ATTO - Atento: Fundamentally Unprofitable Operates In A Declining Industry

Summary

• ATTO is one of the leading providers of CRM BPO in Latin America.
• The company's business is in secular decline because much cheaper AI-based solutions are replacing it. This trend will continue.
• ATTO's industry has undesirable competitive characteristics pushing towards low asset returns. ATTO is not an exception.
• The interest on ATTO's debts is higher than ATTO's return on its assets. This makes ATTO's operations fundamentally unprofitable.
• To solve the capitalization problem, ATTO would have to get acquired, or significantly dilute current shareholders.

Atento ( ATTO ) is a customer relationship manager outsourcer. The company manages call centers for other companies, particularly telcos and financials.

ATTO is in a declining, competitive, and generally unprofitable industry. Further, the company pays more in interest on its debt than what it can make on its assets.

For these two reasons, ATTO is fundamentally unprofitable and is not a desirable investment at these prices. The company should recapitalize to improve, but this implies dilution for shareholders.

Note: Unless otherwise stated, all information has been obtained from ATTO's filings with the SEC .

Business description

A spin-off from Telefonica : ATTO was born as a spin-off from the then burgeoning CRM BPO arm of Telefonica ( TEF ) in the late 1990s. Telefonica is one of the leading telecommunication carriers in Latin America and Spain and still represents 32% of ATTO's revenues.

Human based CRM BPO, an ailing industry : ATTO's main business is to manage call centers for other companies. Some industries need significant human-based CRM operations. We can think of telco carriers, banks, credit card issuers, or travel agencies.

However, the advent of chatbots and other digital technologies reduced the need for human-based CRM. With recent advances in AI voice generation and natural conversation, it is easy to picture an AI-based CRM system that could replace call centers almost entirely.

ATTO has been affected by this reality and suffered from consistent business loss.

A competitive industry : BPO is also an industry with undesirable competitive characteristics. It sells to businesses, especially big corporations, making bargaining harder. Most importantly, companies can easily calculate how much it would cost them to replace ATTO's services, which puts a strong cap on the company's margins.

The company cannot earn a sufficient return : What makes ATTO an unprofitable business, on top of its low margins and declining industry, is that its debt yields a higher return than what the company can generate with the assets it has in place.

As seen in the first chart below, the company has only barely scratched a 10% operating income yield on its assets. However, the second chart shows that the company's effective yield on its debts (interest over debts) is consistently above 10%.

Accruals and cash flows : Some readers might be surprised by comparing ATTO's net income to FCF, because the latter shows a better picture than the former. However, several adjustments modify this picture.

First, readers should be aware that under IFRS, companies can report their lease payments ($45 million yearly for ATTO) in financing cash flows, therefore increasing FCF compared to a U.S. GAAP reporting company. Still, when comparing depreciation & amortization with capital expenditures plus lease obligations, a gap of $30 to $40 million remains.

Provisions cover part of that gap. ATTO recorded an average of $26 million in provisions between FY19 and FY21, primarily related to labor and tax litigation. In addition, some of the contingencies associated with these provisions materialized. For example, the company made payments of $30 million in FY20 and $15 million in FY21 .

For that reason, although ATTO's FCF looks better than its net income, the FCF should be adjusted.

Value destruction : For the reasons explained above, ATTO has destroyed a lot of shareholder value. The company had a market cap of $800 million less than ten years ago, and it now trades at a market cap below $60 million.

Going forward

Recapitalization : At its core, what makes ATTO's unsustainable in the long term is the expensive cost of its debt compared to the low return it obtains on assets. The company could generate positive returns if capitalized with equity, rather than debt. Of course, it would not be able to earn a decent return on equity, but that is another issue.

Dilution : To reduce its financial leverage, the company should dilute its current shareholders. With the ATTO stock trading below $5, to repay its $585 million in long term debts, ATTO should issue more than 120 million shares. Such share issuance would imply a 10 to 1 dilution to current shareholders, given that ATTO currently has less than 15 million shares outstanding.

No debt earnings : If the company recapitalized (or if an acquirer repaid all of its debts), ATTO would save approximately $60 million in yearly interest payments. This implies ATTO would remain unprofitable on an accrual basis, considering the current TTM net income of -$130 million. On a cash flow basis, the situation would not change much, given that we explained cash and accruals are relatively similar once some adjustments (for provisions and leases) are made.

Acquisition : A bigger conglomerate could acquire the company, but it is improbable that the acquirer would pay a substantial premium on current share prices. The reason is that the acquirer should take care of ATTO's net debt, for an EV of $570 million. From what we have seen, even on a cash basis, the company is not generating an incredible return on that price.

The alternative is not nice : A company can only generate negative net income for a while. It will eventually face problems in renovating its debt obligations. Although ATTO's long term debt has long maturities, with most of the current $550 million maturing in 2026, the company will eventually need cash to pay its interest expenses.

The industry is still dying : Even if ATTO was recapitalized, and the company was able to generate positive net income, that would not change the secular dynamics of its industry and business model. Although companies will always need humans to deal with their clients, the need for human based CRM BPO systems like the ones provided by ATTO will only decrease. Simple chatbots already more than halved the company's revenues, what would happen if it became feasible to have conversations with an AI with human voice?

Upside risks

This article is not a short recommendation, but I add a few counterarguments to my thesis, which is primarily bearish.

Recovery in Latin America : ATTO generates more than 80% of its revenues in Latin America, a region that has not seen growth for more than a decade ( Latam's GDP peaked in 2011 ). A secular recovery of the continent would probably lift ATTO's business with it.

An excessive multiple paid by an acquirer : Although I do not see how an informed investor could pay more than what the company is currently trading for, acquisitions usually end up in overvaluations. An acquirer could pay more for the company's business, especially if the context is propitious. For example, if Latin American companies are in vogue in the market.

Conclusions

ATTO is fundamentally unprofitable for two reasons: it operates in a low-margin, competitive, ailing industry, and its debts yield higher interest than the (sometimes negative) margin the company earns on its assets.

The industry problem is challenging to solve. AI-based CRM solutions are improving daily and will probably continue eating ATTO's lunch. The company could find a niche where AI-based solutions are imperfect and scale its operations down to fill that niche, but that has not been the case up to this point.

The capitalization problem can be solved by share issuance or by being acquired by a bigger company. However, in both cases, current shareholders would probably get diluted to a small proportion of their current holdings.

For these reasons, I do not believe ATTO is an opportunity.

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