Teleperformance Stock: This Hidden Anti-AI Stock Is Now A Strong Buy (OTCMKTS:TLPFF)

Introduction

Back in November 2023, I wrote my first article on multinational business services provider Teleperformance SE (OTCPK:TLPFF, OTCPK:TLPFY). At the time, TP shares were trading at around €140, well below their all-time high of €400 in 2021. What looked like a deep value opportunity at first glance, however, turned out to be not that cheap after all considering the challenges of the business.

Five months later, TP stock price has fallen to less than €90, almost 40% below the level at the time of publication of my first article. So in this update, I explain why I believe the share price now offers ample margin of safety to justify a strong buy. As I detailed Teleperformance’s fundamentals back in November, I won’t repeat everything in this update, but I will of course take a look at the 2023 full-year results and the year-end balance sheet (the presentation and annual report can be found here).

Why TP Stock Is A Strong Buy Now After The Full-Year Results And Another 40% Price Decline

Quick Review Of Teleperformance’s 2023 Results

For 2023, management reported revenue growth of just 2.3% compared to the previous year, a significant decline compared to previous years. Excluding the contribution from Majorel (the acquisition was announced in April 2023 but is only consolidated since November 1, 2023), revenue even fell by 1.8% year-over-year on a comparable basis (Figure 1).

However, Teleperformance benefited significantly from the pandemic and secondary effects, so the performance in 2021 and 2022 should be interpreted as front-loaded growth. With this in mind, I consider TP’s normalized longer-term growth to be very solid indeed – a CAGR of 11.4% since 2017. Majorel will be a significant contributor to sales going forward, and hypothetically assuming it was consolidated at the start of 2023, TP would have generated revenue of around €10 billion (light blue bar in Figure 1).

Things also look good in terms of profitability (Figure 2), but note the comparatively weak free cash flow (FCF) conversion. While the rate has improved significantly in recent years, a cash conversion rate of 46% (slide 35, earnings presentation) nonetheless leaves room for improvement.

The acquisition of Majorel will dilute Teleperformance’s profitability somewhat, at least in the near future. On slide 13 of the earnings presentation, management noted that TP including Majorel would have an adjusted EBITDA margin of 20.6%, 100 basis points lower than the legacy Teleperformance. The adjusted operating margin including Majorel would be about 90 basis points lower.

As an aside, please note that the margins shown in Figure 2 are generally based on actual reported figures, excluding the impact of goodwill impairments, but including other items considered by management to be “non-recurring” or “non-cash”, such as stock-based compensation. SBC in particular are relatively significant at Teleperformance (8% of operating cash flow most recently). I have no issue with this in principle, but I consider its impact to be relevant and therefore treat it as a “cash expense”, as the performance shares granted (or options exercised) will eventually have to be repurchased to offset dilution.

Going forward, margin expansion is expected as Majorel is integrated, implementation costs are eliminated and synergies are realized. By 2025, management expects to spend €100 million on the integration of Majorel and thereby realize annual – recurring – synergies of €150 million, of which €50 million are expected to be realized in 2024. As a result, the operating and free cash flow margin should improve in the coming years. However, there is a significant integration risk – as I explained in detail in my previous article – so I personally take a more conservative approach in my updated valuation below and do not account for merger-related synergies.

That said, I don’t want to be misunderstood as being skeptical about the Majorel acquisition. I think it is an excellent fit and Teleperformance has clearly demonstrated its ability to grow inorganically as well. In this context, I think it is positive that Bertelsmann as well as Saham Customer Relationship Investments and Saham Outsourcing Luxembourg (they previously controlled 39.4% of Majorel’s share capital) have agreed to receive part of the consideration in the form of Teleperformance shares. As a result, the Saham Group and the Bertelsmann Group now each hold 3.6% of Teleperformance’s share capital.

A Fresh Look At The Balance Sheet Of Teleperformance

Before proceeding with the valuation, let’s take a fresh look at Teleperformance’s balance sheet. As I explained in my last article, the acquisition was financed not only by issuing new shares (the number of TP shares outstanding increased by around 4 million to 64 million), but also by debt.

As a result of the takeover, TP’s net debt has almost doubled compared to the end of 2022 – from €1.9 billion to €3.7 billion. The leverage ratio, measured by net debt in relation to average FCF over the last three years, increased from 2.8 to 6.3 (Figure 3). Including the estimated FCF contribution from Majorel, but excluding synergies for reasons of prudence, the leverage ratio would be 5.2x FCF. If we include operating lease liabilities, the leverage ratio would be 8.2x and 6.7x without and with Majorel’s estimated FCF contribution, respectively (Figure 3, light blue and light red).

This is certainly a significant amount of debt, and given the updated debt maturity profile (Figure 4), it is clear that Teleperformance should prioritize debt paydown – especially considering €1.3 billion of upcoming maturities in 2028 and 28% floating rate debt.

