2023-09-15 11:40:35 ET
Summary
- Concentrix currently resembles a falling knife, but it might in fact be a good buying opportunity.
- They have evolved from being only an operator of call centers, to being a partner and extension of the brand for top multinationals when it comes to customer experience journeys.
- There is certainly an AI- and Macro overhang, but the current selloff seems unjustified.
Summary
Concentrix, along with many of its peers in the customer experience ((CX)) industry, have been hard-hit by fears that the relevance of their businesses would be nullified by the rise of generative AI models like ChatGPT.
While certain areas of the industry will certainly see increased automation (which is not necessarily a bad thing for these companies), it is important to remember that there will almost certainly still be an intermediary between large multinational enterprises, and their CX operations. It will not all of a sudden be insourced and handed over to the likes ChatGPT without human oversight.
Concentrix, and their peers, are confident that this is merely the next step in the evolution of their industry, following on from a number of previous technologies like automated chatbots, interactive voice response, etc. which have all proven to be important tools in their arsenal, rather than the industry-ending technologies they were once feared to be.
I believe the level to which some of the largest players in the industry have derated is overdone, and provides a compelling rerating opportunity as the market realises that these companies are here to stay.
Company Overview
Concentrix describes themselves as a customer experience ((CX)) and engagement company, driving customer lifecycle engagement and differentiated experiences for their clients. They place a focus on delivering the brand as if you are the brand. They operate on the belief that every single customer experience is critical – a simple enough idea.
Business goal (Author)
This is also evident from the below quote from an investor day presentation .
“That moment? It’s an opportunity. When a customer asks a question, sends a chat, or makes a purchase, you want to show your brand at its best—smoothly get the customer what they need, and give them a reason to come back again and again”.
They can be thought of as an extension to their clients’ operations, performing functions that could potentially be insourced (and for a large part of the industry still is), but companies choose to outsource as it enables them to focus on their core competencies, while also achieving cost savings. Fidelity Management estimates the saving to be in the region of 15-20% over inhouse solutions. (Unclear which exact service/solution they are referring to for this number, but the idea is clear).
Concentrix does this through different processes/business functions. These can basically be divided into 2 main segments.
- Customer Engagement
- Digital Transformation
Customer Engagement
This has historically been their core competence and includes services like general customer and technical inquires, sales, cross-selling and retention. Concentrix is the global no.2 player in customer services. This is done through standard voice-based solutions like call centres, as well as through chat functionality, chat bot and email response automation etc. They perform these services for major global companies. The names of these companies are not disclosed, as the aim is to have the service feel like an extension of the brand. Most of us have probably used Concentrix services before without realising it, as their clients include marquee companies like the following:
Concentrix clients (Investor Presentation)
Digital Transformation
Concentrix indicates that their industry traditionally ran CX solutions on behalf of clients. Over time, they’ve invested into being able to design and build solutions as well – and then ultimately run them. The solutions have thus become more end-to-end.
In an increasingly digital world, companies need to adjust their strategy to account for this if they are to remain relevant. This includes functions like digital strategy development and adoption, AI integration, etc. This is an area where the lines between IT services, CX services and BPO becomes somewhat blurry. Concentrix, however, indicates that while bigger peers like Accenture ( ACN ), Infosys ( INFY ) and Tata Consulting ((TCS)) will operate horizontally, they hone in on only the CX vertical itself.
The Design and Build part of the business happens via Catalyst – an offshoot from the acquisition of PK in recent years – this gives them a unique edge over many smaller peers.
Within this segment – they aim to 1. Design, 2. Build, and 3. Run the future of CX.
- Design – here they have strategy consultants envisioning the journey for customers. How to transform, drive loyalty and increase revenue.
- Build – here they have what they call the most complete toolkit in the industry. Mix of tech required to automate CX operations and provide infrastructure for everything CX related.
- Run – they then run your CX as an extension of client’s brand.. They then provide you with the data generated to further improve the experience.
