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Looked at in a vacuum, TDCX TDCX 0.00 appears to be a ‘no-doubt’ opportunity created by broad market weakness. Shares are down 46% from the initial offering price set just under a year ago, and off two-thirds from December highs. Yet little, if anything, seems to have changed regarding the company’s long-term outlook. At Friday’s close below $10, valuation looks enormously attractive in the context of a multi-year track record of growth.

Of course, TDCX, like any other stock, can’t be looked at solely in a vacuum. Broad market indices are threatening 21-month lows not just because of investor sentiment (or the Federal Reserve), but because of real fundamental factors. And those fundamental factors threaten recent growth, helping to explain why TDCX stock looks mispriced at the moment.

There are risks here, even beyond the possibility of more short-term selling in the market. But it’s worth noting that TDCX stock has held up better than most of late — down less than 3% this month — and there does seem to be some reason for that. TDCX might not be the slam-dunk buy the headline numbers suggest. But it does look like a buy.

Introducing TDCX

Singapore-based TDCX provides outsourced CX (customer experience) solutions, mostly out of locations in Southeast Asia. The company reports revenue from three separate offerings:

• Omnichannel CX solutions (59% of trailing twelve-month revenue): This essentially is outsourced customer service and technical support, whether via call centers, email, text messaging, or chat. TDCX’s key customer in this offering is Airbnb (ABNB); Netflix (NFLX) is another client1.

• Sales and digital marketing (23%): TDCX works with advertising platforms to bring end customers into their ecosystems. Meta Platforms (META) is the key customer here; TDCX also works with Alphabet (GOOG) (GOOGL) unit Google2.

• Content, trust and safety services (17%)3: In a business that began in 2018, TDCX works with Meta’s Facebook to moderate content and, starting late last year, to label data to improve machine learning models.

The company was founded in 1995 as a standard, outsourced call-center operator by Laurent Junique, who still owns the majority of the company and controls voting power through a dual-class structure.

In 2012, what was then known as Teledirect Telecommerce (the company thankfully changed its name in 2019) acquired its first “new economy” customer (which appears to be Google). Since then, the company has aggressively built out its offering, and it now gets 90%-plus of revenue from new economy clients.

That list has grown impressively of late: according to filings, between the beginning of 2018 and June 30 of this year, TDCX went from 11 clients to 60. But two remain paramount: Meta accounted for 43% of 2021 revenue, and Airbnb 19%4. Another 11% came from an unspecified third company

Of late, TDCX has looked to expand geographically as well. In 2021, offices in Singapore, the Philippines, and Thailand each accounted for about one-quarter of revenue. (The location of the office does not necessarily correlate to the location of the end user being served; a North American Netflix customer could deal with customer service operating out of Manila.) But the company has expanded into Spain, Romania, Colombia, India, and South Korea as well. According to the Q1 call Vietnam and Indonesia are on the schedule as well.

Revenue in those locations is tiny at the moment. In 2021, $5.2 million from Spain and less than $500,000 total in the other four newest markets. The success of the company’s “land and expand” strategy with major customers, and the sharply growing number of new clients suggest optimism that new offices will drive revenue growth going forward. Indeed, in Q1, TDCX acquired a “leading short-form video sharing social media company” (likely TikTok). Per the Q1 call, TDCX will begin the contract in both Spain and Singapore.

That said, competition is fierce worldwide. Even in Southeast Asia, per the F-1, the top 15 CX players in Southeast Asia control a little over half the industry. France’s Teleperformance (TLPFY) and Concentrix each lead with over 9% share. Privately held Alorica, TTEC (TTEC), and TELUS International (TIXT) are in the 3-4% range, with TDCX at 3.2%.

The Fundamental Case Looks Strong

At the moment, TDCX stock looks cheap. Based on the midpoint of the guided ranges for revenue and EBITDA margins, and adding back share-based comp, shares trade at just 8.7x EV/EBITDA. Ex-cash, 2022 P/E should be in the range of 16x, and price to normalized free cash flow should be closer to 12-13x.

Those are value multiples for what still looks like a growth stock. The midpoint of TDCX’s outlook implies 19.3% revenue growth in local currency. If that target is hit, TDCX revenue will increase 265% from 2018 levels, a 38% compound annualized growth rate.

