Description

Overview

I believe Atento S.A. stock (NYSE:ATTO) at current prices ($13.93) is a compelling investment opportunity with potential for 100% upside over the next two to three years.  Atento offers customer relationship management and business process outsourcing services primarily in Latin America.  It has a legacy EMEA business that represents 15% of revenues, and a small, but growing US business.  Atento is a Bain Capital controlled (85% current ownership) LBO that was taken public in a very inhospitable environment for Latin America related IPO’s.  The original pricing range was $19 to $22 per share.  Due to poor demand for Latin America exposed businesses, the deal was downsized and ultimately priced at $15 per share in October of 2014.  It opened at $13.75 and closed down nearly 15% on its first day of trading.  The small float and low liquidity have been a further depressant.  I believe the poor sentiment has created an attractive opportunity to invest in a good business that has a good return on capital, attractive long term organic growth prospects, and is undervalued on both an absolute and relative basis.  Teleperformance (RCF FP), Atento’s closest peer, trades at ~9x forward EBITDA and on 16x forward EPS.  Atento, which in local currency terms is growing at a faster rate than Teleperformance, trades at 5x forward EBITDA and on 10x forward EPS.  I believe that Atento's stock will appreciate as management executes its strategy, and as investors gain more data points that confirm the company’s growth profile and attractive economics.  The private equity overhang should subside over the next several years as Bain sells down its stake and the liquidity of the stock increases.

Brief History

In 1999, global telecommunications group, Telefonica SA, formed Atento in order to consolidate its CRM services into a single subsidiary.  In December 2012, Bain acquired Atento from Telefonica Group from EUR 1.05 billion.  At the time of the acquisition, Atento signed a MSA agreement through which Telefonica committed to minimum revenue contracts through 2021.  In 2014, Atento generated 46% of its sales from Telefonica Group, but the ratio has been steadily decreasing as Atento broadens its customer base and wins new contracts. 

Business and Industry

In terms of revenues, Atento is the third largest customer relationship management / business processing outsourcing (CRM BPO) company, after Teleperformance and Convergys.  It provides various outsourcing functions, such as call center customer support, sales and marketing outsourcing, technical support, credit management and other back office functionalities.  Over time, Atento has been expanding beyond traditional call center work to more “value added services,” such as collections, bank processing and other more integrated client functions.  Value added services represent more than 25% of sales, are growing at a faster rate and generate a higher margin than traditional call center operations.

Atento’s legacy Telefonica relationship provided current management the scale on which to build.  Strong execution and a strong reputation have enabled Atento to become the leader in Latin American CRM BPO solutions.  Atento has a diversified client base of over 400 clients.  It employees 160,000 employees and operations 82,000 work stations across nearly 100 contact centers.  In the United States, the top three industry players account for 16% of revenues.  Atento alone controls 20% of the Latin America CRM BPO market.  The top three players in Latin America account for 45% of the market.  In Brazil (50% of Atento’s revenues) concentration is even greater, with the top 3 players commanding a combined 61%  market share.  Atento holds 26% market share in Brazil, and the company has been steadily gaining market share in the country, as its share has increased from 23% in 2009.  In addition to Brazil, Atento is the market leader in Chile, Colombia, Mexico and Peru.  The US represents a small but rapidly growing part of Atento’s business.

Atento’s revenue stream is highly recurring.  A typical contract last five years.  Customers include leading businesses across multiple verticals, such as:  Vodafone, Vivo, Banco Itau, Banco Santander, Samsung, Coca-Cola to name a few.  By vertical, 51% of sales come from telecommunications, 35% from financial services, and 14% from multi-sector.  Sixty nine percent of sales come from clients that have worked with Atento for over 10 years.  Eighty five percent of sales come from clients that have worked with Atento for over five years. The annual customer retention rate has been steady at 99%.  The high customer retention rate reflects the high level of integration with customers and the high switching costs for customers.