As part of this offering, Concentrix Catalyst (This business was about 450 million in revenue in 2022) was introduced in 2022. This is basically their team that specialises in delivering CX technology. (They are a combination of an existing unit, and the Tigerstrike and PK acquisitions)
Concentrix Catalyst Operations (Investor Presentation)
Partnerships
Concentrix lists 3 types of partners, with their growth being fastest in the most important category.
- Strategic brand partners. (grew wallet share by 35% here in 2021)
- Integrated Partners. (grew wallet share by 18% here in 2021)
- Partners. (grew wallet share by 3% in 2021)
Partnership Levels (Investor Presentation)
Increasing wallet share to the right (Strategic Partners) is a great outcome for Concentrix, as the “Partner” level is the least complex, lowest-margin type of work they do. Faster growth in the most complex categories will lead to stickier, more valuable, and more entrenched relationships with their clients.
The crux of the investment case is threefold in my view.
- What will the effect of AI be on the business?
- Does Concentrix have a reasonable chance of taking some lunch from peers?
- If they don’t, does it really matter? (Given the current low valuation)
This will be looked at in more detail throughout the rest of the report.
Industry Overview
As seems to be the case in most industries, industry size data should probably be taken with a grain of salt, with the growth rates attached to these numbers probably being the more pertinent factor to consider.
In the case of Concentrix, they split the market into a few different segments as described below.
- Core CX market (Inner Ring) ? roughly $90 billion. (Increased to $110b in latest fireside chats) This is the old-school customer services core of the business. Expected growth rate ? 5%, with only about 30% of the market currently outsourced.
- Expanded CX market (Middle Ring) ? $320 billion Includes services like analytics, consulting, voice of the customer, journey mapping etc – Concentrix recording stronger growth here. Expected growth rate ? 8%
- Digital IT Services market (Outer Ring) ?$270 billion (This is where they design and build their customer experience operations. They focus purely on services around the customer experience. Expected growth rate ? 17%
The Core CX market is basically the overlap in a Venn Diagram of the two larger markets (270 +320), which puts the total TAM at $550 b.
Concentrix’s home was traditionally the core CX ($90 b) market, which is expected to grow the slowest over the coming years, although estimated outsourcing percentage is also still fairly low.
Within this core, Concentrix is the second largest player, with roughly 5-6% of the market. Estimates are that the top 10 players account for roughly 35% of the market – so there is plenty of room for consolidation.
TAM (Investor Presentations)
They have, however, also branched out into the faster growing adjacent markets.
The CX Adjacent market is expected to grow slightly faster than the core CX and BPO market, however there is some tough competition in this arena – the likes of Accenture, Cognizant and Tata Consulting Services.
The other side of the market is Digital IT services. Total IT services is estimated at close to a trillion-dollar industry, growing at about 9% p.a. Within IT, the Digital IT market is expected to grow much faster at 17% p.a. Concentrix’s acquisition of PK gave them entry into this space – which consists of functions like consulting, app development, cloud access services etc.
However, here they also run into some formidable peers like Endava and Epam
TAM (Investor Presentations)
Macro Environment
From a cyclical perspective, Concentrix typically generates most of their revenue and profits during Q4, as this period usually comes with an uptick in business trends for their clients as well. (This makes sense given that ±50% of the business comes from the retail and travel verticals.)
They also claim to perform reasonably well in both good and bad economic environments, as client goals just shift from expansion to cost reduction – with both being areas in which they can assist.
To support this – they pointed out that during the GFC crisis, clients outsourced more in order to convert fixed cost to variable, and the services market remained fairly strong during that period. Management also indicates that sectors of the business is fairly resilient to recessions. Healthcare, Social Media and IT devices typically don’t see big downturns during a recession, as an example. Given that most of their cost base is labour, management notes that this can be reduced fairly quickly if required.
They have noted on several occasions that the current macro environment is strange. They have seen some slowdown with new projects being paused etc, so not an expansionary environment. However, clients are also not yet in the cost-cutting downturn cycle. It seems we are currently in an in-between-lull.
