PeopleSupport Sell-off Overdone: Why Now is the Time to Buy

Mar.12.07 | About: PeopleSupport Inc. (PSPT)

PeopleSupport (PSPT) reported earnings after the market close last Thursday that were below analyst expectations and offered a Q1 outlook that also failed to make the consensus estimate on an EPS basis. As a result the stock price dropped 38%.

In my opinion, this represents a tremendous opportunity to get in on a solid name at a rather attractive valuation. But first let us review some of the highlights of the fourth quarter:

1) Revenue - Revenue of $31 million clocked in ahead of company guidance of $29-$30 million. This represents 82% y-o-y growth and 3% growth sequentially. What is impressive is that this top-line performance came in its seasonally weakest quarter, showing that clients continue to appreciate and recognize the service offerings being provided by PeopleSupport.

2) Gross Margins - Gross Margins of 31.5% declined from 41.6% in Q4'05 and 35.3% in Q3'06. Gross Margins came in below expectations primarily due to the strengthening of the Peso versus the dollar. To give some sort of color, the Peso in Q4'06 averaged 49.8 versus the dollar as compared to 51.3 n Q3'06 and 54.6 in Q4'05. Management stated that 80% of its cost of revenues is directly exposed to F/X movements. Prior to the end of Q4, management did not have a hedging strategy in place. Going forward, management has stated that they will implement hedges in place to smooth out such volatility.

3) Operating Income - Operating margins came in below estimates due to a $500,000 write-off of bad debt, as well as higher than expected depreciation expense due to investments in technology and infrastructure. Operating Margins in Q4'06 declined to 2.6% versus 13.6% in Q4'05 and 13.2% in Q3'06.

All in all this resulted in Q4 EPS of $0.07, which came in below the $0.11 consensus estimate. Pointing to FY'07, PeopleSupport offered revenue guidance in the range of $140-$145 million. This came in below consensus expectations of $146 million. This, however, still equates to robust growth of 27%-31% year over year. Note also that PeopleSupport has been known to raise its revenue guidance throughout the course of the year, and its guidance may prove conservative. Management guided to operating margins below 10% for '07.

I believe that 2007 represents a year of investment for the Company as it develops its footprint and enhances its capabilities across the BPO landscape. For Q1'07 PeopleSupport pointed to revenues in the range of $32-$33 million versus consensus estimate of $32.1 million. For EPS, the Company guided to a range of $0.10-$0.11 versus consensus of $0.15. Margins are expected to be impacted by increased infrastructure cost, early stage revenue from larger clients and SOX related expenses.

What does this portend for PeopleSupport? I firmly believe that these are some of the teething pains that are encountered by a rapidly growing company. I will have to give the Management the benefit of the doubt here in relation to their growth strategy, as they have been nothing short of exemplary thus far. 2007 is going to be a year of investment for PeopleSupport as it prepares its platform for the next stage of its evolution. I believe these are the necessary steps as the Company continues to develop its global footprint in the BPO market.

Further, PeopleSupport sports a pristine Balance Sheet with $140.5 million in cash / securities (~5.75 per share) and no long term debt. This provides the Company with the much needed gun-powder to make investments in infrastructure as well as to make opportunistic acquisitions to broaden and complement its current capabilities and service offerings.

With its 38% drop, I believe that expectations have reset, and this results in the potential for tremendous upside. Note, also, that PeopleSupport would make a very attractive acquisition candidate for some of the larger BPO / Contact Center players, especially after last Friday's drop.

Fundamentally the long-term growth story has not changed a bit since PeopleSupport priced its secondary offering at $20 per share in November, 2006. BPO is here to stay and PeopleSupport represents one of the brightest prospects to continue to ride this strong secular growth theme.

PSPT 1-yr chart


Disclosure: Author has no position in PSPT.