- Many positive events have happened, in the face of adversity, since my last report in Dec 2019, yet the stock price is at the same level it was back then.
- COVID posed a real threat to the company, but this management team took the bull by its horns forcing a business transformation to survive. Survival led to innovation.
- Sheer resilience, determination and forced innovation turned one of the most challenging years in the company's history into a story of success and accomplishment.
- I believe we will see further evidence of this continued success when they report Q4'2020 earnings next Monday, March 15, 2021; and throughout 2021 as some business normalcy returns.
For those of you new to the story:
Startek (NYSE:SRT) is a leading global provider of technology-enabled business process management solutions. The Company provides omni-channel customer experience, digital transformation and technology services to some of the finest brands globally. Startek is committed to impacting clients’ business outcomes by focusing on enhancing customer experience and digital enablement across all touch points and channels. Startek has more than 40,000 CX experts globally spread across 46 delivery campuses in 13 countries. The Company services over 250 clients across a range of industries such as Banking and Financial Services, Insurance, Technology, Telecom, Healthcare, Travel & Hospitality, Consumer Goods, Retail, and Energy & Utilities. The Company offers a repository of digital and omnichannel solutions based on decades of experience in driving growth by putting the customer at the center of our business. Because no one solution fits all, we have crafted solution delivery to suit a variety of industries. Startek has delivery campuses across India, United States, Malaysia, Philippines, Australia, South Africa, Canada, Honduras, Jamaica, Kingdom of Saudi Arabia, Argentina, Peru and Sri Lanka. - Source: Startek
How COVID took the wind out of their sails
As I described in my last write-up, while 2019 was coming to an end, Startek was showing clear evidence of returning to revenue growth with higher AEBITDA margins, resulting in solidly positive cash flow from operations and net debt reduction. The company was positioned to build upon enormous momentum coming out of Q4'2019 into Q1'2020, but as the pandemic made its way throughout the globe, the last two weeks of March dragged it down. By this time, the company was also very close to achieving a significant milestone it had been targeting since the merger: the refinancing of its bank term loan once it was able to show improved results proving that the merger actually worked (more on this later). But COVID had other plans.
At the flip of a switch, its reality went from focusing on business growth to one of crisis management: agents were not able to come into its campuses to work, mass transportation was shut down in many cities around the world, and obstacles related to employees working from home (including the lack of a secure network platform at WFH locations) made a transition difficult given client liability concerns. Even as some clients quickly provided indemnifications to move activity from secure sites to WFH environments, physically having to move systems to worker homes contained its own set of challenges given that a number of countries had declared total lockdowns (i.e. India, Malaysia, Philippines, Honduras, etc.). This all resulted in a large part of their footprint becoming unavailable combined with a sharp contraction in demand; in short, the situation was dire and the focus became survive, sustain and secure.
Formulating a plan to reprioritize actions that would shore up cash, the management team was not going to allow the ship to sink under any circumstance. As such, it initiated the implementation of key initiatives that had to produce quick results (in days and weeks) to raise and conserve cash, including:
- Increased A/R collection efforts while pushing out A/P as much as possible.
- Negotiation of lease payment deferrals or concessions from landlords.
- A complete top to bottom review of expenses at all levels to find efficiencies and cut all non-essential spending and capex, aligning the cost structure to the contraction in demand it was experiencing.
- Negotiate loan covenant waivers with the ultimate goal of restructuring the bank term loan to defer the loan principal repayment schedule.
- Find ways to creatively improve the balance sheet while increasing liquidity.
- Develop a credible and scalable work from home solution that clients can not only adhere to without security concerns, but that would also deliver great performance and quality.
- Once a WFH solution is developed, rapidly execute the transition of a significant portion of the global workforce from an office to a work-from-home environment within weeks.
This management team did what stellar management teams do; take existential challenges and turn them into game-changing opportunities. The results were stunning and fast.
By the time the company reported Q2'2020 earnings in August 2020, a number of significant milestones had been achieved both on the liquidity and client solution fronts.
Liquidity, debt and cost structure
- April 2020: The company entered into a securitization transaction to sell trade receivables up to $35 million at a discount on a non-recourse basis. The company used the proceeds of the transaction to prepay and terminate its existing revolving credit facility. This move essentially allowed it to remove about $22 million in debt from the balance sheet, significantly improving the net debt leverage ratio and placing it in a better negotiating position to refinance the term loan once things stabilized; a home run. (Term loan refinancing was announced two weeks ago, more on this later).
- July 2020: The company entered into an amendment of the bank term loan providing for financial covenant waivers, deferment of principal repayments until February 2021, and an increased revolving facility. In connection with this amendment, the company raised $7.5 million via private placement of common shares to CSP, its principal shareholder. Between the equity raise and the increased revolving facility, the company had more than $27 million in additional liquidity available over the rest of 2020.
- August 2020: During the Q2'2020 earnings call, the company reported the lowest quarterly SG&A expense line to date after extensive cost-cutting initiatives that delivered a new fixed costs baseline going forward. Quick decision making at the direct cost level also prevented deeper decreases in the gross margin.