SWOT
Strengths
Scale : Operations in more than 40 countries and in more than 70 languages with 300k employees. Allows servicing large multinationals all over the world (49 of top 50 clients use them in multiple countries, the one where they don’t is a government contract for specific region). Smaller peers will not be able to do this.
The CEO letter in 2021 annual report speak to this point:
2021 Annual Report
Recurring Revenue. By the end of 2021, almost 90% of their revenues were generated from long term integrated and strategic brand partnerships.
Long lasting client relationships. The average tenure of top clients indicate satisfaction and serves as a big nod of approval of trust in their product.
Investor Presentations
Strong execution through COVID. CEO indicated that after COVID response and Concentrix’s ability to keep on serving customers, 90% of impacted clients indicated a willingness to give them more business based on their pandemic response.
Supporting big players.
Growing Client Base (Author via 10K's)
Well regarded management. Bank of America ’s industry analyst spoke glowingly of CEO and CFO. States that they have really been the ones who built this company from where it had 25 employees in 2006 to where it has more than 300 000 today.
Weaknesses
Math. They just don’t get it.
Investor Presentations
Opportunities
Cross selling . The pending Webhelp acquisition has very little overlap with Concentrix, this presents a cross-selling opportunity into a “captive”, existing client base.
Threats
Cybersecurity/Reputation. Given the entire business is based on interaction between brands and their customers – reputation is a big risk. The risk from breaches in their services to banks, or healthcare – could be devastating. Given the increasing number of smart, connected devices, data is being generated at a scale never seen before. This provides more contact points but also more opportunities for “malicious actors”.
From a reputation perspective – there are also things like the UK Tax fraud case to consider. Concentrix did not commit any fraud – but a very poor level of service delivery means they will struggle to restore their reputation with this client.
While the above might seem like an indictment on the quality of the business, I take comfort in the fact that Concentrix's portfolio of marquee clients have stuck with them for 16 years. The above clearly had to be a small enough issue for companies not to take notice/care.
Generative AI
No doubt though, that the biggest risk, and overhang to the share price, is the rise of generative AI models like ChatGPT.
It has created massive winners and losers in the market in 2023. Concentrix and main peer Teleperformance ( TLPFF ) fall into the latter category.
Since ChatGPT was unveiled at the end of 2022, the market’s reaction to supposed winners (Nvidia, Adobe etc), the neutral (Accenture, Capgemini etc) and losers (Concentrix, Teleperformance etc) has been telling.
The biggest risk to the investment case is undoubtedly the effect of GenAI and whether this could nullify a large part of the business. This is clearly a threat to the industry (or at least a specific part of it), and not just Concentrix.
These fears are also quite evident when looking at the recent sell side price target moves for Concentrix.
- BoA from 165 to 95.
- Harrington Research from 165 to 98
- Canaccord from 150 to 125
Blood in the streets = sell side running for cover = buying time, or is this business in terminal decline? Revenue numbers doesn’t suggest this – more on that later.
In Concentrix’s defence – they have been mentioning AI for a number of years now in their annual reports – talking about investments in the space and how they have utilized AI to streamline their services.
See extract from 10k 2020 :
Annual 10K
In fact, they state their belief that companies at the forefront of CX will benefit from AI, rather than be threatened by it. Quizzed on a TV show about how AI would affect the number of people employed by Concentrix – the GM of Concentrix Philippines (where they have a large workforce) said that he believes it might lead to them employing more people, rather than less. While they will need less than before for the same tasks, the increased efficiencies will drive more work in their direction, leading to them requiring even more people. It will, however, require a certain amount of upskilling. A few years ago, the biggest issue that customers had was how to reset a password. Nobody calls about this anymore. The landscape is getting more and more complex, so people need to be reskilled on more complexity and comprehension.
