Conduent: One Of The Better Small-Cap Tech Names Around
- Conduent has a well-diversified business model.
- CNDT does not have any major debt obligations in 2021 and recently also refinanced its long-term debt.
- CNDT’s valuations are cheap relative to its own history as well as the sector median, but it may find it difficult to flourish when sentiment towards small caps remains weak.
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“Conduent is in the pivot. It will be a growth company, and we're very close to declaring it so.”- Clifford Skelton, CEO - Conduent
Conduent Incorporation (NASDAQ:CNDT) is an American-based BPO that delivers mission-critical services and solutions on behalf of businesses and governments. According to a study conducted by HFS measuring the quality of the Top 50 BPO providers, CNDT finished 2nd. For the uninitiated, CNDT previously belonged to Xerox but was spun off in 2017 as a value-unlocking exercise. One can appreciate the grievances of long-standing holders of the CNDT stock, given that the stock has grossly underperformed the Nasdaq (QQQ) since its listing date. That said, there are encouraging signs under the new management team that has been in place since Q3-19.
Also, note that, on a YTD basis, CNDT has provided more than double the returns of the QQQ.
Diversified model and promising future
CNDT is essentially a small-cap IT player that offers products, services, and solutions to the majority of Fortune 100 clients within the commercial and government space. CNDT’s expertise is tapped from a range of industries, including healthcare, travel, and aerospace, and its presence across the American diaspora is well noted. For instance, 75% of insured patients in the US are covered by its healthcare and other BPS services. Similarly, it also processes nearly 9 million tolling transactions per day, covering more than 40% of US tolling. Recently, the company has also been noted for its payment process work tied to the government’s SNAP payment scheme.
CNDT’s diversified portfolio of services rendered across various industries and different market conditions helps bring a degree of resilience to the operating model. Last year, during the pandemic, when there was a lot of uncertainty with its commercial clients or when transportation volumes had come to a halt during the peak of the pandemic, CNDT was able to rely on its government services solutions where it served as one of the chief agents of pandemic payment processing; additional COVID-related business from CNDT’s government segment contributed $149m in FY20 and helped mitigate the weakness seen in the commercial and transportation segments. Going forward, they are unlikely to see the same uplift in government-related processing as they saw last year, but tolling volumes are inching closer to pre-pandemic levels and business confidence in the commercial segment has picked up leading to potentially higher discretionary spending. Overall, in Q1-21, the company saw its new business signings (in terms of total contract value) grow by ~10% and hit $356m (out of this, $221m was from commercial clients).
Looking ahead, I believe there’s a lot of juice left in all of CNDT’s three focus areas. In aggregate, the management feels they are dealing with an aggregate total address market of $186bn across all of their three key divisions. Of this $186bn, the bulk of the opportunities lie in the commercial space (the total addressable market here is growing at a CAGR of 3.2%). CNDT already enjoys deep expertise in areas such as claims processing and healthcare solutions, but the next leg of growth will be driven by their investments in digitization, automation, and cloud-based offerings particularly for potential financial clients.
Under the previous management regime, CNDT had been perceived as an IT player that didn’t have the requisite tech offering to move up the value chain, but they’ve been attempting to correct this by producing products that will have an edge in this new post-pandemic era. For instance, recently, they launched a new digitized back-office product offering for commercial clients who are permanently transitioning to a remote working environment. Even in the transportation space where CNDT is a key player, one ought to acknowledge the development of various secular tailwinds such as greater use of digitized ticketing services, contactless services, increased electronic tagging transactions, etc.
CNDT has the balance sheet to support its plans
To get ahead in this space, it is important for companies to keep making sustained investments in building innovative products (CNDT spends ~3% of its sales on CAPEX initiatives), and to do so, they need to have the requisite balance sheet to support this. CNDT compares rather favorably to some of the other small-cap tech peers that look excessively financially levered and are chasing growth at all costs. When the current CEO took over, net debt was over the ~$1.6bn mark, but this has now come down over time and stood at $1.37bn at the end of Q1-21. Basically, as a percentage of EBITDA, the net debt is fairly well controlled, at a little over 2x. In the immediate future, the company also does not have to fret over any major financial encumbrances as they only have a little over ~$80m due this year. A couple of months back, it also did well to refinance some of its dues in 2022 and 2023, by replacing them with new term loans and notes due in 2028 and 2029. This should enable the firm to forge ahead with its organic investments without the cloud of immediate debt repayments.
Despite a rather sturdy performance in 2021, CNDT’s valuations are still not prohibitive. You can currently pick up the stock at 11x forward P/E, a ~23% discount to its long-term multiple. CNDT compares even more favorably when you consider that the sector median multiple in this space is closer to 25x. Having said that, CNDT may continue to be impacted by the general lack of bullish conviction in small caps for much of this year. Small caps have done nothing this year and have lagged all the other segments.
As mentioned in The Lead-Lag Report, market breadth in the US markets has not been particularly encouraging, and much of the outperformance is on account of a few mega-cap names. If we were truly in a healthy market, one wouldn't see such prolonged underperformance in the small-cap space. US GDP still needs to eclipse its 2019 peak, and the labor market is still a long way from hitting full employment levels. Small caps are evidently reflecting this. Those who subscribe to The Lead-Lag report already know that three out of my four risk signals are already in risk-off mode, and typically, when this is in play, small caps struggle to deliver ample alpha. CNDT is also due to announce its Q3 results soon. It would be preferable to digest those results and wait for some of the inter-market signals to shift to risk-on mode before taking the plunge with CNDT.
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