December 19, 2008 - 11:39am EST by
2008 2009
Price: 3.96 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 59 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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ICT Group (Nasdaq: ICTG) offers tremendous value at current prices with little potential downside. Engrm842 wrote it up on 8/27/07 at much higher prices, and you should refer to it for more background on the firm. The stock is currently trading ~$3.70, and my view is that it could double or potentially far more in the next 12-18 months. 

The combination of a weak economy, customer sector concentration, and the aggressive offshoring of its operations over the past two years has impacted sales and earnings quite a bit. The stock is trading as if it is close to bankruptcy, but, in reality, the Company generates a massive amount of free cash flow and maintains a rock-solid balance sheet. 

From a valuation perspective, the stock is very cheap on a lot of levels:
           2009 P/E:                               13.7x
            P/Sales                                   0.1x
            P/Book Value                         0.4x
            P/Tangible Book Value         0.4x
            EV/2009 EBITDA                  1.0x
            2009 FCF Yield                       >40%
            Net Cash/Share                     $1.68  

An outsourced call center company, ICTG was founded in 1983 with a primary emphasis on telesales. Current CEO John Brennan acquired the Company in 1987; Brennan still owns roughly one-third of the Company. He is not a young man and is likely looking to turn the business around to sell it for a reasonable price. Since the 1996 IPO (priced at $16), revenues have grown at a compounded annual growth rate of ~20%. A secondary offering raised $53 million on a net basis in 2006 (average gross price of $22.74 per share), most of which was used to pay down existing debt. The Company now has $1.68/share in net cash on the balance sheet.

ICTG’s business has changed quite a bit over the last 8 years. In 2001, 62% of revenues were Telesales, 32% Customer Care services, and 6% Marketing, Technology and BPO Solutions. The introduction of the “Do Not Call” regulation in 2003 decimated ICTG’s outbound calling business, and, accordingly, the Company focused its efforts away from its Telesales segment. Today, Customer Care represents 82% of ICTG’s total business. Management steered the Company back on an aggressive growth path in 2004 and 2005, with the Company growing its top line faster than 20%. Since then, management has been focused on closing N. American production and moving it to the Philippines, which has impacted sales (Philippine business has a lower price to the customer but is more profitable to ICTG). Having duplicative operations resulted in earnings being decimated in the short-term, but this issue is temporary in nature.
Management places a heavy emphasis on targeting customers that have the greatest potential to provide recurring revenue streams to the Company, which is part of its historically limited exposure to the technology industry. Its Customer Care clients typically enter into multi-year contractual relationships that may contain provisions for early contract terminations, while the Company generally operates under month-to-month contractual relationships with its Telesales clients. The pricing component of a contract is usually comprised of a base service charge and separate charges for ancillary services. On top of that base service charge, ICTG bills its clients based upon per-minute or hourly rates. In certain cases, the Company is paid incentives based on completed sales.

The economics of ICTG’s offshore operations are far more attractive than its U.S. operations. The key revenue and expense items are listed below:

Ø The typical fee charged by ICTG is about $20-$25 per hour in the United States and about $10-$13 in low wage offshore sites. Annualized revenue per work station across the Company is roughly $33,000.

Ø U.S. contact center reps are paid $9-$11 hourly and as low as $1-3 in India and the Philippines. Benefits costs add another 40% to the U.S. wage rate. 71% of the Company’s 2006 cost of sales is labor related.

Ø Operating profits offshore, assuming peak utilization rates of 75-85%, can reach the mid double-digits. In the United States, operating profits at peak utilization rates are targeted in the high single digits. Thus, operating profits are roughly equal per customer, but the average cost per transaction (and overall attractiveness of the Company’s services) to the customer is much lower.

The Customer Care Services division provides support services across a broad range of industries. The Company assumes sole or shared responsibility of a client’s Customer Care operation, which, in some cases, includes technical support for technology customers. Today, ICTG has the capacity to support in English, Spanish, French, Italian, and German.