Looking forward, there’s still room for optimism as well. Geographic expansion should provide a multi-year runway for growth. New clients acquired this year will boost performance in 2023 and 2024. The longer-term trend of outsourcing to Asia has been intact for decades; wage inflation in North America, in particular, should only accelerate that trend. Fintech quickly has become the company’s third-largest vertical, and in areas like KYC (Know Your Customer) there’s room for more growth as well.

This simply seems to be a case where the market has badly overreacted, whether because it is selling off stocks almost indiscriminately, or because it is responding to weakness in META stock. At this point, TDCX looks not only too cheap, but ridiculously so.

The Meta Problem

That perception, however, gets to the key question here: is TDCX a value play or a value trap? There are risks here that might lead investors to believe the latter.

Most notable is the importance of Meta. On a percentage basis, the platform’s contribution to TDCX revenue likely is coming down this year. In Q2, top-two concentration was just 57% of revenue, and that was with growth in the travel vertical (no doubt driven at least in part by Airbnb). Still, even a reduction to, say, 38% of revenue against 2021’s 43% still leaves TDCX heavily reliant on a company whose share price has declined 58% so far this year.

But it’s worth disentangling the TDCX/Meta relationship from the META stock price. For one, Meta’s revenue is still expected to be roughly flat this year, before 10% growth in 2023 (at least per Wall Street consensus). The issue for META stock is more on the margin front, after the pandemic and high consumer demand drove digital advertising pricing through the roof in late 2020 and 2021.

As long as Meta’s usage holds up, the revenue going from the social media giant to TDCX should be roughly the same.

Second, TDCX is guiding for nearly 20% growth this year despite the fact that Meta already has proven to be a headwind. The content moderation contract with Meta appears to account for more than one-third of revenue coming from that platform. Yet revenue in the content, trust and safety services segment has barely budged in recent quarters, and grew just 5.9% year-over-year in Q2. That includes some contribution from fintech KYC revenue which is growing. In that context, the actual content moderation revenue from Meta/Facebook may even be declining.

With Accenture (ACN) losing its content moderation business with the platform, that may change in coming quarters. But even if it doesn’t, it’s not as if TDCX’s revenue should suddenly stall out as Meta goes negative.

Finally, there’s the possibility that a cost-conscious and revenue-desperate Meta may ramp its spending with TDCX. Junique has said that in a downturn, sales offerings tend to do better, and his company has worked on adding sales capabilities to customer service offerings in response.

The Macro Problem

The concerns about Meta echo the larger concern here: that TDCX is at risk of seeing revenue growth slow significantly amid a macroeconomic downturn. Indeed, the entire sector has turned south:

source: YCharts

For outsourced providers, lower macro activity essentially leads directly to lower business activity. And so it’s not terribly surprising that the space as a whole has underperformed the Russell 2000 (which is -25% year-to-date).

This risk can’t be ignored. And it’s part of the concern about Meta: fewer customers onboarding that platform in turn means lower revenue for at least some of TDCX’s contracts.

But there are some mitigating factors. It’s certainly possible that cost-cutting tech firms will look to TDXC to drive savings, particularly with wage inflation in North America running above that seen in Southeast Asia. That trend would not be enough on its own to offset macro issues, but it would at least blunt some of the impact.

There’s another, more important, point to keep in mind for TDCX. It’s not as if 2022 necessarily is a perfect environment. Per the Q2 call, the travel vertical still sits 16% below 2019 levels; the delayed recovery from the pandemic in much of Asia no doubt has kept a lid on Airbnb revenue (which, as noted earlier, was stagnant in 2020 and 2021).

Netflix might see some sub pressure, but its revenue is unlikely to decline. The same is true for Google and other newer Big Tech clients. On the margin front, TDCX contracts don’t have inflation adjustments built in, meaning the company is forced to eat higher wages.

The fundamental logic behind the ~50% declines in so many small- and mid-cap stocks is that a combination of flat (or worse) revenue, reduced margins, and compressed multiples makes the math work. That math makes sense for businesses that were overearning in 2021 and/or 2022.

