May 07, 2009 - 12:56pm EST by
2009 2010
Price: 5.70 EPS .07 (taxed) .30 (taxed)
Shares Out. (in M): 56 P/E 81.0x 19.0x
Market Cap (in $M): 320 P/FCF 16.0x 15.0x
Net Debt (in $M): 6 EBIT 11 32
TEV ($): 326 TEV/EBIT 29.0x 10.0x
Borrow Cost: NA

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This will be a short write-up as the opportunity is timely.  APAC Customer Services (APAC) is a richly-valued, lightly-shorted, provider of outsourced customer service.  Based on due diligence that I have done, the service they provide is decent but undifferentiated, and it is largely a commodity.  Below are some metrics for APAC and their competitors (note, I have made some estimates for CVG to account for only the customer care portion):


  09 revs 09 ebitda margin book revs/book p/book seats revs/seat tev tev/seat seat
SYKE          840.0           94.0 11.2%          384.0                  2.2             1.9          30,400               28             507               17             3.1
ICTG          400.0           28.0 7.0%          119.5                  3.3             1.0          12,500               32               83                 7             2.2
TTEC      1,280.0         153.0 12.0%          355.9                  3.6             2.2          40,000               32             765               19             3.8
CVG      2,000.0         220.0 11.0%          690.1                  2.9             1.8          45,000               44         1,600               21             2.9
  average                          3.0             1.7             34.0             15.9             3.0
APAC          275.0           44.0 16.0%            46.3                  5.9             6.2            8,500           32.4             309           36.3             5.2


APAC generated EBITDA margins of 19% in the first quarter, a fact which they attributed to customers asking them to work "overtime", which allowed them to leverage fixed costs in an unsustainable manner.  Despite a large revenue "beat", they left 2009 revenue guidance flat, and the chairman instituted a 10b5-1 plan to sell 5 million shares. 

It seems clear to me that EBITDA margins will have to decline to industry average over time, as there is little differentiation among companies.  Indeed, as there are economies of scale in this industry, it seems like a below-industry margin, such as ICT Group has, is potentially more reasonable.  The company has said that current levels are unsustainable, as they hire more people and pay out bonuses to their managers.  In addition, the company will use the last of its NOL in 2009, so reported EPS will likely decline in 2010.

If the company were to produce 10% EBITDA margins and trade at 5x, the stock would trade at $2.50, or more than 50% downside from current prices; at a 12% margin it would trade at $3.00 (on a fully taxed basis a 12% EBITDA margin would imply $.22 of EPS).  Given the conservative guidance and the one-time benefit seen in Q109, I would expect the momentum investors who have propelled the stock to current levels to be disappointed by the second quarter report, so those levels could be approached in the near future.


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