Tough times breed innovation: StarCloud is born
Out of the need for a fast and secure work-from-home client solution, the team partnered with clients to get approvals and establish protocols for a virtual desktop at the employee's home providing a secure, scalable, and flexible WFH ecosystem. Its comprehensive WFH solution, StarCloud, was born and built to seamlessly transition from the office environment to the home environment and vice versa based on business requirements and maintaining business continuity.
StarCloud is a smart WFH platform that delivers business continuity and agility with a global, virtual, cloud-enabled workforce. The platform allows the agent to merge two channels of communication: voice and screen, through the interconnectivity with their client's server; bringing this access into a single unit gives the agent the ability to speak to the customer on the same line as well as work simultaneously. This is a significant technological system integration with multiple partners that the technology team was able to put together quickly for the WFH model.
Once the WFH solution was developed and ready to be deployed, the challenge then became executing the transition of the idle global workforce (total workforce comprised of more than 40,000 CX experts globally spread across 46 delivery campuses in 13 countries) from an office to a WFH environment under strict lockdowns and within days and weeks. To accomplish this transition around the lockdowns, the team utilized midnight packers and movers; I can only imagine the magnitude of this endeavor.
Proof is in the pudding
In its Q2'2020 earnings release and call, the company reported that it transitioned approximately 50% of the global workforce to WFH within three weeks! Only 60% of the workforce was active by mid-April, and by the time Q2 earnings were released in August, the company had approximately 90% of the workforce active with 65% through its new StarCloud remote work capability and 25% through its delivery campuses.
In all honesty, my expectation for Q2 earnings results was for a total disaster as I did not believe it could move fast enough. Although the results weren't pretty, they were not even remotely close to what I would call a disaster...wow, was I pleasantly surprised. Although revenue was significantly impacted by the lower active workforce in most geographies, its cost-cutting measures were reflected in a gross margin that could have been much, much lower and in a 43% reduction in SG&A as compared to the same quarter the previous year (19% reduction versus previous quarter). In addition, cash had increased by $16.7 million and net debt had decreased to $93.5 million from $135.5 million at March 31, 2020, as a result from its liquidity initiatives including: tight working capital management, cost controls, the term loan amendment, completion of the ABL facility, and the equity raise.
Given the reality the company was facing from late March to mid-April, the results reported for Q2 were nothing short of stunning, in my view. By the time it reported in August (well into Q3), the company was experiencing strong demand from many clients and an improving business allowing them to reinvest in needed IT capex for the back half of the year. It successfully realigned the organization towards a new set of demands within a short period of time while optimizing its cost. The execution of the plan of action not only averted a potentially devastating position, but it also allowed for a quick recovery as clients became more flexible to adopt this new WFH platform while embracing digital capabilities, a testament to the sharpness of this truly entrepreneurial, seasoned management team that has been tried and tested.
StarCloud and a global footprint: The Great Differentiator
StarCloud essentially allows agents to work from anywhere in the world with an internet connection making Startek a truly global organization. With this platform, it now has an infinite seat capacity that can be lit up anywhere in the world. Startek's ability to ride on its global infrastructure and package both a brick and mortar and a WFH cloud-based solution that now has been proven in a large scale with similar kind of accuracy and security, all in a single sales conversation, is a great differentiator.
Aparup Sengupta, Startek's Global CEO, commented to me in one of our discussions:
When a brand says, hey we need to light up in most geographies simultaneously when launching a service...Startek is definitely through the door of any RFP because of our global presence. There are very few companies in the world today that can say: I'm going to light up in New Zealand, South Africa, Malaysia, Singapore, Philippines, US, Canada and the Middle East...all in one go. This is also a clear competitive advantage. We are now aggressively pursuing more deals through the door using our global presence and flexibility of offering a combination of a brick and mortar or a WFH solution or both. We can have a WFH solution up and running within 12 to 18 hours.
Rajiv Ahuja, Startek's President, added:
Because we do foresee the WFH solution forming a reasonably significant component of the total workforce and network strategy....speaking now on behalf of some of the clients we have been talking to, we have put into place systems and technology to back that up where we can now have potential hires or employees go in for what we hiring, onboarding, training, etc. based on performance management....so that the entire hire to retire cycle could be done virtually from home as opposed to bringing people through the campuses. This gives us a lot more speed and telescopes our time to market if we had to hire, rehire or retrain for any specific program. Our costs would also be much lower and faster speed to have them producing revenue.
