Description

Thesis

This is an opportunity to make a quick 15% profit in a couple of weeks or hold long-term for a 150% return.  Startek is a thinly traded stock with a 3rd party tender offer to purchase 2-4 million shares (5-9.9% of outstanding shares) at $4.20/sh by December 20.  A quick arbitrage is to purchase SRT shares in the open market today at $3.63/sh and sell them through the tender offer.  The risk here is if the tender offer doesn’t go through or shares are oversubscribed.  However, even without the tender offer, I believe SRT is undervalued at the current share price and provides a 150% upside potential to $9/sh.  

3rd Party Tender Offer

On 11/22, MCI filed a tender offer to purchase 2-4 million shares of SRT (5%-9.9% of outstanding shares) at $4.20/sh, a 30% premium from the prior day close.  This offer came as a surprise as even the management team was not aware of it.  

Marlowe Companies Inc. (MCI) is a holding company that was founded by Anthony Marlowe to own and operate contact centers.  Anthony Marlowe started his career at a telecommunications company as a telemarketer working the phones himself and quickly moved up the ranks.  By 22 he led a sales organization of over 200 employees and ranked 0.01% of results company-wide.  Then in 2003, Anthony Marlowe founded a BPO (Business Process Outsourcing) company called TMone that was later sold to Carlyle Group in 2013.  He then established MCI in 2015 as a holding company to reacquire TMone and build a service powerhouse.  Since buying back his company, MCI has gone from a couple hundred employees to over 5k and from $15 million in revenue in 2016 to $240 million in 2021.  MCI was also named one of the 500 fastest growing private companies in the US.  Therefore, Anthony Marlowe’s interest in SRT came as a positive surprise and his industry knowledge and expertise could be beneficial to SRT management and the company.  

MCI issued a tender offer for SRT because it is hard to build a sizable position with shares thinly traded.  Average trading volume is 40k shares per day, so it would take at least 80 trading days to build a 4 million position.  MCI would move the market trying to buy as many shares as possible in the open market.  

The reason it’s so thinly traded is that the actual float in the market is very low.  CSP owns 56% of the company and long-term shareholders own another 20%.  Assuming CSP and long-term holders are not sellers in this market, that leaves only 25% of outstanding shares, or 10 million shares, that MCI can purchase.  If MCI wants to buy 4 million shares, that would be 40% of the remaining float.  It would be difficult for MCI to build a 10% position within a month in the open market without moving the price.  

MCI’s tender offer expires on 12/20 and as the date approaches, I believe the share price will close the gap to $4.20/sh as investors take the arbitrage opportunity.  This is an opportunity for small investors to gain a quick 15%, but if the tender offer is oversubscribed and they’re left with SRT shares, I still think this is a good opportunity to invest in a company that is undervalued.  

Business and Industry Overview

Startek (SRT) is a service outsourcing company that helps companies interact with customers through contact centers and digital solutions.  Think of this as call centers or chatbots with additional services in managing social media channels, customer data analytics, and business automations.  Whenever you call your bank, cable company, phone service, etc. with issues, you are either talking to an in-house representative or, if outsourced, a BPO company like SRT.  

Companies outsource customer services to BPOs for labor arbitrage and lower costs.  SRT has over 45k employees in 13 countries, available in 36 languages, and provides 24/7 customer service.  It is time consuming and inefficient for companies to build a global labor force like SRT in-house.  Additionally, in an economically uncertain period and a tight labor market, companies can take advantage of cost flexibility by outsourcing.  Outsourcing allows companies to convert fixed labor cost to variable cost that can easily increase and decrease depending on business flow.  

Additionally, small to mid-market companies that once preferred to stay onshore are increasingly opening up to nearshore (outsourcing to countries located in close proximity) and offshore (outsourcing to far-away countries) opportunities as inflationary challenges increase the ability to attract and retain people.  Typically, offshore and nearshore can reduce costs by 35-40% over a five-year period and automation & analytics can save an additional 15-20%.  Therefore, outsourcing will help companies reduce costs, increase flexibility, and allow them to focus on their core competencies.  Due to these advantages, an increasing number of companies are willing to outsource their in-house customer services to BPOs.

