Capita (“CPI” or “the Company”) is a London based business process outsourcing provider. The Company’s products include business process management, business transformation services and HR functions. Capita delivers its services to a wide range of differing industries including high growth end markets such as Healthcare, Education and Defense. Capita caters to both the public and private sector in the United Kingdom. Capita is currently trading at ~£38/share. The Company currently represents ~6 % of my total portfolio and my position has generated a ~30.6% profit since purchase. Compared to the FTSE100 which is up ~1% YTD, Capita is up ~51%. I believe that Capita is still undervalued relative to industry peers and am bullish about the long-term growth prospects of the Company.
Business Process Outsourcing (“BPO”) is a unique industry because industry players typically benefit from rising interest rates. As monetary policy makers across the world are increasing the cost of borrowing, businesses are forced to look towards external parties to do their standard business processes. For example, rising rates leads to the outsourcing of HR and accounting processes to reduce overhead costs. However, simultaneously the profit margins of BPO providers are hurt greatly by rising wages. Labor is often the highest expense category for these businesses. The recent success of Capita suggests impressive cost management of these high labor costs.
In the United States, major industry players are $ACN $CNDT and TD SYNNEX. Together these three companies make up 25% of the US market share in BPO. IT Consulting and Business Process Outsourcing in the United Kingdom is a much more fragmented market. Key players include Big 4 accounting professional service providers, and other more industry specific players like Capita. The total market size of UK Business Process Outsourcing is projected to reach ~$27B by the end of 2023, compared to ~$130B in the US. The UK market is expected to grow at a CAGR of 6.8% from 2023-2027.
One of the important aspects about Business Services is the ability to benefit from success in high-growth end markets. As clients in these end markets expand, they usually streamline their business processes and outsource to external players. For Capita, a key growth initiative surrounds acquiring a higher quality contract portfolio to increase margins. High margin clients include $SMSN.L the UK Army, and NHS England. Additionally, Capita management is focused on increasing their suite of product offerings beyond business process outsourcing to include more tech enabled services.
Comparable public companies in the IT consulting and business process outsourcing industries suggest that Capita is undervalued. CPI has a PE ratio of 8.53x. US peers are trading at a much higher valuation. Companies like Accenture (25.78x), TD SYNNEX (13.06x) and $EPAM systems (40.30x) have much higher PE ratios despite providing a similar suite of Business Process Outsourcing services. Although Accenture and TD SYNNEX likely have a size premium compared to Capita, EPAM systems has $4.8B in revenue; making it similar in size to Capita. According to Simply Wall Street, the average PE ratio for UK professional service providers is 26.3x. Despite recent success, Capita may still be undervalued relative to peers.
• Market Cap: 651.335M
• Revenue: 3.08B TTM
• Current Ratio: 0.57
• Forward PE: 8.53x
• Net Debt: 482M
• EV/EBITDA: 6.41X
• Levered FCF: (23.07M)
Capita is not currently profitable from a free cash flow perspective due to struggles with liquidity. The current ratio less than 1.0 reflects the need to use a revolving line of credit to pay for the Company’s short term obligations. However, the company reduced its net debt from over $600M in 2021. The Company is likely very close to FCF profitability. If the company continues to succeed, its likely that the stock price will continue to increase.
Capita is a strong player in the UK IT consulting and Business Process Outsourcing space. The Company is undervalued relative to peers and caters to high growth end markets such as Defense, Healthcare and Education. The Company’s management is focused on repaying their existing debt to solve short term liquidity problems. I am bullish about the long-term growth prospects of Capita (LON: CPI).