TDCX - TDCX: Leading Service Provider In Asia Well Positioned To Return To Healthy Growth

2023-10-04 06:58:24 ET

Summary

• TDCX’s revenue has grown at a CAGR of 34% during the last 4 quarters, while EBITDA has slightly lagged at 30%. The business has aggressively expanded throughout Asia.
• The company has targeted growth businesses, allowing it to partake in their upward trajectory while deeply embedding itself within their operations.
• The industry looks primed to grow well, owing to outsourcing tailwinds, technological advancements, and broader growth in the Asian economies. TDCX is expanding globally to benefit from this.
• TDCX’s performance has slowed but we attribute this heavily to the current macro conditions, with the business well positioned to return to healthy growth in the coming year.
• TDCX stock is cheaply priced at 4x NTM EBITDA. The company has $408m in cash and a MC of $535m. When considered in conjunction with an EBITDA-M of 23%, the business appears far too cheap.

Investment thesis

Our current investment thesis is:

• TDCX is facing risks associated with greater competition and cementing itself as a leading player in the Asian market. This said, we believe the negative sentiment and share price performance are overblown. The company remains highly profitable and is growing, while continuing to develop its service offering. The industry is well positioned to grow and at a minimum, TDCX should be able to achieve MSD/HSD growth through investing in growth.
• The downside risk is protected due to its valuation in our view, particularly due to Management’s conservative capital allocation approach. We believe this is likely slightly early due to the heightened risks associated with a continuation of its weak performance but now represents a good time to begin building a position.

Company description

TDCX ( TDCX ) is a leading provider of customer experience solutions, headquartered in Singapore. With a diverse global presence, the company specializes in delivering exceptional customer support, technical assistance, and sales services to various industries, enhancing client relationships and driving business growth.

Share price

TDCX’s share price performance has been dire, losing over 60% of its value in an incredibly short period of time. This is a reflection of a change in the company’s fortunes in recent quarters and a broader switch in investors’ outlook.

Financial analysis

Presented above are TDCX's financial results.

Revenue & Commercial Factors

TDCX’s revenue has grown exceptionally well, with a CAGR of 34% into LTM Jun23. In conjunction with this, margins have lagged behind, with an average rate of 30%. Its growth has been broadly consistent, although with a noticeable slowdown observed in recent quarters.

Business Model

TDCX specializes in outsourcing customer service operations for companies. This outsourcing includes functions like handling customer inquiries, managing product-related issues, providing technical support, and even managing sales processes. The company services a wide range of industries, although has a particular focus on technology-enabled companies.

Case Studies - Industries - TDCX

TDCX tailors its services to the specific needs of its clients, seeking to be flexible and broad in its delivery. This customization involves training customer service representatives to understand the nuances of the client's products or services, ensuring a seamless experience for the end customers. By being flexible in such a manner, TDCX has greater scope to embed itself with its clients’ operations, contributing to stickier revenue and cross-selling opportunities.

TDCX incorporates advanced technologies such as chatbots, AI-driven analytics, and CRM systems to optimize customer interactions. These technologies enhance efficiency, enabling faster query resolution and improving overall customer experience. TDCX is investing heavily to expand its capabilities, with the objective of differentiating itself through a superior market offering. The key weakness of this industry is that the ability to develop a moat is difficult (low barriers to entry). Anyone can theoretically create a team of trained staff to provide outsourced services. The scope for moat building comes with providing more complex services in a seamless, high-quality manner. Management communications imply development is going well, although it is currently too early to judge.

TDCX operates globally, serving clients from various regions. Its global presence allows it to tap into a diverse talent pool and offer services across different time zones, ensuring round-the-clock customer support and local knowledge where required. Management currently has ambitious plans to continue its expansion.

Competitive Positioning

According to MorganLewis , the BPO industry is forecast to grow at a CAGR of 8.5% into 2032, although APAC is expected to outperform this at 10.2%. The key value drivers are considered to be labor cost challenges, increased need for skilled workers, and digital investment. We believe TDCX is positioned well to exploit this and outperform, owing to its strong regional presence, existing relationships, and strong service offering.

In conjunction with this, we consider the following broader themes to be key factors:

• Outsourcing Tailwinds - Many businesses, especially in the e-commerce and technology sectors, require cost-effective solutions and specialized expertise in order to provide many of their “back-end” services. So long as these industries continue to grow well, which appears very likely, we expect TDCX to experience incremental growth in its TAM.
• Technological Advancements - It is worth highlighting again that the integration of advanced technologies such as AI and automation will enable TDCX to offer efficient and innovative solutions to its clients, reducing incremental costs and improving its commercial positioning.
• Global Expansion and GDP growth - Asia is expected to grow well in the coming decade, contributing to growth tailwinds and a rise in new businesses. TDCX’s current global expansion strategy will lend well to this as it creates a presence in many of these countries.
• Agility and Flexibility - TDCX's willingness and ability to adapt to different industries and client needs has been a significant factor in its growth. Naturally, businesses appreciate partners who can tailor their services according to specific requirements, allowing for more dynamic collaborations. We expect this need to develop further as operating conditions only increase in complexity.

Margins

TDCX operates with impressive margins, reflecting the importance of the services it provides. Importantly, services such as content moderation and customer service are not generally provided in-house due to bloating costs, contributing to sticky demand and the ability to earn outsized margins.

