Description

Startek Inc. (NYSE: SRT) Description:

Interested in an illiquid microcap call center company, with nearly indigestible financials after a recent reverse merger with an Indian BPO, carrying more than a modicum of debt? I’ll admit the stock isn’t even cheap based on the business’ current run rate earnings power and the company is in the initial stages of what CEO Lance Rosenzweig termed a “multi-quarter turnaround process” which inevitably will get messy at some point. I forgot to even mention the currency headaches involved with running a multinational business, and the significant decline in revenues that legacy Startek experienced related to their telco business over the past 18 months.

So why bother with Startek? It’s also a self-help story with a significant cost cutting program led by a new management team that has a history of running successful public and private companies in the BPO industry and generating excellent returns for shareholders. It's also an investment that, if it works, can play out over a few years which is necessary in today's tax climate.  

Company Background:

The new Startek is the arranged marriage of a primarily international call center/BPO (Aegis International) with a subscale primarily America/Philippines centric call center company with lots of excess capacity (legacy Startek) with the goal of building a global BPO that can serve the needs of multinational customers and have best in class margins and best in class growth characteristics under the leadership of Lance Rosenzweig.

History:

Lance Rosenzweig has a history in the BPO space as the former CEO of PeopleSupport which he founded and ran from 1998-2010. Along the way PeopleSupport (PSPT) was named 9th fastest growing small company by Fortune and employer of the year in the Philippines. He eventually sold PeopleSupport to Aegis a division of Indian company Essar in 2008. In 2013 Lance returned to the space be the CEO of Aegis’s $400m revenue USA division leading up to the sale of that business to Teleperformance for $600m or 1.5x sales. Essar kept the International BPO piece which they sold in 2017 to Capital Square Partners a Singaporean PE fund (CSP) for $300m or .75x revenue. Capital Square Partners called Lance and asked him to come in and run Aegis international. During that process Lance said he would come back but he needed North American capacity to match with Aegis’s international presence in order to serve multi-nationals across the world, something that the Aegis business lacked following the split and sale of Aegis USA. Subsequently Lance worked with CSP to orchestrate the merger of Startek with the Aegis international business creating a public company albeit one in which CSP owns 55% of the shares.

Thesis:

The opportunity is for Lance and his management team to take this newly created platform, leverage the cost structure through synergy capture, implement best practices to improve operational efficiency, and cross sell global capacity driving rapid EBITDA and FCF growth over the next 3 years.

Lance knows best practices are in BPO companies and neither of the companies that merged to create the new Startek Inc were running with them. This is the opportunity.

Strategy:

Lance and his team are implementing a multi-part strategy to transform SRT into a world class BPO:  

1. Focus on cost:

1. De-duplicate the organization to drive synergy  

2. Zero-based budgeting approach

2. Sales focus:

1. Cross sell the two customer bases based on expanded geographic coverage

2. Changed comp plans to focus increasingly on margin

3. New Chief Revenue Officer

4. Additional sales resources

3. Targeted Growth Verticals:

1. Focus on driving business is high growth verticals such as financial services, health care, travel and reduce exposure to low margin telecom business which carries high customer concentration risk

Recent Trends:

Startek has difficult to decode financials due to the reverse merger accounting. They key observations I have come to are that results don’t look great. Revenue has been under pressure at legacy Startek due to significant reduction in business from large mobile customers as well as the complete loss of a 10% customer Sprint, due to the prior management’s attempt to raise prices significantly. Reported revenues at Aegis have also declined, although almost all this decline is due to adverse currency movements. See filings for more details but Aegis had a nice piece of business in Argentina that nearly went away when the peso deteriorated.

Numbers:

On the merger call in March of 2018 Startek cited roughly $700m in pro forma revenue and $50m of pro forma EBITDA for the consolidated company in 2017 with a goal to realize $30m in synergies by 2020. To be fair based on the recent declines in the business, perhaps the baseline has been reset to $40m so the opportunity for EBITDA in 2020 may be more like $70m instead of $80m. I think the $80m is achievable but may take an extra year to play out given it will require regaining some lost revenues (numbers above are after NCI).

Amazon:

Thought you had finally found an Amazon free investment? Nope. Amazon oddly enough struck a warrant deal with SRT prior management in January of 2018 for the right to acquire up to 4m shares of SRT with a strike price of $9.96 per share. The warrants will vest based on Amazon’s payment of up to $600m to Startek or any of its affiliates. As of 9/30/18 none of the performance-based warrants had vested.

What does this deal mean? Maybe nothing. I look at it as a free call option. Is SRT tied to AmazonConnect or is Amazon looking to SRT for their internal contact center needs?  

Valuation:

If SRT can produce $70m in EBITDA in 2020 that translates to >$1/share of FCF which compared to SRT’s current stock price of $7.70 seems attractive. If SRT can achieve some revenue growth through Lance’s sales initiatives $80-90m in 2021 EBITDA seems possible which could yield a $20 stock.

Based on Lance’s 584k stock options with a $6.79 strike price, he stands to make nearly $8m dollars if he can get the stock to $20.

Peer Comps:

To be fair the BPO/call center business isn’t exactly sexy. Some comps trade at drillbit multiples like Sykes which trades at 7x EBITDA. However, in buying SRT I think you have to believe this isn’t the next Sykes but can become over time something closer to Aegis USA which was sold for 1.5x Revenue or Teleperformance which trades at 12x EBITDA. While I certainly don’t underwrite EV/EBITDA for SRT above 10x its possible to dream.

Risks:

There is always the risk of integration issues or dis-synergies although I think this management team is well above average for a $285m market cap company. There is also macroeconomic risk.  Capital Square Partners could act in a way that disadvantages minority shareholders (little is known about them). Lance could leave. The stock barely trades. There are surely other risks that I can’t think envision but I wish I could. Clearly this is a bit of a high-risk idea.

Catalyst

Revenue and EBITDA and FCF growth