The SRT executive team is focused on capturing this opportunity.  The whole executive level was overturned with the new CEO, CRO, CDO, and CMO joining late last year and new CFO and CIO joining early this year.  The new executive team has expressed to us that they are taking on more urgency in growing the business.  Since the merger with Aegis in 2018, SRT’s revenue remained flat while peers have seen double-digit year-over-year growth.  I believe this disappointing growth is the reason why SRT shares have been underperforming.  Therefore, SRT has increased investment in sales, marketing, and digital activities.  Initiatives have been taken to strengthen the sales ecosystem, expand digital solutions, and target new markets. 

These efforts are starting to bear fruit as the pace of new customer wins are increasing.  SRT added 28 new customers in 2022 with 10 new customers in the 3rd quarter.  So far, SRT has been adding new logos faster in 2022 than both 2020 and 2021.  Additionally, brand awareness campaigns over the past couple quarters led to several expanded contracts with existing clients.  The expanded client portfolio will start generating revenue in 2023 as it takes a quarter or two to set up all the equipment and train agents.  As new logos ramp up, SRT should experience a meaningful uplift in sales.  Margins will also expand as costs are already in place.  

As this positive momentum continues, I believe SRT can be a good acquisition target for a larger BPO company.  Scale is an advantage in this industry because it allows BPOs to have a global presence and provide a wholistic service with higher margins.  The industry is highly fragmented with SRT in the Top 10 by revenue, but representing only 0.8% market share.  Teleperformance is the largest player with approximately 8% market share followed by Concentrix at 6%, Sitel at 4%, and Teletech at 2%.  The industry is going through a consolidation phase and I think SRT will fit well within one of these portfolios.  Competing and winning large contracts against these giants is challenging, but SRT can cater to small- and medium-sized companies as well as emerging enterprises that require more hand-holding.  

SRT’s current majority owner, CSP, has a history of doing deals with Teleperformance.  In 2014, CSP sold Aegis USA to Teleperformance for $610 million when it was generating $400 million in revenue.  That is a 1.5x revenue multiple compared to SRT’s current revenue multiple of 0.2x.  As a private equity, CSP is highly motivated to sell the company at a profit after a turnaround and return proceeds to its investors.  

Knowing the opportunity SRT has, CSP attempted to buy out the company at $4.65/sh through a tender offer.  The initial offer was made on December 17, 2021 at $5.35/sh, which was lowered to $4.65/sh on August 8, 2022.  As CSP controls both the executive-level and board seats, a special committee was formed to assess the offer.  This could have been a cram down to minority owners at an unattractive price, but on September 9, 2022, the special committee rejected CSP’s tender offer citing the proposed price was inadequate and not in the best interest of the shareholders.  CSP has not renewed its proposal.  

Overall, MCI’s tender offer, CSP’s tender offer, and special committee’s rejection all point to SRT’s current share price being undervalued.  

Valuation

SRT is trading like a distressed company at 5x EV/EBITDA and 0.2x P/S despite generating approximately $25 million in free cash flow to the firm and having a healthy balance sheet with net debt declining from $160 million after the Aegis merger in 2018 to $120 million in 3Q22.  I believe the depressed share price is due to stalled growth and low operating margins.  Using a DCF model, the implied growth rate from today’s share price is -1%.  If we assume a small growth of 2% per year, the value of SRT increases to $8.6/sh.  

Looking at comparisons, Teleperformance and TTEC are currently trading at 1x revenue and 10x EV/EBITDA, and last year Sitel Group acquired Syke Enterprises at 1.2x revenue or 11x EBITDA.  Therefore, as SRT’s growth accelerates and margins improve from new contracts and better brand awareness, SRT should trade closer to 8x EV/EBITDA or 0.5x sales, valuing SRT at $9/sh.  

Catalyst

• Completion of Tender offer

• Acquisition target by a larger firm or private equity

• Demonstration of sales growth and margin expansion