TDCX is seeking to enhance this with the development of its technological capabilities, also allowing for a superior competitive position through differentiation. We believe this is absolutely critical to the company’s long-term success, as with its current margins we suspect new market entrants will be encouraged, contributing to a dilution of profitability.

Quarterly results

TDCX’s revenue growth has materially slowed in recent quarters, with a year-on-year rate of +16.1%, +14.2%, +8.2%, and +5.5% in the last 4 quarters. In conjunction with this, margins have slipped.

The decline in financial performance is a reflection of global macro-conditions, with inflationary pressures and rising rates contributing to a reduction in growth. The companies TDCX targets are particularly exposed to this, contributing to a degree of cyclicality. Despite this, the inherent nature of its services means the company has strong resilience among its core clientele, with growth (especially from big-ticket new clients) being the area of difficulty.

We expect conditions to remain difficult in the coming quarters, with Central Banks showing an unwavering commitment to bringing inflation under control. We suspect TDCX can trade flat, although is reliant on the business continuing its expansion.

The key takeaways from its most recent quarter are:

• The company is being heavily impacted by adverse FX movements, with underlying growth of 11.3% in the most recent quarter (compared to an actual of 5.5%). This is a fundamental issue in the outsourcing industry, with a location misalignment of costs and revenue generation.
• The company is seeing good progress with its investments in AI, although we note some of its peers have already launched products. It is yet to be seen how successful this will be.
• Client count is up 52% YoY (total of 91), with revenue from its top 5 customers declining to 73%. This is good progress but we are not overly surprised given the aggressive expansion strategy and the inevitable result of scale.
• Full-year revision down significantly to growth of 2-4% (from 3-8%) and Adj. EBITDA-M down to 25-27% (from 25-29%). This is one of the issues TDCX could have easily done without, as Management’s forecasts have contributed to unnecessary downward share price pressure.

Balance sheet & Cash Flows

TDCX’s balance sheet is incredibly clean, reflecting its human-capital nature. The company has minimal debt while having c.$408m in cash (MC is c.$535m). This is the vast majority of the company’s assets/equity, contributing to a fantastic return relative to inputs.

The company’s FCF generation is broadly consistent relative to profitability, implying good management of working capital. This should mean TDCX’s cash balance continues to accumulate, creating a new problem for Management. With Capex at 4% of revenue already, we suspect growth is already well-financed, implying distributions are the obvious avenue. We would like Management to consider M&A at a time when financing options are squeezed, allowing the company to be aggressive when others are forced to be careful.

Outlook

Presented above is Wall Street's consensus view on the coming 3 years.

Analysts are forecasting a reduction in TDCX’s growth trajectory, with a CAGR of 7% into FY25F. In conjunction with this, margins are expected to sequentially improve.

We consider the revenue assumptions to be conservative. The slowdown experienced is clearly heavily impacted by macro-conditions, implying the underlying performance of the business during better conditions is substantially higher. Based on the assumption that inflation has likely peaked, we could see expansionary policy return in mid-to-late 2024. We believe there is not sufficient evidence to rule out a growth rate of low double-digits.

Margin expectations appear reasonable in our view. Analysts are expecting a reversion to its FY22 levels as macro conditions improve. This said, the broader risks around margin erosion from competition should not be discounted.

Industry analysis

Presented above is a comparison of TDCX's growth and profitability to the average of its industry, as defined by Seeking Alpha (18 companies).

TDCX performs well relative to its peer group. The company’s growth, both revenue and profitability, exceeds its peers well over a 3Y period, reflecting the company’s impressive trajectory. We attribute this to the development of a compelling suite of services in conjunction with aggressive investment in growth. This said, the business is expected to disproportionately suffer in the coming year, which we attribute to its clientele’s exposure to macro-conditions.

What is quite compelling for us is that despite an aggressive growth approach, the company still significantly outperforms on margins, although we concede this is not the case from a FCF perspective.

Valuation

TDCX is currently trading at 5x LTM EBITDA and 4x NTM EBITDA. This is a discount to its (short) historical average.

Given the short trading history, we will not rely too heavily on assessing TDCX’s valuation relative to its historical period. This said, it is worth highlighting the significance of the change in investor sentiment over a short period. Importantly, the company is generating more cash relative to its valuation than it was historically.

TDCX is trading at a substantial discount to its peer group (134% on an LTM EBITDA level and 28% on a NTM P/E level). Given the uncertainty associated with its future trajectory, a conservative investor could imply a small discount is appropriate. This said, with superior margins and better growth, a premium is reasonably argued. Regardless, there is clearly value at this depressed share price. The only question in our view is when given the macro slowdown.

Key risks with our thesis

The risks to our current thesis are:

• Ongoing economic slowdown.
• Margin erosion with scale.
• Geopolitical development in Asia.
• Superior technological development by peers, in areas such as AI and data analytics.

Final thoughts

TDCX is a high-quality business in our view. The company has achieved strong growth in recent years, attributable to the development of a compelling suite of services and a successful go-to-market strategy. Although this has slowed, we heavily attribute this to market conditions rather than a clear weakness in the company’s business model, implying a return to good growth is possible.

With economic growth primed to continue in Asia, alongside technological development and a growing complexity in the corporate world, we believe the outsourcing industry should grow well in the coming years.

At 4x NTM EBITDA and strong margins, we consider TDCX a highly attractive investment opportunity.

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