BoA estimates that 10-15% of Concentrix’s revenues are highly transactional (either voice or non-voice), more or less in line with Concentrix’s own statements, see Partner Diagram on page 7. This would be the part of the business most vulnerable to LLM (Large language Models) like ChatGPT. This part has historically been declining over time. They somewhat agree with management that AI is more of an enabler for Concentrix than a negative disruptor. A tool that can be useful in their drive to move towards lower volume, higher value from higher volume, lower value.
The (artificial) elephant in the room...
Given the importance of AI on this investment case, it is worth digging into this some more.
There are clearly 2 schools of thought on this.
- Investors fear the disruptive influence, potentially nullifying the business model.
- Management sees GenAI as a natural evolution from previous AI and machine learning, and an opportunity to further automate low level, low-margin tasks.
Concentrix and Teleperformance management have spent a lot of time on recent earnings calls and investor events trying to ease investor fears about the disruptive potential of AI. Both see it as an opportunity for their industry, not a threat. Some important points are discussed below.
How are solutions like these implemented?
This depends on lot on the client. Generally, there are 3 different types of clients:
- Some want to decide on the tech standard and they implement it themselves. Then they will use outside partners to run, drive and optimize their solution.
- Some will come up with a specific standard, and then get partners to design, implement run and manage it.
- Other clients want absolutely nothing to do with it. They basically say, you are the experts. You go and deal with this.
Is this new ?
- These businesses have consistently evolved as new tech tools became available. At first, the largest part of CNXC’s business was answering phones on behalf of AT&T to settle bill issues.
- Later, while doing work for e-commerce companies, they would deal with things like parcel queries. That was their role in e-commerce. Given the new automated tools for all of this, their role has evolved to things like verifying legitimacy of reviews, verifying 3 rd party sellers and authenticity of goods etc. This is all work that did not exist 10 years ago.
- Technology further evolved to things like Interactive Voice Response (Press 1 for X, press 2 for Y), and pre-programmed chatbots, and people feared it might be the end for these companies, however it has just become tools in their arsenal.
GenAI is the new buzzword. AI and ML, however, have been used in the industry for years. CNXC already deploys AI tools across about 60% of the business and they are on track to have this closer to 80% of the business come year end.
Size :
- CNXC have stated before that around 10% of their business currently is commoditized, and they are constantly trying to automate this. A year ago, it was 13% of the business. They are actively trying to automate these low-impact, low-margin transactions, thus any tech that enables this is welcomed. It creates opportunities for higher margin, more complex interactions.
- Teleperformance stated that they believe they might be able to automate 20-30% of volume over the next 3 years, minimizing low-level interactions.
Issues :
With GenAI specifically, there are still a number of issues that will have to be resolved going forward. These include:
- Data security, data ownership, data integrity. Enterprises generally don’t want their data to go into the world into an open format for use in large language models. That means they will likely need to use their own proprietary models. They’ll need partners to assist them with implementing and running these. It’s not a self-operated plug and play solution.
- Solutions like this generally do not run on their own. They still require human oversight. Concentrix plays in this last mile, helping customers develop and build these last mile connections. This is a crucial connection between brand and client, and enterprises aren’t likely to completely sever all human interaction from the CX experience.
- Predictability and reliability issues with LLM’s. These brands need to provide a consistent experience and feel to all customers worldwide. Inaccurately generated response, or inconsistently generated responses would be a big threat here.
It’s a far cry from saying hey – this is ChatGPT – let’s put our entire enterprise CX on it.
Financial Impact :
- CNXC and TEP both indicate benefits would be things like reduced handling time per query (increased efficacy) and thus reduced staffing costs for the same work. Whether profits are kept 100% or split with client, it should provide a boost either way.
- In terms of impact on financials from automation. There is generally some impact on the revenue line. A dollar transaction is not worth a dollar anymore, but the margin from that dollar increases due to less costs on their side to produce that value. Over the years, automation has been very profitable for them – this was one of the big drivers of their operating margin over several years.
