Description

Teleperformance (TEP) is the largest Business Process Outsourcing (BPO) company with an extensive global network spanning 91 countries, 410K employees, and servicing over 300 languages.  TEP’s offerings encompass a wide spectrum of customer interaction functions, including call centers, chat services, e-mail correspondence, direct messaging, and a suite of business services such as digital content management, content moderation, payment fraud detection, and localization & interpretation services.  Leveraging its worldwide presence, TEP delivers 24/7 services to clients across the globe with the widest geographical coverage and a 10% market share (after the Majorel acquisition) of the customer experience industry. 

Generating approximately €10 billion in annual sales and earning €1 billion in free cash flow, TEP is not only the largest by market share, but also has an industry-leading EBITA margin of 15%.  However, TEP’s shares have recently experienced a steep decline, plummeting 70% from their peak in 2021 and 40% year-to-date, resulting in a conservative valuation of 6x EBITDA and 12x P/E multiple.  Despite being a profitable business, the sell-off was caused by (1) a deceleration in revenue growth to mid-single digit from 10-20% during COVID years, (2) concerns surrounding the potential displacement of contact centers by AI, (3) normalization from previously elevated multiples in the 20x range, and (4) reservations regarding the Majorel acquisition, which is perceived as suboptimal cash utilization. 

Due to the recent sell-off, an opportunity has emerged to capitalize on TEP’s compelling prospects while enjoying a reasonable margin of safety.  TEP stands out with ROIC of 20%, €1bn of free cash flow, single-digit organic revenue growth, and a healthy balance sheet with €2.6bn net debt at 2%.  Over the past decade, TEP has achieved an average organic growth rate of 10%, outpacing the industry average of 4%, and has expanded EBITA margin from 9% to 16%.  However, the current valuation paints a different picture.  With a market cap of €7 billion, equivalent to a 6x EBITDA multiple (the lowest since 2013), current share price implies a free cash flow projection that falls 25% below the present value when assessed using a reverse DCF methodology.  Recognizing this disparity, TEP recently initiated a €500M share buyback program, a strategic move that enhances earnings accretion in the current market conditions. 

In light of the expected slowdown in revenue growth due to global economic headwinds in the near term, TEP stands to benefit substantially from the offshore/nearshore trend.  As businesses strive to trim costs, the momentum behind discussions about outsourcing business functions is accelerating.  While the switch to offshore customer care can be a headwind to the top line, offshoring services are generally accretive to margins.  Furthermore, the emergence of AI is unlikely to lead the industry to a downfall.  Instead, AI can potentially enhance operational efficiency and heighten overall effectiveness, presenting TEP an opportunity to refine its service offerings.  

Based on a 2% annual expansion in free cash flow, I estimate TEP’s intrinsic value to be €200/sh.  This valuation implies an attractive EV/EBITDA multiple of 8x and a 60% potential upside from current market prices. 

Industry Trend

The trend of outsourcing customer experience is gaining momentum as organizations strive to achieve cost efficiencies and enhance customer satisfaction in an environment that is becoming more global and digitally complex.  Over the past decade, the industry has grown steadily at 8% a year to $110 billion.  This growth is mirrored in the upward trajectory of outsourced customer experience, which has risen from 20% in 2010 to 30% at present.  

Strategically outsourcing to regions with lower labor costs provides an opportunity for companies to maintain high-quality customer service while effectively managing expenses.  Offshoring, which refers to moving business operations to a different continent, and nearshoring, which refers to moving business operations to a country that is nearby, are accelerating as companies seek to reduce costs.  Businesses can achieve cost savings of 30-60% (Deloitte) when outsourcing customer care to offshore/nearshore destinations (such as Asia), compared to maintaining in-house customer service in higher-cost regions (such as North America).  Notably, offshore/nearshore is becoming a bigger portion of TEP’s business as revenue proportion has increased from 35% in 2010 to over 50% at present.  

The increasing complexity of the digital landscape is another driving force.  With the proliferation of diverse digital channels, ranging from social media platforms to online chat services, businesses face the challenge of maintaining a seamless and consistent customer experience across multiple touchpoints.  Given the intricate nature of customer experience operations, outsourcing providers are equipped with technology to navigate this multifaceted environment, offering omnichannel support that ensures customers receive cohesive interactions across various platforms.  This is evidenced by the share of digital solutions within the outsourced customer experience market increasing from 5% to 11% in the past 5 years.  Additionally, global expansion has necessitated a scalable and responsive customer experience approach, which outsourcing providers are well-equipped to offer with an expansive global workforce.  

This convergence of cost optimization, global expansion, and complex digital environment underscores the growing popularity of outsourcing customer experience as an attractive solution manage the evolving complexities of the modern customer journey. 

Impact from AI

AI has taken center stage at every discussion since the release of ChatGPT in 2022 and is an imperative topic for TEP.  Companies worldwide are scrambling to integrate generative AI into every part of their operations and will have huge implications on how businesses are conducted.  

Within the customer experience industry, AI is poised to revolutionize the way companies interact with their customers.  AI Chatbots, virtual assistants, and natural language processing have the potential to streamline and enhance customer interactions with businesses.  These intelligent tools can provide instantaneous responses to customer inquiries, offer personalized recommendations, and even engage in human-like conversations.  