That’s simply not the case for TDCX. The environment in 2021 was beneficial, absolutely, but given Airbnb’s weakness (again, 19% of revenue) far from perfect. Now in 2022, inflation is picking up and clients are delaying product launches.

TDCX did cut guidance after the first quarter amid delayed project launches, but still sees revenue growing high double-digits and EBITDA margins are still 30%-plus. The lowered guidance was reiterated after Q2, sending the stock higher, and it’s likely that outlook is helping to keep the stock afloat at the moment.

If TDCX can grow revenue 19% and keep margins intact in this environment, there’s still plenty of room for growth should the macro situation deteriorate. And it’s worth noting that the strong U.S. dollar actually is a tailwind going forward, since TDCX books its costs in local currencies yet receives some revenue in USD.

If that dollar strength, as some bears fear, drives a currency/financial crisis in the region, then TDCX is going to have downside from here. But a more standard macro downturn appears more than priced in. TDCX is being priced as if 2022 is a cyclical high for the business. There’s not a lot of evidence to suggest that’s the case.

What Else Goes Wrong

The final category of risks on their own are relatively small, but in aggregate could drive some caution. They’re the kind of risks that suggest the -49% YTD performance is being driven by the fact that TDXC stock was overvalued after its IPO, in part because bullish investors ignored some of the yellow flags surrounding the stock.

One key, and unanswered question, is what precisely has driven the growth in recent years. Again, Teledirect Telecommerce was founded in 1995. At the end of 2017, it had nine clients. The 20-F repeatedly uses the phrase “particularly from 2012” in describing its growth, including in the context of the company’s finding of a material weakness in internal controls (another of the yellow flags).

2012 is the year the company appears to have onboarded Google, and ostensibly made its pivot toward “new economy” clients. As noted, it then picked up Meta, Airbnb, and Netflix in 2014-2015. The inflection point there makes some sense.

But in 2018, advertising giant WPP plc (WPP) still owned 40% of the company after acquiring its stake back in 1997. WPP sold that stake for $28 million, implying a valuation for the entire business of just $70 million. The sale appears to have closed early that year, so perhaps WPP’s timing was just awful (and the company may have agreed to the deal before TDCX picked up content moderation revenue from Meta). Still, TDCX still has an enterprise value roughly 16x the valuation implied by the ad agency’s divestment.

Junique’s control is a modest concern. So is a bank loan used to acquire his original ownership interest in the company for S$252 million, a loan paid off using IPO proceeds.

The reiterated guidance post-Q2 might not be quite as good news as it seems, given that the range in USD was reduced. Again, TDCX does receive revenue directly in USD, which in turn should provide a modest tailwind to revenue reported in SGD. And there does seem to have been a bit of elevated churn in the first half, per earnings calls, though that’s not a huge surprise given macro pressures.

Why TDCX?

But in the context of a valuation that implies essentially no growth going forward, both the larger risks and the smaller ones seem worth taking. There’s a reasonable case for a multi-year double here, assuming mid- to high-single-digit free cash flow growth and multiple expansion up to the high teens.

There’s some downside protection here as well. Fixed costs here are not substantial: almost 80% of operating expenses come from employee costs. Even in a downturn, margins in theory should hold up. The balance sheet is rock-solid: cash of $276 million (almost 20% of current market cap) and no debt.

With the sector down so sharply, one question might be whether to take on broader risks elsewhere. But TDCX does look like the best choice.

CNXC is cheaper looking to 2022 results, but growing slower and somewhat leveraged. The latter applies to Teleperformance as well, but that stock actually trades at a premium in terms of both EV/EBITDA and free cash flow.

TTEC has sharply lower margins, yet higher multiples. Based on guidance, TIXT trades at over 20x this year’s EPS. TASK actually does look interesting at ~16x this year’s free cash flow with revenue growth guided above TDXC (~22% vs ~19%). But it has lower margins, while a big plunge after its own Q2 report (and recent weakness) suggest some risk.

In this kind of market, buying the ‘cheapest’ name is not always the correct strategy. But what drives the bull case for TDCX is not just that the stock is cheap. The company is still growing, and between new clients, new business with existing clients, and new geographies, that growth should continue. That’s enough for a buy — even in this kind of market.

As of this writing, Vince Martin is long shares of TDCX.

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