- Concentrix also mentions that there are some meaningful costs that clients don’t really see. Stuff on the backend where they can drive margin improvement. This would be the amount of training, scheduling, quality monitoring etc. They can drive savings on these items and have large proportions of the benefit accrue to them.
AI Takeaway :
Teleperformance via a call with IR indicated that CX accounts for only 1-5% of a client’s costs base (around 1-3% of this is voice). Their clients tell them that personalization and the human element is still important and might therefore look to reinvest the cost savings. Compared to running solutions like this inhouse, building up a capable team etc, it does not seem worth it.
Concentrix also mentioned that they find it quite strange that they have been affected this much. They see it as the logical next step in the evolution of the industry. There have been plenty of inflections before, and it just makes their work more complex and higher value. They’ve always been pro-automation. It lessens their volume and increases their value.
- I think it basically boils down to companies continuing to outsource work that’s not their core competence, whether there are tools available to do it themselves or not. This is similar to advertising agencies, for example. Even though all the tools exist for companies to do their own advertising, they don’t. They are not the experts. They outsource the work to someone that utilises those tools.
CX represents a very small cost component, but for a critical part of the business – one of the main touchpoints with customers. I don’t think large enterprises will have the appetite to try and insource something like this.
Pending Webhelp Acquisition
Earlier this year, Concentrix announced the planned acquisition of WebHelp – which is a rather chunky one. Webhelp is a tech enabled BPO, specializing in CX, sales, marketing, and payment services.
Webhelp Acquisition Data (Investor Presentations)
Some points to note about the transaction:
- Concentrix market cap at time the deal was announced was $4.7 billion, and the value of the deal in total was $4.8 billion at the time.
- The deal will be financed via cash, debt and equity issuance.
- $540 million in cash, $750 million note to Webhelp shareholders payable within 2 years. (Interest at 2%).
- Will refinance about $1.5 billion of Webhelp debt.
- Importantly, the number of shares to be issued is fixed at 14.9 million. Thus, with the price dropping from $120 to $72, the deal is currently considerably cheaper than when announced. ($800 m cheaper). There is also an extra 750k shares that will vest if Concentrix share price breaches $170 within a specific timeframe. This is around 140% above current levels. After issuance, Webhelp shareholders will own about 23% of Concentrix.
- Post closing – debt will be around $5 billion, (net leverage of about 3x) so more leverage in a weaker macro environment with higher rates.
- Debt raised for the deal is spread over 3, 5, and 10-year tranches with an average rate of about 6.5% - in line with their planning & forecasts.
- Concentrix is very confident that they can continue divis, buybacks to offset dilution, and deleverage back to about 2x within 2 years, while still having some cash for small bolt on M&A or increased buybacks.
- This confidence comes from past experience, and the high FCF generative industry they operate in. They expect to generate around $500 million in FCF this year ex Webhelp. (About $750 million including Webhelp)
- The combined entity is expected to maintain an investment grade credit rating.
- EPS accretion of about 7% expected in the first full year post close, and DD increase in year 2.
- Combined entity will still generate only about 20% of revenue from top 5 clients.
Concentrix indicated that the rationale behind issuing equity for the deal was to maintain their investment grade debt rating, so a level where both themselves and the rating agencies were happy with their leverage profile.
Webhelp:
- Webhelp is expected to have revenue of about $3 billion, and EBITDA of 500 million in 2022.
- They have been growing revenue organically at around 10% p.a. over the last 5 years.
Rationale for deal:
- Increase exposure in Europe and Latam. Both areas where Concentrix were not very strong and had been increasing investment to reach the scale and level required. This deal accomplishes that.
- Very little overlap in the client base, so almost no cannibalization, and significant cross-selling opportunities.
- Revenue will be spread geographically, around 1/3 each from Americas, EMEA and APAC – giving them a balanced footprint.