The Telesales business provides inbound and outbound telesales support activities primarily for clients in the financial services, insurance and telecom industries. Telesales are more project-oriented and less recurring than the Customer Care business. This is the part of the business that has most been hurt in the current economic downturn.

The United States accounts for 50% of the global market for customer interaction services, and less than 25% of the U.S. market is currently outsourced (and even less outside the U.S. market). The customer base is highly fragmented with the 7 largest companies combined accounting for less than 15% of the total market today. According to IDC, Convergys, ICTG’s largest competitor, maintains roughly a 4% market share of this $40 billion market.

Due to the Company’s continued offshoring of operations, ICTG has been able to cut its income tax rates drastically from 33% in 2004 to 10% in 2006. The Company enjoys a sizable tax holiday for its Philippine operations, as well as at its Costa Rican operations.

Since 2006, management has been aggressive in moving its operations to the Philippines to cut costs for their customers and improve overall profitability. This outsourcing caused has been a more major project than expected, and the combination of the current recession and a heavy reliance on the financial services industry (~50% of total sales) compounded the Company’s issues.

In the most recent quarter, ICTG reported a respectable quarter in the face of a lot of headwinds. Revenues dropped -4.9% to $108 million, but adjusted EPS was $0.09, six cents above consensus. With the Company’s solid performance and prudent working capital management, the Company generated $14 million in free cash flow in the quarter and expects Q4 free cash flow to also be positive – not too shabby for a company with $32 million in enterprise value. 

Production volumes increased 3% sequentially, which helped to push utilization up 300 bps sequentially to 76%. Gross margin improvement assisted the Company to post its first operating profit since Q4 2007. This quarter’s results may be a signal that the Company is finally starting to see some results from its aggressive offshoring and a bottoming of financial services weakness from the Company’s customers. Margin volatility and negative call volume trends are showing elements of stabilization, but the deteriorating economic environment will likely continue to hamper revenues and EPS growth.

Q4 guidance may have stolen the show, however. Guidance was below consensus estimates and previous estimates, with revenue expected to decline sequentially, due to the strengthening dollar and an increased amount of volume being handled in lower-priced offshore sites. EPS are expected to be $0.04 - $0.08, down from previous guidance of $0.09 - $0.13.

Management provided additional clarity on its large financial customers who have been involved in recent consolidation. Both J.P. Morgan (4-5% of sales) and Washington Mutual (3% of sales) are clients; management believes that current volumes should stay steady with these customers. Wells Fargo is a client, but Wachovia is not; ICTG believes that they might gain some Wachovia business from the merger. During 2009, management expects financial services to decrease to 40-45% of sales from 50% in 2008 due to stronger growth in other vertical markets.

My estimated valuation for ICTG through my discounted cash flow model is $11.50. This valuation implies a 2009 P/E of 36.2x (historic median of 17.7x) and an EV/EBIDTA of 4.9x (historic median of 7.7x). The P/E is artificially high because near-term earnings are so depressed; my 2009 EPS estimate assumes an operating margin of 1.8%, but the company's median historic operating margin is 4%, and management's goal is to boost the operating margin to 6-8% long-term.

I also believe that there is significant upside from my intrinsic value. As a frame of reference, if ICTG hits its 2010 goals, the stock could earn $1.50 per share. If a 15x multiple is used on this earnings estimate, then ICTG could be a $22-$23 stock by the end of 2009. The stock price was $37 less than two years ago.
There is no question that significant risks remain (execution, currency, illiquid stock, macro-economic, succession, tax legislation, threat of substitutes, competition, and more), but the risk/reward is attractive at these prices. It is very possible that ICTG shares tread water for the next few months until investors get more visibility into 2010, but the long-term prospects remain bright. 


Ø Reaching a trough in sales deceleration from lost financial services business and the offshoring of production to the Philippines.

Ø Improvement of operating margins after finishing its production changes.
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