Description

Summary:

• What is Concentrix? Concentrix is the #2 outsourced CX (customer experience) provider worldwide. They contract with medium and large companies to provice outsourced customer service. They help design  customer service systems and then staff the phone/chat/email systems when customers reach out with complains and questions.
• Why is Concentrix a good business? This business has secular tailwinds as more businesses outsource over time. Customers are often quite sticky, it can be quite difficult/expensive to move CX providers and so it is rarely done. Also, Concentrix benefits from scale – only a small number of players (2 or 3) can serve the most expansive customer proposals that demand large amounts of staffing across a variety of geographies. Scale also drives higher margin.
• How do I get returns? Concentrix should be able to grow revenue at a 7% CAGR organically and EBITDA at 9% CAGR. Combined with strong FCF generation, at peer multiples this should result low to mid 20s IRR

History of Company

Concentrix was “incubated” within TD Synnex, an IT product distributor. The origin of the company has its roots at least back to 2004, when Synnex acquired a 20 person sales and marketing company. Current CEO Chris Caldwell was tasked then with running what was then a tiny business. In 2006 they acquired Concentrix and merged it with their existing business. The business was still quite subscale, but in 2013 they made the decision to scale up by acquiring IBM’s $1.2B CX business.

After successfully turning the former IBM business around the management team went off and acquired multiple smaller businesses (Minacs in 2016, Tigerspike in 2017). Then, in 2018, they doubled down and bought Convergys. At the time, this business was struggling with a combination of issues. Convergys had too much exposure to a weak telecom end market, too much customer concentration (3 customers were ~35% of revenue in 2016, and AT&T was 21%), and a poor management team. Concentrix bought this business and exited some of the low margin telecom contracts. Notably, these acquisitions were all done at good prices, under 10x EBITDA.

In January 2020, Synnex decided to spin off Concentrix, as it had grown to a critical mass and no longer made sense to keep under the same umbrella as an IT distribution business. Despite the obvious disruption of Covid, Synnex elected to continue the path to the spinoff. While Concentrix did see a weak 2Q20 (organic growth -7%), the business rebounded rapidly and was flat in the third quarter and up 6% organically in 4Q20.

Concentrix spun off in November 2020 and was left as somewhat of an orphaned stock. Few analysts covered it (even today just Barrington and an IT distribution analyst from BAML cover it). Still, there was a massive rebound in demand in 2021, and the business (along with competitors) accelerated significantly, growing 17% organically in 2021. This was driven by the post-covid recovery in the economy, especially from CNXC’s “new economy customers”.

Concentrix decided to diversify into the digital services space by buying Pro Karma in late 2021 for a high price (19x EBITDA). While the price was higher than many (perhaps even management) would have liked, the asset was subject to a significant bidding war amongst large CX players. In buying PK, CNXC sought the capabilities to help their customers digitize their CX. Specifically, CNXC mentioned they tried to build this capability organically, but was unable to do so, and thus paid up for it.

More recently, the stock has de-rated as it has been hit by the temporary reversal of some of these tailwinds. Tech demand isn’t what it used to be (and the low single digit percent of their business from crypto has mostly vanished), and the company has blamed slow 4Q/1Q results on a weak holiday season for its ecommerce/consumer electronics customers. The business is also facing losing temporary covid projects and seeing work moved from their onshore centers to offshore aggressively which creates a small revenue headwind. The combination of these effects have led to a serious deceleration in revenue (+6% organic in 4Q22, 3% guided in 1Q23). These effects appear temporary, but for a stock that without a deep ownership base and with limited coverage this caused a deep pullback – the stock troughed in late 2022 ~40% below its February 2022 peak.   

These headwinds on the business should be temporary. By late 2023, CNXC will have lapped many of the headwinds, and eventually this tech winter will reverse itself (or at least stop getting worse). The business should reaccelerate within 12-18 months.

Why is this a good business?

Concentrix is a high quality business because of the stickiness of its services, as well as secular tailwinds and scale advantages

• Secular tailwinds – Concentrix benefits from secular tailwinds in the industry. Currently, roughly 25-30% of CX roles are outsourced, a number that grows steadily over time. Combined with underlying growth of CX overall (both insourced + outsourced) at a roughly GDP rate, this produces mid-single digit industry growth over the long term
• Scale benefits – Larger CX outsourcers have significant advantage. Aside from simply having higher margin as they scale, they can also compete for more bids. Many large companies want comprehensive CX solutions across multiple geographies. Smaller companies simply lack the geographic presence to compete for many of these large deals. Additionally, large customers often demand so much staff such that it can be impossible for small players to guarantee they can onboard and train the staffing. Only 3 players (CNXC, Teleperformance and Sitel) truly have the scale to meet needs of these large multi-nationals, and as a result these large players are gaining share
• Sticky revenue – Setting up a new CX provider is tricky for many companies. It takes often takes 6-12 months of planning, training and tech integration. If a changeover is fumbled, it risks seriously disrupting customer service, which is a risk companies take very seriously. As a result, companies are quite hesitant to change providers unless they feel essentially forced to do so. This is why they have a 96% customer renewal rate (from 2020 investor day) and their top 25 clients have an average tenure of 16 years (2022 investor day). As an example, we spoke with one significant CNXC customer, a large health insurer. When their contract with CNXC was up for up for rebid, the customer didn’t even bother doing an RFP, stating “I don’t have the resources on my team to handle a sunset and new partnership… Concentrix honestly has good leverage” – the thought of the additional expense, risk and time required to move rendered going to a different competitor nearly impossible