Q3'2020 Earnings: Evidence of a rebound setting the stage for a return to growth
- Q over Q revenue growth of 14% and essentially flat vs prior year
- Gross profit rebounded 43% Q over Q
- SG&A at 9% of revenue down from 10% the previous Q despite the growth
- Adjusted EPS of .08 on a non-GAAP basis, well above any estimate
- AEBITDA increased 77% Q over Q to $15.6 million; the second highest quarterly level achieved since the merger
- FCF positive; and a net debt reduction of $14.1 million as compared to the previous quarter from $93.5 million to $79.4 million
- TTM net debt leverage ratio ended the Q at 1.54x as compared to 3.6x at the end of 2018 and 2.73x at the end of 2019
The quarter saw continued recovery in activity and margins as new client programs were launched and clients continued to adopt their new platforms increasing capacity utilization rates. As a result, free cash flow generation surged as the company enjoyed the significant operating leverage it created during the preceding difficult months, and its focus on cash preservation remained. The company described a continued robust demand in the e-commerce and healthcare verticals as clients further embrace its digital solutions; it expects its digital initiatives to become key drivers of revenue growth and margin expansion going forward.
Based on the results and what it sees coming, the company began investing back into the business in terms of capex to stay ahead of the curve in technology and sales hires, specifically. I believe the company is now in a growth trajectory positioned to sustain the momentum they have built.
Recent accomplishments and announcements
Bank Term Loan Refinance
About two weeks ago on February 24, 2021, the company announced the long awaited successful refinancing of its bank syndicated term loan facility. The accomplishment of this milestone is extremely positive news for a number of reasons:
- Although I was not surprised to see it done this soon given how the net debt leverage ratio improved as at Q3'2020, I thought it might also need a follow through quarter to cement tis prospects and negotiating position. The terms negotiated allows for principal repayments to begin 21 months from now with interest margins tied to net debt leverage ratio measurements, as well as enhanced liquidity for targeted acquisitions and working capital needs.
- Reading through the loan agreement, it became clear to me that an acquisition might have been the works; sure enough, it announced a strategic investment in CSS Corp. the day after. Aside from limiting the allowed financial indebtedness the company could sustain following an acquisition, the loan agreement also stipulates that in any permitted acquisition: "the target company has demonstrated positive EBITDA and positive operating cash flows for the Relevant Period ending on the most recent Quarter Date".
- Additionally, the loan agreement required Startek to submit its Base Case Model: a "financial model including profit and loss, balance sheet and cash flow projections in agreed form relating to the Group, each prepared by the Company". I think we can safely infer from this that the bank lender group has reviewed the company's Q4'2020 performance and felt comfortable enough with the expected trajectory to not only move forward with the refinancing, but to also allow for targeted, accretive acquisitions.
The bullet points above alone should have moved the stock 15% to 20% to the upside at the very least.
Strategic minority investment in CSS Corp
On February 25, 2021, Startek announced an indirect beneficial interest of approximately 26% in CSS Corp for $30 million. CSS Corp. is a new-age IT services and technology support solutions company that harnesses the power of AI, automation, analytics, cloud and digital to address customer needs. The company made the investment to accelerate its adoption of digital-driven services and improve its potential for margin expansion, according to the press release. I'm sure we will learn a lot more about this move next week.
On the same day, the company also announced a change to the CFO position. In my view, Ramesh Kamath has been an absolute rock star, so the news came as a bit of a surprise. Ramesh did communicate to me via e-mail that he has been wanting to move on for some time now due to personal reasons, but had not done so due to the COVID challenges, the debt refinance still being outstanding, and the investment in CSS. Now that these have been accomplished, he is looking forward to continuing to help Startek on its journey under his new role. He also had excellent things to say about the new CFO, Vikash Sureka. On this, I have to say that, when it comes to talent acquisition, I stopped questioning Aparup a long time ago.
My expectations going forward and valuation
For Q4'2020, given that it is seasonally its best quarter of the year and the momentum built from Q3 as more business activity returns, I expect to see further revenue growth quarter over quarter at a level similar to what was achieved in the same quarter last year around $173 million. At that revenue level with the operating leverage created over the last two quarters, I expect a slight gross margin improvement resulting in an AEBITDA of around $17 to $18 million. These kind of results would put it in a position to easily beat street Adjusted EPS estimates of 0.10 per share.
Forecasts and Valuation
For 2021, I assume a conservative 9% revenue growth to $700 million that, based on the current cost structure, could deliver AEBTDA upwards of $80 million approaching a 12% AEBITDA margin.
For 2022, I assume a conservative 6% revenue growth to $745 million with further margin expansion as they continue to scale the business that could deliver AEBTDA upwards of $90 million approaching a 13% AEBITDA margin.
In my view, the stock deserves no less than a 9x AEBITDA multiple today for a target price of $10/share. Over the medium term, as revenue growth continues and it realizes the operating leverage already built into the cost structure, the AEBITDA multiple should be no less than 10x which would translate into a double from here in 12 months and a triple in 18 to 24 months.
2020 was one heck of a year, and for Startek, one huge bump on the road. But this management team's resilience and agility to adapt made sure that only a bump it was; nothing more. A bump it used to realign the business, innovate, and thrive to the point where I dare say positions the company to reach that $1 billion in annual revenue goal sooner than planned.
As an investor, I judge companies and their managements not by what they say, but by their actions that back up what they say. I have full confidence that the management and people behind Startek have proven, with their actions, that it is not a matter of if, but when, their goals will be met.
This article was written by
Analyst’s Disclosure: I am/we are long SRT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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