GLOBANT SA GLOB S
January 19, 2018 - 10:14am EST by
danconia17
2018 2019
Price: 46.62 EPS 1 1.25
Shares Out. (in M): 35 P/E 46 37
Market Cap (in $M): 1,636 P/FCF N/A N/A
Net Debt (in $M): -26 EBIT 0 0
TEV ($): 1,610 TEV/EBIT N/A N/A
Borrow Cost: Available 0-15% cost

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Description

Summary:

Globant is a highly overvalued software and web-development company based in Argentina. Their growth is overstated, they generate no FCF, and their services are mostly commodity offerings. As the street recognizes this, GLOB shares will decline by 50%+.

There are numerous red flags in the story:

 

  • Organic growth is <10%, compared to management's claim of 20%+
  • Free cash flow since IPO has been negative--unlike all of its peers which are highly FCF generative.
  • The CEO, CFO and co-founders have dumped most of their shares—at prices much lower than today’s.
  • Globant’s heavy use of non-GAAP metrics meaningfully overstate earnings.
  • Globant got busted for using phony visas to sneak its employees into the country.
  • There have been questionable related party transactions in the past.

 

What does Globant do for it’s customers?

According to the Company:

“We are a digitally native technology services company. We dream and build digital journeys that matter to millions of users. We are the place where engineering, design, and innovation meet scale.”

Much deeper into the Globant annual report is a more succinct answer:

“The Company generates revenue primarily from the provision of software development, testing, infrastructure management, application maintenance, outsourcing services and second screen or similar.”

Globant is a software development company, whose primary differentiation is a workforce that is based in Argentina.  It has some marquis contracts with customers like Disney and Southwest.  Globant helped Disney collect and manage data for their MagicBand used at Disney Parks.  Globant helped develop Southwest’s new reservation system, put into place in early 2017.

 

They pitch these contracts with customers as long-term and recurring in nature, but the reality is they follow a normal software lifecycle.   There is heavy up-front investment, and then ongoing maintenance.  This was the case with Southwest, whose revenues fell off dramatically in 2017 once the new reservation system was operational.

Globant's early lead in digital offerings enabled them to win some early contracts. As much larger and well-capitalized competitors have beefed up digital offerings, competition has increased dramatically. Their real value today is as a pricing lever vs. to keep their competitors honest on pricing.

 

The growth story

Given the increase in competition, Globant started running into a wall in terms of growth in 2016.   In order to grow to achieve it’s longer-term goal of over $1bn in sales, they started a program called 50 squared, which would attempt to generate $50m of revenue from its 50 top customers.  The implementation of this would be to double down on large customers and cull smaller customers from their base.

While this story sounds compelling, it doesn’t hold true.  Looking at the breakdown in revenue disclosure from the Q3 report, it suggests that the top 5 customers were 26.8% of revenue vs 33.9% last year.  This implies growth of 5.2%.  Hardly the picture of a 20%+ organic grower!

The real reason they have been able to hit their growth targets is a massive step in up in M&A.  Notice how many acquisitions this company started making mid-2016:

May 2016 We Are London Limited
November 2016 Difier
November 2016 L4 Mobile, LLC
February 2017 Ratio Cypress, LLC
June 2017 PointSource, LLC

 

When we analyze the semi-annual report (6-k from 8/17/17), they break out the pieces of organic growth.   Adding the growth implied growth from the acquisitions in 2016 (3 acquisitions), and subtracting the added pieces from 2017 (2 acquisitions) implies organic growth of around 5-10% vs the ~25% growth the company was reporting.

However, management’s comments regarding organic growth from the Q2 call suggested something different:

Analyst : : …just the revenue guidance change. How much of that is inorganic from acquisitions versus any other organic changes?

CEO: "Organic is most of it. Inorganic is just a bit on the guidance. Organic is most of it based on some customers that are [indiscernible] (42:27) quite very well.

So while we can easily calculate organic growth of 5-10%, management suggests that “most of” their growth is organic.  They are just straight liars.

 

Revising down estimates

All of these acquisitions have increased revenue estimates for Globant.   Right now the street assumes 20.6% revenue growth for 2018, which includes some acquisitions that will anniversary next year.

 

However, EPS estimates for 2018 have been revised down dramatically through 2017 as these acquisitions are significantly less profitable.

The company will blame the weak Argentine peso for their missing of estimates.  This doesn’t make sense, as the peso weakening should help their cost structure dramatically (their revenues are in USD and costs in ARS).  They have always had wage inflation, so when currency helps them it should be less of a drag.