All this comes together to produce a business that has the following impressive attributes:

• Revenue growth – Understanding CNXC’s organic growth has been a challenge due frequent M&A. In recent years, it has seen significant headwinds and tailwinds between exits of Convergys contracts (2019), Covid and the 2021 boom in the industry. However, in the years prior (2014-2018) to this, I estimate that the business grew 5-6%, slightly ahead of the overall market during that period. Buying PK should add another point or so to that growth (the business was expected to grow >20%), and added scale post-Convergys should add at least a bit of further growth given, getting growth up to roughly high single digits
• Margin enhancement – Concentrix has done an impressive job boosting margins as they have scaled. Operating margins have rerated up from 8.3% in 2016 to 14.0% in 2022, nearly 100bps a year. While the company has guided to only +30bps in 2023, we believe as the company scales organically and via M&A, there is significant margin upside from here

• Cash generation – CNXC has always been somewhat asset light, needing only to build call centers as they scale. Now, with ~40% of their staff currently working at home (and with relatively similar levels projected going forward), growth comes cheaper than it has in the past. Historically, they have guided capex to be roughly 3% of revenue, however in 2022 they only spent 2.2% and future levels have been guided to below 3% as well. As a result, CNXC should generate a good deal of cash, guiding to $500M+ FCF in 2023. They plan to invest this cash in growing via acquisition, though they also have indicated a limited interest in share repurchases

Valuation:

Concentrix is cheap on both on an absolute and relative basis. On a relative basis, I compare CNXC to other traditional CX players Teleperformance, TTEC and Telus International. These companies have a median consensus 2023 P/E of nearly 19x when stock based comp is treated as an expense. In contrast, CNXC trades under a 14x PE on this basis. There is no apparent reason for this discrepancy – Concentrix’s growth is roughly the middle of the pack of these players.

Table as of 2/6/23

On an absolute basis, it is hard to understand why a business with secular tailwinds, recession resiliency, and scale advantages should trade at a multiple roughly 5x below the S&P.

Returns:

As far as trying to pencil out returns, the company issued 2025 targets in early 2022 which can be helpful for framing the medium-term model. They called for a 9% organic growth CAGR, 130bps of margin improvement from 2021 levels, and 1.5B of inorganic growth, getting the company to $10B of revenue at 14.5% EBIT margins.

So far, the company is tracking somewhat behind on organic revenue (8.2% 2022 organic CC growth, 5% guide in 2023). But they are ahead of schedule on EBIT (guiding to 14.3% 2023 EBIT margin) and believe they can surpass their margin target barring any unforeseen setbacks. As a result, I am underwriting a base case that contemplates roughly 7% organic growth CAGR from here. Combined with the margin tailwind, this gets me to a 9% EBITDA CAGR from 2022 to 2026.

I value this on an EBITDA (excl stock comp) multiple basis at exit. Using TTEC’s 10.1x forward multiple (TTEC is a bit of a dog – featuring consistent slow growth and a lack of a significant offshore presence, so it is reasonable to think CNXC should trade at least that well), CNXC delivers a 21% IRR. It is not unreasonable to think that CNXC could trade more in line with Teleperformance’s 11.1x multiple. If it manages to do so, that extra turn takes the returns up to a 26.1% IRR.

It is worth noting in my modeling that while the company is guiding to more M&A between now and 2025, I am not building this in. Instead, keeping leverage flat at 2x (roughly where the company has said they aim to be) and assuming share repurchases with the extra cash. While I don’t think this is likely, based on conversations with the company they are aiming for deals valued much more in line with their deals prior to Pro Karma, and so I am assuming these deals will be at least as accretive as repurchasing stock.

Risks

• AI/Automation – Given the current environment, this risk gets a lot of discussion. And there is something to this: over the past 10-20 years, CX has gotten steadily more automated and efficient which does create some headwind to the market. I expect this will continue as it has – and the market has been able to grow well despite these pressures. In some senses, this is an opportunity for CNXC as a more digitally sophisticated player (especially with the recent PK acquisition) to win more work from CX players who are more “butts in seats” players. They can do so by pitching more pitching solutions with a higher component of automation, driving down costs to the customer. Also, in speaking with leaders who work at companies developing CX automation solutions, no one expects a significant breakthrough/step change in automation on the horizon (yes, these people have heard of GPT 3, etc.)
• Recession – While recession would no doubt have a negative impact on CNXC, the business is buoyed by companies accelerating outsourcing to save money during downturns. While CNXC didn’t exist in previous recessions, it’s notable that peer Teleperformance saw a roughly 13% decline in organic EBITDA from peak to trough during the financial crisis, and actually grew earnings through the 2001 recession. As a result, I believe CNXC should outperform during a recession, even if it may decline somewhat

Catalyst

earnings growth + rerating over time