In his remarks (about 50 minutes into the conference call), CFO Olivier Rigaudy was very clear – Teleperformance “will do whatever it takes” to maintain its BBB rating from S&P. Net debt should fall to less than 2x EBITDA by year-end 2024 (it was 2.56x at year-end 2023). The fact that he brought up shareholder returns after addressing debt is very reassuring in my opinion as it underlines management’s long-term view and conservative approach. Of course, this means that the dividend could remain flat for another year (Figure 5, current yield 4.4% but keep in mind the French dividend withholding tax), and I wouldn’t completely rule out a modest dividend cut either. However, we should also not forget that Teleperformance has committed to return up to 2/3 of its FCF to shareholders via dividends and share buybacks, with the latter amounting to €366 million last year. Therefore, I think it is possible that with the focus on deleveraging, the dividend could take precedence over ongoing share buybacks.

Valuation Of TP Stock – Priced For Decline

As noted in the introduction, Teleperformance shares have fallen by almost 40% since my first article and are currently trading at levels last seen in 2016, when the company generated revenues of €3.6 billion and FCF of around €200 million. Teleperformance has since evolved into a much more diversified and stronger company, more than doubling its revenue and almost tripling its FCF. Investors are currently shunning TP shares because of the narrative that artificial intelligence could render the company obsolete. As I explained in my first article, I believe this risk is only partially justified, due to Teleperformance’s leading position in its field and the fact that the company started using artificial intelligence tools years ago. In my view, the truth is somewhere in the middle, but I still require a significant margin of safety for such an investment – also given the integration risk underlying the acquisition of Majorel and the high leverage.

Figure 6 shows an updated historical valuation of TP stock, according to which Teleperformance is significantly undervalued – by 60% to 70% depending on the metric, and the current valuation multiples do not even take into account the impact of Majorel, but the enterprise value (EV) used to calculate the EV-to-FCF ratio is actually based on the 2023 year-end balance sheet, so it includes the acquisition-related debt. I realize that this is probably an overly conservative approach to valuing the stock, so Figure 7 shows a comparison of the historical average valuation to the multiples that include Majorel’s estimated sales, operating income and free cash flow contribution. TP stock does indeed look obscenely cheap.

However, skeptical investors could argue that the historical valuation is not a reasonably realistic benchmark in this case. What if the days of double-digit growth at Teleperformance are indeed over? What if AI eventually makes Teleperformance’s business model obsolete?

What I like to do in such cases is to come up with a truly conservative valuation approach. A while ago, I wrote an article on the valuation of tobacco companies in which I assumed a rapid decline in sales and operating profitability. At the example of the second-tier cigarette manufacturer Imperial Brands p.l.c. (OTCQX:IMBBY, OTCQX:IMBBF), I showed that investors can expect a solid return even if these particularly negative scenarios materialize.

In the case of Teleperformance, I started with free cash flow including the expected contribution from Majorel, but ignoring potential cost synergies. I have assumed an FCF growth rate of 3% for 2024, which is in line with management’s growth guidance for the year. I then modeled a 100 basis point annual decline in the growth rate and maintained the -6% annual decline in free cash flow starting in 2033. Frankly, I highly doubt this will be the future of Teleperformance (in fact, I believe the company can at least maintain its current free cash flow), but even if it does, TP stock is still cheap today.

Assuming that an investor is comfortable with a cost of equity of 9.7% (as per my previous article), the stock would be fairly valued at €93 under the assumption of terminal decline. At today’s share price of €87, a cost of equity of 10.7% is therefore a realistic return expectation. And if Teleperformance is indeed able to maintain its current free cash flow, investors would be looking at 11.5% p.a. (sensitivity analysis in Figure 9).

All in all, there is no denying that the market is extremely negative on Teleperformance shares at the moment. Even if one assumes that Teleperformance is a company in decline (while actual growth has been in double digits over the last decade!), the stock is still cheap and represents ample margin of safety is sufficient to justify an investment.

Conclusion

As per my last article, I maintain that Teleperformance is an interesting, founder-led company with a strong history and a well-diversified business. It looks well entrenched with many leading companies and I don’t think AI should be seen as an outright headwind for the company, let alone that it could ultimately render TP obsolete. Teleperformance is a leader in its field and its growth track record over the last decade is extremely solid and attributable to strong organic growth but also to acquisitions. Although I think it is unreasonable to expect a continuation of the double-digit growth rates that investors have become accustomed to over the years, I do not see Teleperformance as a company in decline either.

The market obviously disagrees, valuing TP shares at a 60% to 70% discount to the 2016 to 2023 average valuation, depending on the metric is used and whether or not Majorel’s revenue and earnings contribution is included. Looking at Teleperformance’s valuation through the lens of discounted cash flow analysis, it is clear that the market has priced the stock for terminal decline. With an expected cost of equity of 10%, the company’s free cash flow could decline at an accelerating rate from 2028 onwards. Even if free cash flow falls by 6% per year from 2033, the stock is still undervalued at its current price of €87.

In my view, this is a sufficient margin of safety. I therefore recently initiated a position in TP stock at approximately €90, representing approximately 0.3% of my portfolio and which I expect to add to over the coming weeks and probably months.

Thank you very much for reading my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there’s anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your due diligence.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.