Company is performing well vs their competitors on the league tables, the relationships are extremely sticky. The proof is in the increased business from all of those major relationships. Contract expiration is for price and/or service renegotiation. The truth is that if a provider is not performing to standard, the client can pull out at any moment. Of course, switching call volume from one provider to the next is not easy as the infrastructure has to be in place....the keys is continuously hitting and improving customer satisfaction metrics for your client...the better you perform, the more business you get. And that has been Chad's job 1 since he took over...and the increased business activity has followed. Right before Chad took over, ATT was cutting business lines with StarTek and TMobile was stagnant. Since then, TMobile, Comcast, Time Warner and ATT have all significantly increased business as a result from SRT remaining on top of their league tables.

 

StarTek has improved their customer concentration immensely over the past 2 to 3 years...at one point back in early 2010, ATT alone comprised 67% of revenues....to now 25%. However, customer concentration is not foreign to this industry....look at CVG with $2B in revenues and 46% of that in 3 clients or SYKE with $1.2B in revenues and 48% of that in their top 10 clients.

[APG12]

I have been following this company since 2009 and at some point I realized I wasn't doing enough research...so I changed that and decided to put it in reports so other value investor can follow the progress easily.

 

I see. Well thanks again, the reports are awesome.

 

an overall 20% GM is achievable especially in a Q4 result, but I always like to err on the side of caution and wait for the company to print that before I make that assumption. your segment GM assumptions are spot on.

 

Okay great. I was going for a longer-term normalized number with that but given that my bear case/base case assumptions are generally conservative (I think), it does make sense to temper my optimism on the upside too.

 

Should the concentration in sources of revenue between AT&T, T-Mobile and Comcast (~70% of revenues) be a cause of concern?  According to the notes the AT&T contracts expire 2014-2015, the T-Mobile in 2016 and Comcast this year. 

 

Though these contracts have optional extensions, was wondering if anyone has any insight into the stickiness of these relationships and the risk that these customers change providers at the end of the contract period.

 

Thanks in advance.

 

I'm sure Omar can answer that question better than I can but I'd say it's definitely something to keep an eye on. I don't have my materials on hand either to confirm but IIRC AT&T and T-Mobile alone accounted for 80%+ of revenues as little as three years ago. Comcast is a newer addition as the company has tried to diversify away from these two customers. In a way I think that SRT has to fight to keep its contracts every single day. AT&T is also a client of SYKE and can dole out business as it sees fit. It makes sense from their perspective as they're trying to keep their BPOs in healthy competition. Speaking of SYKE, I think that their top 10 clients account for something like 50% of revenues and CVG's top 3 clients account for ~50% too so revenue concentration isn't abnormal in the BPO space (doesn't mean it's not a risk!).

 

That being said, I believe the larger contracts like AT&T are actually across several lines of business so it's not just one big contract with a single relationship that can go sour. The company also wouldn't reveal exactly which clients the $44mm in new business came from but they did say 'existing clients' which probably implies AT&T, T-Mobile, or Comcast. If that is the case, I'd say it's a sign of healthy relationships.

[APG12]

as long as the Company is performing well vs their competitors on the league tables, the relationships are extremely sticky. The proof is in the increased business from all of those major relationships. Contract expiration is for price and/or service renegotiation. The truth is that if a provider is not performing to standard, the client can pull out at any moment. Of course, switching call volume from one provider to the next is not easy as the infrastructure has to be in place....the keys is continuously hitting and improving customer satisfaction metrics for your client...the better you perform, the more business you get. And that has been Chad's job 1 since he took over...and the increased business activity has followed. Right before Chad took over, ATT was cutting business lines with StarTek and TMobile was stagnant. Since then, TMobile, Comcast, Time Warner and ATT have all significantly increased business as a result from SRT remaining on top of their league tables.

