European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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Mid cap European small and mid caps 17 October 2007 abc Strong management of margins Given the sector’s high fixed-cost structure that is faced with client pricing pressure, call centre companies must strive to improve cost and performance. Teleperformance has managed its profitability well in the past, with an average operating margin of 8.6% over the past six years (lowest level of 7.7% in 2003), despite the economic slowdown in 2001-03 and the negative effect of the ‘do not call’ list in the US in 2003. For 2007, management guides for an operating margin of 10.0%, which represents for us its normative level. We believe the company no longer has any immediate and substantial opportunities at the operating level that could enhance profitability, although it possesses some long-term opportunities, including: 1) the integration of more profitable companies (acquisitions), 2) the growing contribution of higher-margin niche activities, such as technical support, 3) the increased reliance on offshore resources, 4) the development of new teleworking techniques. We think the gradual effect of profitability drivers should allow the company to maintain its margin above 10% over the next three years. We forecast average net profit growth of 15% pa over 2006-09. Investment case Teleperformance is a defensive stock. Over the past six years, its average organic growth reached 9.5% per year (total growth, +15% per year), with an average operating margin of 8.6% (lowest level of 7.7% in 2003), despite the economic slowdown over 2001-03. Its positive net cash position, excluding any refinancing problems, and the distribution of sales are secured by it having the right distribution of client sectors, with a strong position in telecoms (51% of sales) and only 11% of revenues coming from financial services. The company’s exposure to the US dollar accounts for 30% of revenues, but we don’t think this should affect margins. Catalysts After the capital increase in November 2006 (EUR260m), the company’s external growth – paid in cash – and the resulting financial leverage on the balance sheet is the main value driver for the company, in our view. Intrinsically unpredictable, we believe the execution of this acquisition programme, and hence its effect on the company’s balance sheet and, therefore, on its share price, should be considered from a medium-term perspective. Ever since it carried out its cash call, the group has spent EUR210m on four acquisitions, representing sales of EUR250m, or an average ratio of 0.85x sales (see the ‘Key performance indicators’ table above). Once the last acquisition of Alliance One in the US has been paid, Teleperformance should still have net cash of EUR120m at year-end. Based on a maximum gearing of 30%, we think that the group can still invest EUR390m. On the basis of the average ratio of EV/sales already recorded, it represents the acquisition of EUR450m in sales, implying a new increase of 25% of sales and EPS (at constant margin) with no additional dilution. Valuation Our target price of EUR38 is derived from a DCF valuation (WACC of 8.9%, risk-free rate of 4.4%, and a beta of 1). It implies a potential return of 38% and leads to our Overweight rating. 70
Mid cap European small and mid caps 17 October 2007 abc We believe the current price and valuation ratios (2008e EV/sales 0.8x, EV/EBITDA 5.7x, PE 14.2x) represents an investment opportunity taking into account: 1) our expected 2006-09 average annual EPS growth (+15% pa) before acquisitions, 2) the net cash position, excluding any refinancing problems, 3) the good distribution of client sectors, 4) a steady global performance and limited variation in operating margin. Investment risks The following risks could prompt us to change our rating: 1) the setting up of ‘do not call’ lists in new areas, 2) anti-relocation legislation in Europe and the US, a major factor behind growth in group margins, 3) currency fluctuations, mainly the EUR/USD and EUR/BRL exchange rate, 4) significant delays in the execution of the acquisition programme. 71
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European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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