Thursday, January 28, 1999
HOW DID IT DOUBLE?
Since going public in 1996 amidst the teleservices bubble, TeleSpectrum has experienced the full spectrum of boom, bust, and now, apparently, turnaround.
I covered the bust phase in October 1997 with a Daily Trouble on TeleSpectrum and the related CRW Financial (Nasdaq: CRWF). At that point, TeleSpectrum appeared to be basically a scheme to make then Chair/CEO Brian O'Neill a lot of money at the expense of public investors. And it worked -- until fierce competition in the telemarketing business left a number of public companies scrambling to find profits.
Last March, TeleSpectrum dialed up turnaround expert Keith Alessi, former Chair/CEO of Jackson Hewitt, the nation's second-largest tax preparation services company. Alessi came to TeleSpectrum on the heels of an astonishing makeover at Jackson Hewitt that led to that company being acquired by Cendant (NYSE: CD) in a deal that made little old Jackson the top performing stock of 1997.
Since taking the helm, Alessi has continued to implement cost-cutting measures while moving aggressively to sign profitable new contracts in an effort to boost utilization of TeleSpectrum's call centers. That's been no easy task given that MBNA (NYSE: KRB), the credit card firm that accounted for 19% of TeleSpectrum's FY97 revenue, has curtailed its business with the company.
Still, Alessi's efforts have investors dialing for dollars. TeleSpectrum recorded a lower-than-expected Q2 loss ($0.03 per share versus estimates of $0.16). Next, it delivered a Q3 gain of $0.10 per share versus estimates calling for $0.06 per share, as revenue actually increased 9.3% to $44.5 million while operating expenses dropped 26%. Its call centers ran at 82% capacity versus 72% in the typically stronger second quarter and just 60% in Q1.
On January 14, the company announced plans to expand its reach by acquiring International Data Response Corp. (IDRC) for about $91 million in stock and the assumption of $105 million in debt. Given Alessi's track record and his recent success, investors have connected for a Double on TeleSpectrum, figuring more good things are just a phone call away.
TeleSpectrum provides corporate clients with inbound and outbound telemarketing services. For the first nine months of FY98, 75% of revenue came from classic telemarketing where a computer automatically dials up potential customers from a list. When you answer at home, a TeleSpectrum employee reads from a prepared script to market certain goods or services to you.
Higher margin "customer care" offerings, such as customer service, catalogue order processing, and consulting, accounts for the rest of TeleSpectrum's revenue.
Competitors include Apac Teleservices (Nasdaq: APAC), ICT Group (Nasdaq: ICTG), Sitel (NYSE: SWW), and Teletech Holdings (Nasdaq: TTEC). Insiders control about 40.2% of the stock, most of which is held by CRW Financial (Nasdaq: CRWF), a firm controlled by TeleSpectrum founder Brian O'Neill.
12-month sales: $169.2 million
12-month income: ($160.6) million
12-month EPS: ($6.37)
Profit Margin: N/A
Market Cap: $295.4 million
(*Based partly on continuing operations for FY97, including a $139 million goodwill impairment charge.)
Current Assets: $42.7 million
Current Liabilities: $28.5 million
Long-term Debt: $3.0 million
HOW COULD YOU HAVE FOUND THIS DOUBLE?
A year ago, the situation looked bleak. TeleSpectrum was on the way to delivering three consecutive quarters of operating losses to close out FY97. It had spent a lot to build capacity to meet projected growth expectations only to find itself with excess capacity in a marketplace dominated by cutthroat pricing resulting from other players making the same mistake.
So it started closing call centers, a process that continued through Q2 1998. Altogether, 15 of TeleSpectrum's 25 call centers have been closed. As a result, the company took an impairment charge to write down $139 million in goodwill connected to its telemarketing segment.
Early in 1998, it sold off its market research business for $15 million and its direct mail and fulfillment business for $23 million. It was also forced to renegotiate its credit facility because it had fallen out of compliance with certain requirements.
Successful turnarounds are usually painful, and they tend to depend on management changes. While some hyped turnaround experts like Al Dunlap eventually fall on their faces, it's simply worth watching when a downtrodden company brings in a quality exec to run the joint. Alessi brought credibility to TeleSpectrum that the company had lacked.
Given the highly competitive nature of this business, a Fool would have wanted to wait for tangible signs that Alessi was making progress. That came with the estimate-beating second quarter (and, later, the profitable third quarter). Alessi's own open market stock purchases of 100,000 shares in the mid $5 area last August suggested the stock was a bargain when it fell as low as $3 1/4 in early September.
WHERE TO FROM HERE?
The third quarter numbers reveal the challenging nature of this business. Sales increased despite a loss of $10.4 million in revenues from former clients and $7 million in lower revenues from current clients. Some of the lost business may have come from ill-advised, low-margin deals TeleSpectrum signed just to keep call centers occupied a year earlier. Still, one would like to see increasing revenue from existing customers.
While TeleSpectrum has been restructured for profitability, the reported 6% net margin in Q3 is misleading. Due to the reduction in goodwill, amortization expenses have been cut by 84%, which greatly benefited operating profits. The company is also paying no taxes, and it still claims $8 million in net operating loss carryforwards plus the potential for $123 million in future income tax deductions related to the FY97 charges.
Investors need to make other adjustments, too. TeleSpectrum plans to acquire CRW in a stock swap. CRW's main asset is 6.9 million shares of TeleSpectrum. Altogether, the deal will cut 0.8 million shares from TeleSpectrum's fully diluted base. Yet, outstanding rights would still allow CRW holders to purchase an additional 2.0 million new shares for a total price of $5.6 million.
To acquire IDRC, TeleSpectrum will issue 9.2 million shares, refinance its $105 million in debt under an agreement with a syndicate led by Banque Nationale de Paris, and issue warrants allowing IDRC holders to acquire another 3 million TeleSpectrum shares at $9.67.
The IDRC acquisition will transform TeleSpectrum's business, creating the industry's seventh-largest firm, with 30 call centers in the U.S. and 4 in Canada, and total annual revenues of around $330 million. IDRC reportedly has a stronger inbound call business, which is important since that segment delivers better profits.
IDRC's Chair/CEO Jeffrey Stiefler, formerly president of American Express (NYSE: AXP), will focus on generating new business for the combined company. The deal should add to earnings in FY99.
Still, we're talking about a teleservices company with a minimum of 34 million shares outstanding. Add in debt, and TeleSpectrum sports an enterprise value of half a billion dollars. Assuming $330 million in annual sales, the stock trades at a price-to-sales ratio of 1.5, a multiple that assumes either significant revenue growth or a net profit margin in the 4% to 6% range.
Yet, even the best teleservices firms haven't shown the ability to generate such profits. Managerial talent is worth a premium, but telemarketing remains an essentially low-margin business.
-- Louis Corrigan
Would you work for a bunch of Fools?
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