CNXC - Concentrix: A Compelling Investment Opportunity In The Customer Experience Space

Summary

• Concentrix is a leading global provider of customer experience solutions, with a differentiated business model and a strong track record of growth and profitability.
• Despite the company's solid fundamentals and growth prospects, its valuation is currently attractive on both an absolute and relative basis compared to peers, providing an attractive entry point for investors.
• Concentrix is well-positioned to benefit from the trend toward outsourcing and digital transformation, as companies seek to improve customer experiences and streamline operations.

Executive Summary

Concentrix (CNXC) is well-positioned to benefit from the growing demand for CX services, as it has a diverse range of clients across industries and geographies. The company has also been successful in expanding its offerings through strategic acquisitions, which has helped to enhance its capabilities and broaden its customer base. While doing so, Concentrix has demonstrated consistent revenue growth, strong profitability, and healthy cash flow generation. The company has also set ambitious growth targets for the coming years, which I believe are achievable given its strong track record and favorable industry tailwinds.

At current prices, I believe shares of Concentrix offer an attractive entry point and can generate a 3-year IRR in excess of 20%.

Company Overview

Concentrix is a global business services company that provides technology-enabled customer engagement and business performance solutions. The company offers a wide range of services, including customer care, technical support, sales, and digital marketing. They help businesses optimize their operations and improve customer experience by leveraging their expertise in data analytics, automation, and digital transformation. Concentrix works with clients across various industries, including technology, telecommunications, healthcare, and finance. With a global workforce of over 225,000 employees, Concentrix has the scale and expertise to provide customized solutions that meet the unique needs of each client.

The company was originally incubated within TD Synnex, an IT product distributor, and was merged with Synnex's existing business in 2006. Concentrix's origins date back to at least 2004 when Synnex acquired a 20-person sales and marketing company, which was then run by current CEO Chris Caldwell.

In 2013, Concentrix made a strategic decision to scale up by acquiring IBM's $1.2B CX business (Source: Press Release ), which they successfully turned around. After this acquisition, the management team went on to acquire multiple smaller businesses, including Minacs in 2016 and Tigerspike in 2017. In 2018, Concentrix made a bold move and doubled down by buying Convergys, which was struggling with various issues, including too much exposure to a weak telecom end market, too much customer concentration, and a poor management team. Concentrix was able to exit some of the low-margin telecom contracts and acquire Convergys at a good price, which was 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 it under the same umbrella as an IT distribution business.

Concentrix's Moat

Concentrix is a high-quality business that has demonstrated resilience and growth over the years. One of the reasons for its success is the stickiness of its services, as well as the secular tailwinds and scale advantages it benefits from.

In terms of secular tailwinds, the customer experience ((CX)) outsourcing industry is expected to grow steadily over time. Currently, only 25-30% of CX roles are outsourced, leaving significant room for growth. Coupled with the underlying growth of CX overall, which is roughly at the rate of GDP, this produces a mid-single digit industry growth over the long term. Moreover, as businesses prioritize enhancing their customer experience, they are increasingly outsourcing their CX functions to specialized firms like Concentrix.

The scale benefits of Concentrix are also noteworthy. As one of the largest CX outsourcers in the world, it enjoys higher margins as it scales up. It can also compete for more bids and offer comprehensive CX solutions across multiple geographies. Smaller companies, on the other hand, often lack the geographic presence and the ability to onboard and train staff for large multinational clients. Only a few players in the market, including Concentrix, Teleperformance, and Sitel, have the scale to meet the needs of these large clients, which is why these players are gaining market share.

In addition to scale advantages and secular tailwinds, Concentrix's business model is characterized by sticky revenue. Setting up a new CX provider is a complex process that takes months of planning, training, and technology integration. Changing providers is equally challenging, as it poses a risk of disrupting customer service, which companies take very seriously. Therefore, businesses are often hesitant to switch providers unless they feel forced to do so. Concentrix has a 96% customer renewal rate, and its top 25 clients have an average tenure of 16 years. This highlights the strong relationship and trust that Concentrix has built with its clients over the years.