The reality is the acquisitions they have made are significantly lower than company average profitability.  Pointsource, their most recent acquisition, is losing money per the semiannual report.

Given mid single digit organic growth, the company will continue to make dilutive acquisitions.  They may beat their top line numbers, but FCF and EPS should continue to struggle.

 

Free Cash Flow per share

There has been a wide variation between free cash flow and non-GAAP EPS since the IPO.

 

  FCF/Share Non-GAAP EPS
1H 2017 -0.43 0.54
2016 0.39 1.14
2015 -0.54 0.98
2014 0.08 0.81

 

It is highly unusual for a services company like this to not generate free cash flow.   Most of their comps generate significant free cash flow every year.   Globant has generated negative free cash flow since the IPO.

There is no logical reason for this.  A look at the balance sheet sees ballooning receivables, including unbilled receivables as a major driver.   They are essentially pricing these contracts too low to make a profit, and giving exceptional terms to win the business.

 

Issues with Non-GAAP earnings

We focus on free cash flow, but if you are wondering why there is a big divergence between free cash flow and non-gaap EPS, here is a laundry list of reasons.

  • GLOB has capex + capitalized R&D at two times peers like EPAM and LXFT
  • Unusual spikes in stock compensation
  • Stock compensation is added back with out tax-effecting the add-back
  • Add-backs to due write-downs in contingent consideration
  • Add-backs due to re-measuring the fair value of a non-controlling interest
  • Tax-rate that fluctuates significantly from quarter to quarter

Through a combination of acquisitions and non-gaap trickery, Globant is able to “beat” the top line and come within some range of street EPS.

 

Insider Sales

Since the IPO, the founders and key employees like the CEO and CFO have sold between 70-90% of their holdings.  Most of these sales happened between the IPO and through the first follow-on offering at prices between $10 and $18.50.

Because they are foreign private issuers, they don’t file form 4s.  You can find the sales from paper 144 filings on Bloomberg.

Company insiders mostly sold at prices way below current prices.  These guys were eager to sell stock soon after they went public.

 

Unusual Corporate Structure

 

 

 

The company’s customers are in the United States, and it’s employees are in Argentina.  So why is it headquartered in Luxembourg?  It’s unclear, but my theory is currency arbitrage.

Prior to December 2015, Argentina managed the U.S. dollar (USD) / Argentine peso (ARS) exchange rate through currency controls.  Restrictions on the purchase of foreign currency were instituted by the Argentine Central Bank at the end of 2012.  Since the vast majority of Globant’s revenues are generated in US dollars, and most of the company’s employees and cost structure are located in Argentina (and to a lesser extent in other South American countries), Globant was required to pursue unusual methods to move currency across borders.

Due to the currency controls in place, Globant would purchase U.S. dollar-denominated Argentine bonds, in U.S. debt markets and then sell those bonds after a brief holding period into the Argentine debt market in exchange for Argentine pesos.  Because the official exchange rate in Argentina was managed by the country’s central bank, the quoted dollar price in U.S. debt markets was lower than the quoted Argentine peso price received for the bonds in the Argentine debt markets when converted at the official exchange rate.  They were able to generate significant free cash flow from these transactions, which they are no longer able to do.

 

DOJ Settlement

Globant paid $1m to settle allegations of visa fraud with the US DOJ.  They used B-1 visas, which are short-term business visas, for their employees when they should have sought proper work visas.  They did this from 2009-2015.

Travel should be a core competency for a global consulting firm.   It seems odd that a company would get this so wrong for 6 years.   Maybe they have gotten used to cheating?

https://www.justice.gov/usao-ndtx/pr/information-technology-firm-pays-1-million-settle-allegations-visa-fraud

 

Other red flags

There are numerous other red flags you can delve into:

  • Inconsistencies in calculating working capital on the balance sheet, in particular related to the software regime credit
  • Large and growing amount of non-current assets in Spain despite having no significant presence there
  • Related party transactions involving the Globant acquiring a travel company from the founders.
  • IRS investigation regarding taxation.

 

Valuation

So what is it worth?  For the time being, we will assume there is no fraud here, although there are certainly enough red flags to think something more sinister is occuring.  

A 5-10% organic grower with lower margins and scale than it’s large-cap peers implies 15x next years EPS of ~$1.20 or roughly $20.  

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

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