Despite a weak Latin American economy, the company continues to grow its topline at high single digits to low double digit rates in local currency terms and management has confirmed that the recent order pipeline is even stronger this year versus last year.  The reason for such growth is that as companies look to rationalize their cost structures in a weak economy, they are increasing outsourcing their CRM needs.  Atento is well positioned to benefit from this trend.  Latin American outsourcing penetration remains below other regions of the world.  An independent study by Frost & Sullivan projects LatAm BPO/CRM industry services to grow at a 9% CAGR for the rest of the decade.  Penetration in telecommnications and consumer finance have been an important driver thus far, but growth is likely to expand to other industries as we have seen in other parts of the world.  Call center seats per population statistics are lower in most Latin American countries by a wide margin (2-3 per thousand versus 7 in Spain and nearly 16 in the US).  In Latin America, 18 percent of BPO call center seats are utilized for industries outside of financial service and telecom.  This compares with 38 percent in the US.  Atento over time will benefit from a broadening of its client base in other industries.  It is also benefits from having a weak #2 competitor, Contax.  In Brazil, Atento’s growth therefore benefits from both market growth and from market share gains.

Valuation and Financials

In my model, I assume that sales in consolidated local currency will grow at a high single digit rate (between Brazil, Americas and EMEA) driven by market growth and share gains despite the weak economic environment.  I assume that Adjusted EBITDA margins will grow from 13% to 14% over the next two to three years (and continue to approach 15% beyond 2017), which is in line with management’s guidance.  Atento’s management believes margins can steadily head higher over time and eventually exceed Teleperformance’s margins, which have historically been in the 14% to 15% range.  Management believes there are several drivers of potential margin expansion, such as labor cost reduction through the ongoing relocation of centers to lower cost tier 2 and tier 3 cities and through the continued growth of more profitable, value-added services.  Below are my estimates for 2015-2017. 

Sales –                   2015: $2.05BN;   2016:  $2.13BN;    2017:  $2.26BN

Adj EBITDA –      2015: $277M;      2016:  $290M;      2017:  $315M

Adj EPS –              2015:  $1.15;        2016:  $1.40;        2017:  $1.60

FCF  –                    2015: $21M;        2016:  $76M;       2017:  $100M

Despite a slowdown in the Brazilian macro, constant currency sales and EBITDA grew 11% in the most recent quarter.  The Americas grew sales at 17% in Q1.  The smallest segment, EMEA (<15% of sales) saw EBITDA contract 7%.  In Brazil, sales from Telefornica increased by 2%, while non-Telefonica clients grew sales at double digit rates.

The balance sheet is strong.  As of the last quarter, debt stood at USD 612 million and cash and equivalents at USD 190 million, resulting in modest net leverage ratio of 1.5x.  Due to various non-recurring items, free cash flow generation was limited in 2014 and 2015.  As operations normalize and one time costs roll off, FCF will ramp up significantly.  

Risks

Execution – Labor relations are clearly important due to the nature of the industry and the number of people that Atento employs.  While Atento has an industry leading low churn rate, it is an important metric to monitor.

FX – While revenues and expenses do not have a currency mismatch, translation risk exists.  Revenue estimates across the sell-side vary depending on FX assumptions.

Telefonica contract – This is less of a risk as the contract is at market rates, and Telefonica has limited other options due to Atento’s large scale, but clearly Telefonica is important to Atento since Atento generates nearly half of its sales from this customer.

Catalyst

Catalysts

Delivery of earnings – As Atento delivers robust earnings, we believe that the multiple will expand.  Applying 8x EBITDA (a discount to Teleperformance’s forward multiple) on our 315M of 2017 EBITDA estimate yields a stock price of $27/share.

Dividend yield – A potential catalyst for valuation re-rating could come via the introduction of a dividend.  Management has stated that it potentially intends on paying out 25-50 percent of net earnings in dividends.  At today’s stock price, this would imply a dividend yield range of 4 to 6% in two years, which would be very high relative to comparable companies.