 

StarTek has improved their customer concentration immensely over the past 2 to 3 years...at one point back in early 2010, ATT alone comprised 67% of revenues....to now 25%. However, customer concentration is not foreign to this industry....look at CVG with $2B in revenues and 46% of that in 3 clients or SYKE with $1.2B in revenues and 48% of that in their top 10 clients.

 

Doh, you were a little quicker than me but great minds think alike.  ;D

[babysamalot]

the Honduras expansion news released yesterday is not news for us since we had already seen indications of this. however, they did mention in that release that 1,300 are currently employed at the existing Honduran facility. I will still have to confirm how many of those would count as FTEs....but that number is at least 50% higher than my FTEs assumptions for both Q4 and Q1 in Honduras. This could mean a faster ramp there that expected....in this business, the more FTEs the more revenues. Looking forward to the earnings release this coming Monday.

[APG12]

Yup! Looks fantastic!. And as you talked about before, the career part of their website shows that they're opening a facility in Iloilo, Philippines that has not been announced yet (http://www.startek.com/philippines-careers).

 

In my opinion people are just not recognizing what's going on here.

[babysamalot]

for those of you looking at SRT's results today, I thought they showed a pretty solid result. after reconciling for non-cash impairment charges and an accounting loss in real estate asset sales, and for nonrecurring IT platform transition costs, they showed a non-gaap EPS result of .02/share for the operating business. Also, imbedded in the gross margin, they had .04/share related to investments in new business growth....for a non-gaap normalized result of 0.06/share.

beating the .04/share I was expecting on a apples to apples basis.

 

as the new business won continues to fill up their capacity and ramping and training costs get digested, they should continue to improve their GMs during 2014 getting close to optimal results in the second half of the year.

 

[babysamalot]

I'm obviously talking to myself here...but I need to make a correction on my previous post.

 

they actually made 6 cents/share non gaap:

($1m) gaap NI + $0.5m impairment + $0.7m accounting loss on building sales + $$0.7m IT platform transition costs = $0.9m non gaap NI or 6 cents/sh

 

to this you add $0.6m in growth investments (100 bps of GM impact) to get an apples to apples picture of the already ramped operating business = $1.5m or 10 cents/sh!!

 

beating my apples to apples number of 4 cents by 6 cents/sh...they definitely need to do a better job in communicating their results.

[petey2720]

Omar, you're not talking to yourself.  I am reading each post, following the idea and doing my own due diligence.  Thank you for sharing your work.

 

Adam, thank you as well for posting the idea.

 

Pete

[usdtor05]

agree thanks to you both...guessing that was you guys asking the questions as I read the transcript.

[babysamalot]

thanks a lot.

 

Chad is just ultra conservative...look at their Adj EBITDA number reported. They don't add back non-recurring expenses like the IT platform transition costs. They add it back to show operating results but not to Adj EBITDA...go figure. That means they did $4.36m in Adj EBITDA, beating my $3.6m estimate.

[jm25]

Who are the comps - and what do they trade at? If they trade at a discount to the peers on an EV/EBITDA basis, why do they?

[babysamalot]

Comps: CVG, TTEC, SYKE. They trade anywhere between 6x to 8x EV/EBITDA. APAC was bought out at 8.8x EV/EBITDA a couple of years ago. Stream Global was bought out last month at 0.8x Revenues.

 

SRT is in the last stages of a turnaround after new management took over in 2011/2012. They trade at a discount as they have not reached optimal margin performance. for more detail analysis spanning two years go to:

omarsamalotanalysis.com

[yadayada]

any reason why the market is totally missing it really.

[babysamalot]

this stock is not largely followed. but also this is an execution story. If you don't believe that this management can execute the plan or that the expected margins are possible, then this is not for you. I have had the vantage point of seeing this turnaround evolve for over two years, and what they have already achieved to date gives me the confidence that they will achieve their longer term goals...it is a matter of time. Anybody considering this stock should familiarize themselves with management...they have proven that they do not promise what they cannot deliver, they do not hype. Chad and Lisa are masters of the "under promise and over deliver" mantra....and that is one of my investment requirements.