Description

I am recommending the short sale of Sykes Enterprises common (SYKE) based on an 
unsustainably high valuation for a commodity service business with a fair degree of 
cyclicality and unrealistic expectations for growth, margins and cash flow in 2007 and 
beyond.  For background on SYKE, see my VIC writeup of April 2004 recommending the 
stock at $6.24; SYKE was also recommended by peter315 almost exactly 4 years ago at 
$3.18.  Obviously, those writeups were very good calls as the stock has traded as 
high as $21+ this year before falling back to its current trading levels around $17 
after announcing modestly disappointing results last month.



SYKE is one of the 
largest providers of outsourced customer contact solutions, i.e. it operates call 
centers.  Between the two previous writeups and the abundance of information on the 
Company’s website (www.sykes.com) , I will skip a description of the business and 
instead focus on the short thesis.  As I indicated some 20 months ago when SYKE was 
valued at 4.1x LTM TEV/EBITDA, Mr. Market then did not appreciate the fundamental 
turnaround underway in the Company, the cyclical rebound in its business and the 
moderating capital spend and commensurately higher levels of prospective near-term free cash 
flow.  Today, with these facts now solidly in evidence, SYKE trades at 10.5x my 
estimate of 2006 EBITDA of $53mm as indicated below (all figures are my 2006 estimates, 
excluding non-recurring gains, in millions except per share 
data):



Revenues		$570

EBITDA		    53

EPS (adj.)		$0.85

Capex			    17



Market 
Cap		$709

TEV			  559

TEV/EBITDA		  10.5x

TEV/(EBITDA-capx)	 
15.5x

P/E (adj.)		    21x



SYKE’s TEV/EBITDA multiple of 10.5x—which for reasons 
described below is not justifiable—is in fact overstated because in calculating TEV I 
have reduced SYKE’s market cap dollar for dollar for the $150mm of cash on SYKE’s 
balance sheet when 71% ($107mm) of that cash sits trapped overseas, with no 
tax-efficient way of  effecting  repatriation.  When I last wrote-up SYKE, there was some hope 
of determining a tax-efficient way of accessing the cash, but with the expiration 
of the temporary incentives to repatriate cash provided by the American Jobs Creation 
Act of 2004, one must assume that no such tax-efficient repatriation exists.  
Therefore, in evaluating a TEV/EBITDA multiple, one should really adjust (lower) the cash 
by some amount to reflect taxes due in the event of repatriation since the Company 
has very little effective use of the cash (save foreign acquisitions, a risky and 
dubious use of the loot), which sits in various overseas jurisdictions.  Adjusting for 
some tax leakage boosts the EBITDA multiple to over 11x.  The Company’s P/E 
likewise is understated because it reflects an unsustainably low tax rate in 
2006.



In evaluating SYKE’s multiples, investors should consider that the best run, most 
profitable company in this industry (West Corp) recently was taken private after a 
competitive auction at approximately 9.5x EBITDA.  West is larger, more diversified, 
enjoys significantly higher margins and ROIC, and has a better track record of 
profitable growth.  Moreover, as indicated by SYKE’s ~5-6% operating margins, this is a 
highly competitive, commoditized business characterized by relative capital intensity 
for a service business and price competition.  Competition based on price is common, 
driven by the prevalence of relatively large, sophisticated customers, which also 
is reflected in customer concentration (risk) in the industry (SYKE’s top 10 
customers approximate 45% of revenues).  Indeed, despite strong recent growth, SYKE’s gross 
and operating margins have contracted in 2006 (op margins only appear higher because 
of the gain on sale of certain closed call center properties).



I also 
believe SYKE is generating peak levels of free cash flow because it has enjoyed the 
benefits of excess capacity as the industry has undergone a cyclical recovery; however, 
with capacity utilization expected to approach 90% (effectively full utilization) in 
2007, SYKE will be forced to spend additional capital to expand seats just as the 
economic outlook is for slower growth.  Indeed, its capex spend in the second half of 
2006 has exceeded analysts’ estimates.  Finally, with a very high fixed cost base, 
any downturn will have outsized impacts on earnings and cash flow.





In 
sum, SYKE operates in a cyclical, commoditized industry with relatively high 
required cash investments.  It deserves a discount to market multiples not a premium.  A 
combination of slowing growth, contracting margins, disappointing free cash flow and 
continued insider selling should cause the shares to fall in the coming 
year.

Catalyst