Concentrix sees the industry continuing to consolidate. They believe there will be a couple of players in the $10 billion plus range (where this deal would put them), and then a number of boutiques ($1 billion range). They don’t believe the middle will survive, as they see a trend of customers consolidating operations and working with less partners – so you need to be able to deliver at scale across a client’s operations.
Financial Overview
Growth and profitability
There is no doubt that the Concentrix growth story has been impressive thus far, growing revenue at a 50% CAGR over almost 10 years. (Although much of this is via M&A). Over this period, they have also managed to drastically improve profitability by >6% as they moved into higher-value operations.
Growth in sales and profitability (Investor Presentation)
The 2 largest jumps in revenue came in 2014 and 2019, via the acquisitions below:
Concentrix states that part of the reason for the strong growth recently has been the rush toward digitization brought on by COVID, but also because of the increase in new economy companies focusing on- and investing in better CX journeys. The end of the free money era will likely slow this drive somewhat in my view. However, it is certainly true that good CX experiences today are non-negotiable, and more important than ever before.
Assessing this more recent trend paints a pretty picture for Concentrix.
Author
I would put more weight on the 3-year numbers – as these are more organic. (2019 – 2022). Concentrix’s performance over this timeframe has been excellent. While increasing sales and gross profit at roughly 10% p.a., Opex increased by less than 4%. This has led to very impressive profitability growth over the period.
Debt
BoA notes some concern in the market around the possible debt increases for new acquisitions. Interest coverage ratio was still 10 times after the extra debt they took on for the previous acquisitions. This should decline with the Webhelp acquisition.
Concentrix is aiming to maintain leverage of less than 3x net debt/EBITDA. The new acquisition will take them to this level.
Margins
For the last few years, Concentrix’s operating margins have been lagging many of their peers. But there has been a marked increase in 2021 and 2022, putting them more on par with peers. Industry giants like Accenture play in a somewhat different ballpark.
Improving profitability (Author)
Forecasts and Valuations
At their last analyst day in January 2022, Concentrix provided the following targets: (pre-Webhelp)
- Revenue of $10 billion by 2025. (With about $1.5 b of this coming from M&A) – this would basically imply $8.5 b without modelling for further M&A. (My base case reaches $7 billion).
- Overall organic CC growth of 9% between 2023 and 2025. I have modelled 4.8% in my base.
- The market has historically grown at 3-5% (core CX market only). For FY23 and possible downturn, management initially guided to 4-6% organic CC growth, however this was lowered to 2-3% in Q2 earnings call. I model 2%.
- Adjusted operating margin of 14.5% by 2025 vs around 13.9% in 2022 – so very small margin improvement in guidance. BoA noted that they expected higher guidance on this. It does leave for surprises to the upside.
- I reach 14% in 2025 and 14.4% by 2027.
Margin Expansion Targets (Investor Presentation)
I apply a blended forward (12 months out) PE multiple of 13x, which is not stretched vs its own history, or versus peers. In fact, it is below the long-term average for its largest peer Teleperformance. I use Teleperformance as proxy as it has a much longer history than Concentrix (which has only operated as a standalone for about 3 years). The median PE multiple over a period of about 15 years, has been 16.5x, and the average 18.1x. Therefore, 13x certainly does not seem stretched.
Concentrix multiple derating (Bloomberg)
The above leads to a FV of $130, upside of 62% from current levels. This is based on fairly conservative estimates, and even just assuming that management does reach their stated growth targets easily pushes the upside past 100%.
Takeaway
I believe the investment case for Concentrix is fairly binary from this point on. Either the market will see that AI fears are overblown, and Concentrix should see a strong rerating and recovery. On the flipside – if AI does come for its lunch, the risk will likely be a more permanent loss of capital. I believe the probability of this happening in quite low, and a ton of fear is already priced in.
However, given that permanent loss of capital is our ultimate measure of risk, I would argue for a small starting position, which can be systematically increased as the doom and gloom disappears and management starts executing on targets.
Given the ample upside available – this should be a viable strategy.
For further details see:
Concentrix Corporation - Is The Knife Still Falling