Description

Thesis

I am recommending a long position in Tivit (TVIT3 BZ).  Top line growth combined with significant operating leverage should drive earnings growth over the next couple years.  Tivit is trading at 6x 2010 consensus EBITDA with high teens EBITDA growth (18%) forecasted through 2012 and a return on equity approaching 30%.  The company should be able to leverage its end-to-end solution (bundling ITO and BPO) to cross-sell customers and improve margins overtime.  Global peers trade between 7x and 15x EBITDA. 

Tivit was taken public in September 2009 and does not have significant sell side coverage yet.  Three firms cover Tivit compared to 8 to 12 firms covering its Lat Am peers.  The valuation gap should close as the company continues to execute, investors become more comfortable with the hybrid BPO / ITO model and sell side analysts pick up coverage.

Tivit history

Tivit is the result of a 2007 merger between TIVIT Tecnologia (ITO) and Telefutura (BPO), both of which were founded about ten years ago.  The merger created one of the leading IT service platforms in Brazil.  Both companies had a common shareholder, VNN, who decided to merge the two businesses to make an integrated IT services company and take advantage of synergy opportunities across the two businesses.  Around the same time of the merger, Tivit also acquired Softway, a BPO company in Santa Catarina state in order to bolster its BPO platform.

Business description

Tivit has two business segments: IT services (ITO) and business process outsourcing (BPO).

BPO services include outsourcing and managing of critical processes that typically involve the operational, commercial and financial activities of clients.  This allows clients to focus on their core activities.  BPO services usually involve the oversight and management of activities that are focused on people, processes and technology, such as:

• Back-office processing;
• Customer relationship management;
• Customer lifecycle management;
• Inventory management;
• Receivables management;
• Supply chain management; and
• Real-time online transaction processing.

One example, in the pharmaceutical sector, Tivit provides services ranging from knowledge-intensive consulting services and business intelligence, to collection services, healthcare invoicing and medical service authorization, digital invoicing, billing and back-office processing, among others.

BPO is 52% of revenues.  Customer contracts in this segment range from one to five years.

The IT services unit is responsible for planning, developing, integrating and maintaining clients' IT infrastructures, and offers services such as:

• IT infrastructure management
• o Hosting;
• o IT functions management;
• o Database administration;
• o Data warehouse management;
• o Network related services;
• o Information security monitoring and management; and
• o Mainframe processing.
• Technical support services
• o Field services; and
• o Desktop support.
• IT infrastructure related services
• o IT functions consolidation;
• o Technological refresh;
• o Platform migration;
• o Project management services;
• o Data warehouse services;
• o Security; and
• o Document management service.

ITO is 48% of revenues.  Customer contracts in this segment range from one to ten years.  Tivit is the only company in Brazil with two "Level Five" data centers, guaranteeing 99.999% availability for its clients' critical IT operations.

Scalability of business model

There are significant cross-selling opportunities for Tivit.  The company has already demonstrated tangible evidence of cross-selling in the last three years.  For example, eight of Tivit's 20 largest clients for the six month period ended June 30, 2009 contracted the company for integrated IT and BPO solutions.  In 2006, only three of these 20 clients used the integrated offering.  Tivit has a customer base of over 900 clients.

Management is focused on customer service and building long lasting relationships with its customers.  This is evidenced by (1) long term contracts, with an average of 50 months, and (2) a client churn rate below 3% in 2008.  Contracts with terms of at least 24 months generated 90.8% of the company's revenue in the first half of 2009.

In addition to cross-selling opportunities, Tivit can leverage its current infrastructure and employee base to grow revenues with minimal incremental cost.  Tivit revenue per employee is approximately $25,000 and EBITDA per employee is approximately $5,000.  Global peers average $30,000 to $50,000 in revenue per employee and $6,000 to $12,000 in EBTIDA per employee.  It is important to note that the range is broad since there is no pure comp to Tivit.  The leverage and economics are different for ITO and BPO services.  That said, there is no structural reason Tivit will not be able to improve its productivity given its business mix, especially given the 50% / 50% mix of ITO and BPO.  BPO is much more labor intensive as some of the business related to call centers.  96% of Tivit's 22,859 employees are in the BPO business.

Assuming Tivit's focus on productivity and efficiency pays off and revenue per employee improves to $35,000 and EBITDA per employee to approximately $8,000, Tivit can earn between BRL 320-340 mm of EBITDA from BRL 220 estimated in 2010.  The main driver in this assumption is Tivit increasing its revenue per BPO employee to BRL 48,000.  As evidence of management's focus on leveraging its cost structure, Tivit generated a 160% incremental EBITDA margin in the latest quarter.

Industry

Tivit benefits from regional and global secular tailwinds.  IDC estimates that the global market for BPO and IT services in 2008 was US$1.2 trillion, and expects an average annual growth rate of 7.5% through 2013.

According to IDC, Brazil has the largest IT services market in Latin America, with total revenues of US$10.1 billion, representing 58.0% of Latin American IT services spending.  Besides its size, according to IDC, the Brazilian IT services industry is expected to grow at an average annual rate of 8.0% over the 2008-2013 period.

Despite being the largest market for IT services in Latin America, the Brazilian market is still under penetrated compared to more mature markets like the United States.  According to IDC, in 2008 IT services represented only 34.0% of the total IT spending in Brazil, whereas in the United States IT services represented 42.0% of its total IT spending.

Valuation

Tivit is trading at 6x 2010 consensus EBITDA.  Peers trade between 7x and 15x EBITDA.  The company's current valuation is cheap on an absolute and relative basis.  Tivit generates 20-22% EBITDA margins and a return on equity approaching 30%.  Given secular tailwinds and Tivit's ability to cross-sell and better utilize its fixed cost base to grow earnings, a 6x multiple does not make sense.  Using an 11x midpoint multiple, Tivit's shares could be worth BRL 26 compared to BRL 16.40 now.  The shares could be worth mid BRL 30s assuming EBITDA ramps up to BRL 320-340 mm as the company improves its revenue and EBITDA per employee.  Morgan Stanley estimates that facility utilization is running at 70-80% currently.

The company will generate approximately BRL 1.20 of free cash flow per share in 2011.  A 12x multiple yields BRL 14 per share.  This should provide downside support to the shares.

In addition to the reasons listed above for the valuation discount, Tivit's IPO process was challenging and management wanted to get the deal done in late 2009 despite the discount.  Tivit's September IPO was the company's third attempt.  The first attempt was in late 2007 and the second attempt was in mid 2008.  The initial price range was BRL 16.50-20.50 and the shares started trading at BRL15.

Comparable value table

Estimates are in local currency and from Bloomberg consensus.

Summary financials

Risks

Customer concentration - Tivit's 10 largest customers account for approximately 60% of revenues.  The company is continuing to diversify its customer base through cross-selling opportunities.  It is also worth noting 90% of revenues are from contracts with at least a 24 month term.

Global competitors - Large multinational players such as IBM, Accenture and HP have IT and BPO offerings.  As these companies focus on new markets, Tivit could see increased competition and pricing pressure in its local market. However these operators are not new to Brazil and Tivit has been able to compete effectively.

Industry concentration - 29% and 31% of revenues are related to credit cards and banks and insurance companies, respectively. The positive aspect of industry concentration is that financial service penetration in Brazil is very low, and this is a high growth area.

Catalyst

Catalysts

There are no definitive catalysts but continued execution, earnings and additional sell coverage will highlight the Tivit's valuation discount.