CNXC - Concentrix: Cash Flow Returns On Investments Analysis Including Merger Analysis

2023-08-05 11:03:28 ET

Summary

• We initiate Concentrix (CNXC) with a buy rating and FY23 warranted DCF value of $120.
• Share prices have fallen over 60% from the peak and are trading at a discount according to industry average and the company’s historic valuation ratios.
• As it is integrated, the merger with WebHelp is also expected to add value in the mid to long run.
• CNXC provides customer experience solutions and has a strong portfolio of clients, with ample room for growth in the $550bn CX solutions market.

We are initiating Concentrix (NASDAQ: CNXC ) with a buy rating. Share prices have dropped over 30% since the company announced the acquisition of WebHelp on 29 March 2023. Merger analysis based on Cash Flow Returns on Investments shows the deal is not value destructive and is expected to add value in the mid to long term. We see the warranted valuation for FY23 to be $120 and expect the company to continue to add value as Webhelp is integrated.

The Company

CNXC was created on December 1, 2020, when it was spun off as a technology-infused customer experience solutions business from SYNNEX Corporation (NYSE: SNX ). CNXC provides innovative and engaging end-to-end customer experience ((CX)) solutions, in other words, customer engagement and customer management solutions that assist in communication between clients and their customers. They have the expertise and technology to design, build, automate, and run CX. Tools include harnessing the power of data Analytics and generative AI.

In the Q2 2023 Earnings Call , Christopher Caldwell talked about how AI-powered solutions were helping CNXC win new business. These include helping a global generative AI provider with generative AI moderation services, a proposed transformational omnichannel model to a consumer electronics brand, and providing support for airlines to improve the experience.

Their current portfolio consists of 1,000+ clients, and over 130 are among the Fortune Global 500 companies. The total CX solutions market is estimated to be over $550bn. CNXC’s revenue accounts for about 1.1% of this market, providing ample scope for growth.

CNXC may be considered a relatively small player, and that comes with its own risk. More dominant, diversified, and larger well-known names may capture more of the marker share. On the other hand, there is more scope for expansion and growth for the niche solution providers like CNXC. With clients spread across the globe, companies also face foreign exchange risk, but we think these can only be transitory and will not affect the long-term prospects. The main risks to CNXC are from competition eying for the same market share, and CNXC not being able to capitalize on AI as quickly as its deeper-pocketed competition.

Financials

FY22 revenues were $6.3bn with a strong three-year CAGR of 10.3%, EBITDA margins have improved from 14.4% to 19.5%, and over the same period, EPS had a compound annual growth rate of 26.1%. The 2023 Q2 results were weaker than expected and shares closed down just over 3% on the day.

The share prices peaked at just over $200 in the first quarter of 2022, but have been on a downward trend since and have fallen around 60%. At a price of $79.15, it is now trading at a forward P/E of 6.9x, a significant discount to the sector average of 18x. Even though earnings are expected to fall for FY2023, consensus forecasts growth to be on track again in FY24, with EPS growth of over 8%.

Cash Flow Returns On Investments Valuation

We have valued CNXC as a stand-alone company and also modeled the pending merger with Webhelp.

To value a company we use our affiliate ROCGA Research’s quantitative and systematic Cash Flow Returns On Investments based DCF valuation and modeling tools. The first step involves modeling the company, back-testing the valuation for correlation with the historical share prices, and using that same model to forecast forward. CNXC only has three years to backtest, but these fall comfortably within the historic share price range.

For the first two forecast years, we have used consensus EPS, and for FY24 and FY25, a conservative EPS of $12.5 each. Since growth is expected to be slower, in our DCF model we have lowered this from the default 8.6% to 4.3%.

The blue band above represents the share price highs and lows for the year and the orange line is the DCF model-driven historic valuation. The green line is the forecast warranted value derived using the same model along with consensus earnings and the growth input above.

Based on our model, we see the warranted value of CNXC to be $120 for FY2023, a potential upside of 50%, and improving further in the years to follow.

DCF + Merger Analysis

We have modeled the merger with Webhelp and as expected, noticed the deal lowers valuation in the first full year, but with the expected synergies, the deal could be value-neutral in the second full year and should start to add value from year three onwards.

The pro forma combined revenues for the two companies for FY23 are estimated to be $9.8bn, adding approximately $3.2bn to CNXC’s FY23 estimates of $6.6bn. Including debt, the transaction value of Webhelp is approximately $4.8bn. This put the EV/Sales of Webhelp at 1.5x, more than CNXC’s 1x, but significantly less than the sector average of 1.82x.

Assumption of the merger analysis:

• The merger is completed at the beginning of FY24.
• Pre-tax synergies of $100m in FY25 and $120 in FY26.
• Tax rate of 20%.
• 14.9m additional new shares.
• Pro forma numbers use as a guide from schedule 14A , p101 & p102.
• Details are taken from the company announcements .

With the acquisition, Returns on Cash Generating Assets, a calculation similar to Cash Flow Returns on Assets is lower for FY24, but these begin to improve as the expected synergies materialize. The possibility exists that synergies come in significantly lower than expected and there is also the risk of integration involved in all mergers.

The warranted value in FY24 falls to $131 from $141, but as Webhelp is integrated and the synergies applied, this recovers to the pre-merger value of $157 in FY25. For FY26 our warranted Cash Flow Returns on Assets based DCF points to the merger adding $7 on top of the stand-alone default of $172. In the medium to long run, the deal is seen as creating value.

Conclusion

CNXC is trading at a discount to its warranted value, and we expect the merger of Webhelp to add value in the long run. At these low prices, the potential upside is in excess of 50% with limited downside. We are initiating with a buy rating and a conservative target of $120.

Also worth pointing out, CNXC could potentially be a tasty treat as an acquisition target for one of the larger players.

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