StarTek (SRT) – Merger Arbitrage – 30% Upside

Current Price: $4.13

Offer Price: $5.40

Upside: 31%

Expiration Date: mid-2022

This idea was shared by Ilja.

 

In Dec’21, call centre services provider StarTek received a non-binding offer from its 55% shareholder PE firm Capital Square Partners (later CSP) at $5.40/share. The offer is being reviewed by the special committee of independent directors and, during the Q4’21 results call (11th of March), management mentioned that the review is still ongoing. The spread to the offer stands at a staggering 30% and I struggle to find an explanation for that. SRT is cheap, trades below peers, below industry transactions and at the offer price is valued under 5xEBITDA. Upon the offer announcement, SRT shares popped to $5.30+ and for a few weeks the company was trading at <5% spread. The gap started to widen at the time when the war in Ukraine started, although the company has no business neither in Ukraine nor in Russia.

The buyer – Capital Square Partners – fully controls the game here – has 4 out of 7 board seats, including the Chairman and the CEO. The business Process Outsourcing (BPO) industry is in a consolidation mode and given how opportunistic and cheap this offer is, CSP is unlikely to walk away from this deal easily. Shareholder approval for CSP’s low-ball offer might be an issue, but there is plenty of headroom to raise the price to secure minority shareholder consent. A competing bid might be in the cards as well – ex-CEO with some other shareholders is rumoured to be contemplating an offer at a much higher price ($10.5/share).

I might be missing something – 30% spreads for $170m market cap companies on cash offers from controlling shareholders are usually seen only for Chinese going private transactions

A few points worth highlighting for this merger arbitrage situation:

• The offer is very opportunistic. Since 2018 (with the exception of two covid quarters) SRT has been trading within a $6-$9/share range. The shares slid down in Nov’21 after the company reported a security breach. The cyberattack happened in Jul’21 and put some pressure on Q3’21 margins – all of this resulted in a material sell-off. Since then, SRT has announced that the problem is fixed and that the company has eliminated any remnants of the attack and has significantly ramped up its cyber defence mechanisms. This take-private attempt seems to exploit the recent share price weakness to snatch SRT on the cheap.
• The offer values SRT at 4.7x adj. EBITDA 2021, whereas similar peers trade at 5x-6x (see more details below). The industry is consolidating and plenty of recent transactions happened at around 10x adj. EBITDA multiple (more details below). A few weeks ago, rumours appeared that StarTek’s peer Atento is exploring a sale – at post-rumour price, ATTO is now trading at 5x adj. EBITDA even before any offer announcement or confirmation of the rumours. Atento’s case has also been posted on SSI.
• CSP is a Singapore based PE firm, which has experience in the BPO/outsourcing industry (more details below). CSP received its stake in SRT as a result of SRT’s merger with CSP’s owned Aegis back in 2018. During the merger, the combined company was being valued at $390m vs $220m at the current offer price – almost 50% cheaper. Meanwhile, SRT’s financial performance has only improved since the merger.
• SRT had authorized $25m share buyback in 2004 and did not touch it till 2021, when for some reason the company has suddenly started repurchasing shares. During 2021 412k shares were re-purchsed at an average price of $4.61/share, with plenty of shares also repurchased at $5.51-$6.06/share. The only explanation for these sudden open market buybacks is CSP willingness to increase its ownership in SRT, even above the prices of the current offer.

• To spice the story, another interesting twist. Just recently The Deal reported that SRT’s ex-CEO is considering making a competing bid. Basically, the ex-CEO alongside a few other shareholders think CSP’s offer is too low and are considering their options. Reportedly, ex-CEO has spoken with the current CEO (CSP’s affiliate) about launching a counteroffer at $10.50/share (almost a double compared to the current one) and also is saying that in a competitive sale process SRT could fetch 8-10x adj. EBITDA – SRT is an attractive target for strategic bidders even at far higher valuations than the CSP’s bid. However, in the offer announcement CSP clearly stated that they do not want to sell to any third party. Nonetheless, all of the additional noise created by the rumours of a competing bid at the very least should be a positive in pushing CSP to raise their current offer to appease the shareholders.
• Approval by a majority of minority shareholders will be required. Non-CSP management owns 3.7%, SRT co-founder owns a further 7.1% and another private investor holds 6.4%. Not clear if CSP offer would pass without the consent of these shareholders or if CSP has already consulted with them.
• Estimating the downside is trickly. Pre-announcement price stands at $3.94/share (-5%), however, since then SRT has released somewhat soft Q4 earnings – revenue +2% YoY, gross margins -2% YoY, adj. EBITDA $18.9m vs $23.3m last year. However, it’s worth noting again that before the security breach SRT traded at much higher prices and fundamentals have not changed much since.
• There have been some strange management reshuffles post the offer announcement. One of the CSP managing partners became CSP’s president in Oct’21. Then in Feb’22 – he has taken the SRT’s CEO role as well. A few weeks later, SRT announced CFO and CIO changes. Interestingly, the contract for the new CEO included an inducement grant of 100k options to purchase SRT common stock at $5.75/share. This seems quite weird in light of a $5.40/share offer that was already on the table at the time. The market did not react to these announcements.
• Regarding the previous security breach, in Jan’22 a couple of articles appeared that SRT’s employees are preparing a class action suit due to the leaked private information – apparently both customer and employee info might’ve been leaked (here and here). Neither the company nor The Deal article has addressed this.