The fear is that as AI becomes more sophisticated, it could lead to a decline in call volumes handled by human agents, potentially impacting TEP’s core service offerings.  Furthermore, the emergence of a technologically superior and cost-competitive AI-focused company could erode TEP’s market position and proliferation of AI tools could lead companies to internalize their customer experience functions, further affecting TEP’s business landscape.  

The counterpoint, however, suggests that while volume might decline, AI’s role will be to augment rather than entirely replace human agents.  TEP asserts that, with the help of GPT, a standard customer call time can be reduced by 40% while improving accuracy level by 90%.  GPT can quickly analyze the intent of the call, guide the agent with relevant automation sequences, and compile a call summary for CRM system updates.  

Moreover, it’s acknowledged that certain complex tasks will continue to require human assistance.  Additionally, not all customers will prefer AI interactions.  The human touch could remain sought after.  The perceived unreliability and potential for missteps in ChatGPT could render human involvement a safer choice.  In fact, TEP could seize the opportunity to expand its service offerings and revenue streams by extending AI functions to companies unable to implement them in-house cost-effectively.  AI might add a dynamic layer to TEP’s offerings, potentially broadening the scope of its services. 

As such, there are strong arguments on both sides regarding AI’s impact on TEP.  Not all business services will be equally affected.  Therefore, I’ve attempted to break down the potential ramifications of AI across TEP’s various business functions in terms of volume and efficiency.  

As shown in the table, I think the Customer Experience segment is likely to observe a volume decrease while efficiency gains through AI.  Additionally, business services and back-office functions seem poised for a positive outcome, with volume being less affected and efficiency gains contributing to a net positive impact.  Thus, while TEP might face some revenue pressure due to AI adoption, the scenario is unlikely to be as dire as some may portray.  

Even if I assume a 20-30% reduction in volume over the next five years, coupled with a small margin expansion, the current share price seems to account for these factors.  

Drawing definitive conclusions at this juncture proves challenging, given the multitude of variables that influence the eventual outcome.  Apprehensions regarding potential volume reductions and TEP’s adeptness in harnessing the AI potential are both valid.  Nevertheless, I am inclined to think that the existing share price accounts for a more pessimistic scenario, offering a degree of margin of safety.  

Other Advantages

Leveraging Scale: The advantages of scale in this industry are manifold.  Global enterprises prefer engaging with a select few major vendors capable of delivering comprehensive services, rather than dealing with numerous smaller contracts.  TEP’s scale enables the company to secure large contracts by offering versatile and comprehensive services spanning various countries and languages.  Additionally, in a business landscape increasingly defined by digital integration, scale allows TEP to allocate more resources in cutting-edge technologies, IT systems, and provide better security from cyberattacks.  These strengths have led to a trend of vendor consolidation by companies. 

Sticky Customers: TEP has a robust client portfolio of 1,200 clients, comprising 50% global accounts, distinguished by a retention rate of 95% and an average client relationship of 13 years.  Customers are sticky, because the initiation or transition to a new vendor involves substantial costs as the supplier needs to comprehend the client’s specific operations, which can be expensive and disruptive.  Even as sizable corporations possess the ability to redistribute their workloads across multiple vendors, TEP stands to benefit as the industry goes through ongoing vendor consolidation.  

Diversified Revenue: TEP has a well-diversified revenue stream with Healthcare being the largest contributor at 16%, followed by BFSI at 14%, Media & Entertainment at 13%, and Government at 10%.  The largest single client accounts for no more than 5% of revenue, while the top 50 clients represent 55%.  Geographically, revenue is evenly distributed with North America & Asia-Pacific comprising 33%, EMEA at 33%, and LATAM at 20%.  This strategic diversification ensures resilience in the face of changing market dynamics.  With varying verticals experiencing growth rates at different times, TEP’s well-diversified portfolio allows it to strategically allocate resources in line with the prevailing market conditions, optimizing operational efficiency and mitigating risks. 

Geographical Structure: TEP’s geographical grouping is an advantage.  Unlike other companies that silo departments by verticals, TEP organizes its business units by location.  This encourages widespread knowledge sharing and collaboration across departments.  For example, when a RFP comes in, all departments involved—whether insurance, software engineering, or customer service—work together to come up with the best solution.  This improved efficiency allows TEP to combine its offerings in the best way possible and deliver a more comprehensive solution to customers.  

TEP vs Competitors: TEP is often ranked as a visionary leader in outsourced customer experience management companies and content moderations.  TEP has the largest market share in the industry, organic growth rate above industry average, and operating margins greater than peers. 

Valuation

I am assuming free cash flow grows to €850M by 2027, which is a 2.4% CAGR, a conservative growth rate relative to 10% average historical organic growth and a discount rate of 9% lead to €200/sh, a 60% increase from today’s share price.  

Catalyst

• Sustained organic growth through expansion of margins

• Prove that AI is helping, not destroying the business

• Innovation in product line and new services offered using AI development

• Accelerating trend of Offshore/Nearshore

• Share buybacks