Transcom - Turnaround Calling? - Positioning
Dear All,
Please find our model post the release of the Q3 2024 results on Transcom here.
There is a slow & steady progress on the turnaround. While Transcom is suffering from lower customer volumes (in eComm & Tech) which started in Q2 2023 and continued into Q3 2024, the narrative that AI is leading to loss of contracts is proving to be false as the company did win contracts. The new CEO is also moving the shoring mix to offshore from onshore (which will benefit margins) and optimising working capital to generate positive free cash flow. While still a "show me" story, the set up and their outlook for 2025 remains positive as the turnaround continues.
Investment Rationale:
-Senior Secured Notes: We are encouraged by the progress made by the company in re-positioning the company for growth and de-leveraging in 2025 and hence are increasing our long position at 71 from the current 2% of NAV to 4% of NAV.
-We are constructive on the notes because of the current trading price, the levers around the cost structure (70% + variable cost), capex cuts and no acquisitions going forward as well as implied shareholder support.
- The key risks (loss of contracts & continued cash burn) were mitigated in Q3 2024 as the company did win new contracts on a net basis and generated free cash flow.
-The company also stated that the majority of costs incurred in transitioning the business are behind it positioning it for growth and de-leveraging in 2025.
-Additional tailwinds which have not been priced in yet including resumption in growth in the higher margin eCommerce & Tech segments, winning new contracts and better execution from a newly appointed CEO.
-The slow & steady sequential improvement in the coming quarters will be key to the price appreciation of the notes.
-The market value of the notes is creating the valuation of the business at 3.0x which does not assume any turnaround in the business (a discount to already compressed sector valuations witnessed earlier in the year from AI headline risk).
-Sarria projections have assumed no deleveraging in 2025 with leverage at 4.3x and expect shareholder support in the form of an equity injection of at least €50 million as the company looks to refinancing its notes at Q4 2025 (which implies net leverage at 3.7x).
-Based on 2025 EBITDAR of €88 million and a multiple of 3.7x, we think fair value for the notes are in the mid 80s.
Working capital to the rescue
-Transcom generated €5 million of cash inflow from better cash collection and factoring which mitigated any cash burn.
-The cash inflow from working capital offset the negative impact of EBITDA margin compression as the company ramp up costs to support new business and transitions its shoring mix to offshore.
-While in the Q3 2024 investor call, management did state that payment terms from new customers & RFPs would get longer (at 60+ days), Transcom will use more factoring to mitigate that. However, Sarria’s projections do not include any cash inflow from factoring.
Recent Results - still a “show me” story but moving in the right direction
-Topline reflecting contract churn: Q2 2024 sales were €182 million (0.6%) which reflected new contract wins (3.9% with new and existing clients) offsetting exit of low margin contracts.
-Margin temporarily depressed: Q3 2024 EBITDA was €23.9 million (13.1% margin) vs. €25.1 million (13.9% margin) in Q2 2023 due to extensive ramp up costs to support new business. The company did state that the cost of ramping & investment in the sales force was behind them in 2024.
-Capacity optimisation from onshore to offshore will start positively inflecting margins in 2025: The company made reduction in Germany, Croatia, Spain & Portugal but added new capacity in Egypt, Tunisia and India.
-Liquidity remains strong with the cash balance at €40 million and undrawn RCF totalling €75 million. Net leverage remains elevated at 4.3x as decline in EBITDA margins were offset by free cash flow from working capital.
-Growth & outlook pushed to 2025: The company expects 2025 to be relatively strong with 5% - 10% organic growth, de-leveraging and free cash generation.
We look forward to following what could be an interesting turnaround situation in 2025.
Happy to discuss
Saahil
T: +44 203 192 0200
www.sarria.co.uk