 

Valuation

The table below details how SRT valuation at the offer price compares to other publically listed peers.

And here is the of several recent industry transactions – a number of them were shared in The Deal article referenced above. As evidenced by industry transactions (expansion efforts by industry giants + acquisitions by PE firms) and industry commentaries (here and here) the business processes outsourcing/call centre industry has been in consolidation mode for a few years now. SRT itself also mentions industry consolidation multiple times in its reports.

• Teleperformance/Senture in 2021 at a $400m EV or 13x EV/EBITDA ;
• ChrysCapital Management/ResultCX in 2021. Deal terms were undisclosed, but sources say valuation came in at between 9.5 times and 10 times the target’s $47m in 2021 EBITDA. ResultsCX had EBITDA margins around 11.7%;
• Sitel Group/Sykes Enterprises for $2.2bn or just over 7x EBITDA in 2021;
• Brookfield Asset Management/Everise Holdings in 2020. According to The Deal’s sources, reportedly paid between $425m and $450m for Everise. Everise  had reportedly generated revenue of $300m and EBITDA of $40m in its fiscal 2020, which would put Brookfield’s deal multiple at 11x EBITDA. Everise’s EBITDA margins stood at 13%.
• Concentrix/Convergys for around $2.4bn or at an estimated 10x EBITDA in 2018.

Some of SRT’s cheapness relative to peers and industry transactions can be attributed to smaller scale, closely-held shares, and lower margins. The Deal article also argues that SRT is cheap partially due to management avoiding the conferences (being non-promotional) and not providing earnings guidance. All of these seem to be fixable in sale scenario, especially for a strategic buyer and margins have been improving recently and reached 10% in 2021 not far from the previously guided 12% post-synergies adj. EBITDA margins (guided at the time of the merger with Aegis).

 

Capital Square Partners

CSP is a Singapore-based PE firm that invests across telecommunications, media & technology, healthcare and other sectors with footprints across SE Asia and India. CSP says that co-investors of its funds include Hermes GPE, Partners Group, AlpInvest Partners, Aberdeen Private Equity, etc.

CSP has already made a couple of successful deals in the call centre/BPO industries and can be judged to know the dynamics of the industry pretty well.

• In 2014 CSP acquired MINACS – multi-country BPO business for $260m, grew its EBITDA by 50% in 2 years and sold it for $420m in 2016.
• In 2016 CSP acquired 55% stake in Indecomm for $90m. In 2019 it was reported that Warburg Pincus invested $200m in Indecomm and “bought out former investors that were led by CSP”.

 

Background on SRT merger with Aegis

In Nov’17 for $300m CSP acquired Aegis – a multinational BPO/call centre business in India, Indonesia, Australia and South America. In Mar’18 CSP reverse merged Aegis with SRT and was issued 20.6m shares of SRT stock. Ownership of the combined company was split at 55% for CSP and 45% for previous SRT shareholders. CSP part was valued at around $216m at the time, i.e. materially below what CSP paid for Aegis just few months ago.

Back in 2017, the pro-forma combined revenues stood at $681m ($388m by Aegis and $293m by SRT) and adj. EBITDA at $51m ($38m Aegis and $13m SRT).

Given that Aegis was a larger company generating the majority of combined adj. EBITDA, it is somewhat strange that CSP has agreed to this combination at a discount to their cost basis. Moreover, upon the reverse merger, CSP also invested a further $2m at $12/share price (premium to $10.5/share price then). According to SRT management (pre-merger), this showed how much CSP believed in the synergies of the combined entity.

Both firms had no client overlap and guided significant synergies ($30m adj. EBITDA) from revenue opportunities (e.g. cross-selling) and operational efficiency.

Until the merger with Aegis in 2018, SRT used to be a call centre business focused mostly on North American clients. The merger has significantly diversified the revenue base (see graph below) and client concentration – before the merger SRT top 3 clients represented 53% of revenues vs <30% post-merger.

 

Current StarTek

SRT is a call centre business with over 200 clients – mostly in telecom, media/cable and e-commerce sectors. Also has some exposure to the government sector (in the US).

The company focuses on medium-sized businesses and operates on multi-year contracts. Relationships with the 5 largest clients have averaged around nine years. Top 5 clients accounted for 40% of 2021 revenues (the largest client is at 18%).

Geographical revenue segmentation:

• Americas – 37%
• India & Sri Lanka 15%
• Malaysia – 8%
• Middle East – 29%
• Argentina & Peru 5%
• Rest of the world 7%

The company has 45k employees, 95% outside the US (mostly in India, the Philippines and Honduras).

Financial performance:

It seems that since the merger in 2018, SRT’s financial performance and profitability have been steadily improving. In 2021 the company has almost reached the post-synergy adj. EBITDA estimates of $80m (as communicated during the merger with Aegis). 2021 results were also slightly affected by the above-mentioned security breach and leaked information.