Durable Moat Powering Strong Financial Results

The impressive attributes of Concentrix, as mentioned in the previous section, come together to create a well-rounded and highly profitable business. One of the key components of Concentrix's success is its revenue growth and strong market share gains over the years. While understanding its organic growth has been challenging due to frequent mergers and acquisitions, the company has managed to grow by 5-6% in the years prior to 2019 (Source: Concentrix Form 10-K ). This growth rate was ahead of the overall market during that period, implying that the company's strategy of being a multi-product company is paying off via market share gains. The recent acquisition of PK is expected to add another point or so to that growth, as the business was projected to grow at a rate of more than 20%. Furthermore, the added scale post-Convergys should also contribute to further growth, bringing the growth rate up to roughly high single digits.

Another impressive attribute of Concentrix is its consistent margin expansion through scale. The company has managed to boost its operating margins from 8.3% in 2016 to 14.0% in 2022, nearly 100 basis points (bps) per year. While the company has guided to only a +30 bps increase in 2023, there is significant margin upside from here as the company scales organically and via mergers and acquisitions.

In addition to revenue and margin growth, Concentrix also consistently delivered strong free cash flow conversion. The company has always been somewhat asset-light, only requiring call center construction as they scale. With approximately 40% of their staff currently working from home, and similar levels projected to continue in the future, growth comes cheaper than it has in the past. Historically, the company has guided capex to be roughly 3% of revenue, but in 2022, they only spent 2.2%, and future levels have been guided to below 3% as well (Source: Concentrix Form 10-K). As a result, Concentrix is expected to generate a significant amount of cash, with a guidance of $500 million or more in free cash flow ((FCF)) for 2023. The company plans to invest this cash in growing through acquisitions, indicating a strong commitment to continued growth and expansion.

Long-Term Financial Targets

The company's 2025 targets issued in early 2022 provide a useful framework for assessing potential returns. These targets include a 9% CAGR in organic growth, 130bps of margin improvement from 2021 levels, and $1.5 billion in inorganic growth, with the aim of reaching $10 billion in revenue at 14.5% operating margins. While the company is currently tracking slightly behind on organic revenue, they are ahead of schedule on operating income and expect to surpass their margin target. Based on this, I am underwriting a base case that assumes around 7% CAGR in organic growth, combined with a margin tailwind, resulting in a 9% EBITDA CAGR from 2022 to 2026.

Valuation

Concentrix appears to be undervalued both in absolute and relative terms. In comparison to its peers such as Teleperformance, TTEC, and Telus International, which have a median consensus 2023 P/E of almost 19x when accounting for stock-based compensation as an expense, CNXC trades at a lower P/E of under 14x. This valuation gap is puzzling as Concentrix's growth is comparable to its peers, and the quality of its business is also nearly identical.

I have based my valuation of Concentrix on its EBITDA multiple at the exit of its multi-year financial targets. By comparing it to TTEC's forward multiple of 10.3x, which is considered average due to its slow growth and lack of significant offshore presence, I estimate a 20% IRR for CNXC. However, it is not unreasonable to expect CNXC to trade in line with Telus's 11.4x multiple, which could potentially result in a 25% IRR.

It's important to note that my analysis does not include any M&A activity that the company may undertake until 2025, despite their guidance suggesting otherwise. Instead, I have assumed that the company will maintain its leverage at 2x and use any additional cash to repurchase shares.

Overall, as Concentrix continues to execute on its growth strategy, meet sell-side expectations, and deliver on its multi-year financial targets, I expect the valuation gap with its peers to close over time.

Risks

Industry competition: The CX industry is highly competitive, with many players vying for market share. As Concentrix expands into new markets, it will likely face stiff competition from established players as well as new entrants. This could impact its ability to grow and maintain profitability.

Foreign exchange risk: Concentrix operates in multiple countries, which exposes it to foreign exchange risks. Fluctuations in exchange rates could impact the company's revenue, earnings, and cash flows.

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