Genpact Limited trades at 12.7x-14.2x EBITDA, which is below the trading multiples of other peers. The company also shows larger sales growth than its competitors. With cash in hand and net debt of only 1.4x forward EBITDA, Genpact Limited could acquire additional businesses to enhance its sales growth. In summary, I believe that in the coming years, Genpact has many options to deliver value to shareholders. Genpact Limited looks like a buy.
Genpact’s M&A Strategy And The Profile Of Jim Madden
With approximately 96,500 employees, Genpact offers professional services in more than 30 countries. The company is specialized in offering digitally-enabled intelligent operations to clients in a large number of sectors:
Genpact works with large corporations like General Electric, which accounts for 12% of the total revenue. The number of customers is significant. I don’t believe that the customer concentration risk exists:
GE has been our largest client since our inception and accounted for $459 million, or 12%, of our total net revenues in 2020. We serve about one fourth of the Fortune Global 500. Our clients include industry leaders such as Aon, AstraZeneca, AXA, Bayer, Dentsu, Heineken, Hitachi, Konica Minolta, Novartis, Santander, Synchrony Financial and Sysco. Source: 10-k
I researched a bit the business profile of Genpact’s Board of Directors. I found out that the Chairman of Genpact Board is Jim Madden, who claims to have expertise in the private equity industry:
The company’s M&A strategy is, in my opinion, very interesting. Genpact appears to be acquiring a significant number of competitors in order to grow:
As part of our business strategy, we regularly review potential strategic transactions, including potential acquisitions, dispositions, consolidations, joint ventures or similar transactions, some of which may be material. Through the acquisitions we pursue, we may seek opportunities to add to or enhance the services we provide, to enter new industries or expand our client base, or to strengthen our global presence and scale of operations. Source: 10-k
The company’s total headcount increased from close to 25000 in 2006 to more than 96500. Genpact Limited grows its headcount at a quick pace thanks to its M&A strategy. In my view, if the company can acquire more businesses, the business growth will continue:
Genpact Limited Has Cash In Hand To Buy New Companies
As of December 31, 2020, the company reports $680 billion in cash and cash equivalents. The company reports that most of its cash is in non-Bermuda subsidiaries. Many of the subsidiaries are in Australia, China, the United States, Brazil, Czech Republic, India, and other regions. I like that the cash is not in Bermuda because the company will not have to transfer the cash to the subsidiaries to buy new entities. In sum, Genpact Limited appears to have the cash ready to acquire new businesses.
As of December 31, 2020, $666.1 million of our $680.4 million in cash and cash equivalents was held by our foreign (non-Bermuda) subsidiaries. Source: 10-k
Genpact Limited also reports a significant amount of goodwill from recent acquisitions. I believe that investors will like it. Genpact expects synergies. If the synergies are correct, I would expect an increase in EBITDA, which may lead to a share price appreciation:
On December 31, 2020, the Company acquired 100% of the outstanding equity interests in Enquero, Inc., a California corporation for total purchase consideration of $148,905. This amount represents cash consideration of $137,274, net of cash acquired of $11,631. The total purchase consideration paid by the Company to the sellers was $141,938, resulting in a payable of $6,967, which is outstanding as of December 31, 2020. Source: 10-k
According to Zoominfo, Genpact Limited had sales of $126 million. It means that Genpact Limited paid approximately 1.17x sales, which I believe is cheap. Investors will most likely appreciate that the company is making acquisitions at cheap valuations:
On October 5, 2020, the Company acquired 100% of the outstanding equity/limited liability company interests in SomethingDigital.Com LLC, a New York limited liability company, for total purchase consideration of $57,451. This amount represents cash consideration of $56,073, net of cash acquired of $1,378. Source: 10-k
According to Zoominfo, SomethingDigital.Com LLC had 73 employees. The company was bought for $57 million. In my opinion, the transaction was made at a cheap valuation. Genpact Limited obtained 73 employees by paying only $57 million. According to Zoominfo, the target reported sales of $5 million, which I believe is a low level of revenue. I imagine that the real sales figure was larger than $5 million:
Genpact’s Debt Does Not Appear Significant – The Company Can Buy Targets
To calculate the debt, I included $250 million in short-term borrowings, $33 million in short-term debt, $1307 million in long-term debt, and operating leases of $289 million. In total, I obtained a debt of $1879 million. If we take into account $680 million in cash, the company’s net debt is equal to $1.19 billion. If we assume forward EBITDA of $730-$830 million, the company’s net debt is less than 1.4x forward EBITDA.
Genpact Limited could raise additional debt of $500 million to make the net debt / EBITDA equal to 2x. I would be comfortable with that leverage ratio. The management could use the money to buy other targets, which would increase the company’s EBITDA and the valuation of the company. As a result, I would expect the market capitalization to increase. It would be a surprise for most stock analysts, a good surprise.
Source: Market Screener
I studied the company’s contractual obligations carefully. In less than one year, the company has to pay $505 million. With $680 million in debt, I wouldn’t expect the company to have any problem in paying the debt. In one to three years, Genpact will have to pay $1.194 billion. In 2020, the cash flow from operations was equal to $584 million. If we assume that the company’s CFO is equal to $584 million in the next three years, the total amount of cash generated will be equal to $1.75 billion. I have made these calculations to show that Genpact Limited can pay its contractual obligations of $1.19 billion in one to three years.
23% Sales Growth In Two Years
I like the company’s M&A strategy and the fact that Genpact’s strategy appears to be working. From 2018 to 2020, shareholders enjoyed a 23% sales growth. The company is growing at a substantial pace than its peers. With this in mind, I believe that the company will trade more expensively than its peers. Competitors report annual growth of 2.5%-6%:
In 2020, the company reported a gross profit of $1.291 billion, which represents 34% of 2020 net revenue. If we add back the amortization of acquired intangible assets, we obtain an operating income of $481 million. Genpact shows an operating margin of 12%, which is a bit lower than that of competitors. Peers report an operating margin of 13%-24%.
Share Count And Valuation
Very recently, Genpact Limited announced a stock repurchase program. I believe that it is positive. If the company acquires a sufficient number of shares, the demand for the stock may increase:
In February 2021, our board of directors authorized a $500 million increase to our existing $1.25 billion share repurchase program, first announced in February 2015, bringing the total authorization under our existing program to $1.75 billion. Source: 10-k
Having said that, let’s point out that the shares outstanding increased from $193 million in 2018 to 195 million in 2020. In my opinion, the stock buyback program does become a bit useless when the number of shares outstanding is increasing. Taking this into account, I will be studying more carefully the share count than the company’s stock buyback announcements.
If I assume 195 million shares at $46-$50 per share, Genpact has a valuation of $8-$9.7 billion. With net debt of $1.19 billion, the company’s enterprise value is more significant than $9-$10 billion.
Now, I believe that the company has sufficient cash in hand to acquire additional businesses. It means that the company’s net revenue could continue growing. If we assume sales growth of 6%-7% per year, forward net revenue of $3.912 billion is achievable. I will use an EBITDA margin of 18%, which is close to the estimate given by Genpact. Finally, I get a forward EBITDA of $704 million. With an enterprise value of $9-$10 billion, the company’s EV/EBITDA stands at 12.7x-14.2x. It is cheap if we use the EV/EBITDA of the peers, which trade at 12x-19x.
Risks of Foreign Jurisdictions
The company appears to have a significant amount of exposure to the Indian market. Besides, it receives significant benefits from the Government of India. Genpact Limited may suffer a significant impact due to changes in the policies of the Government of India:
We are subject to several risks associated with having a substantial portion of our assets, employees and operations located in India. We have benefited from many policies of the Government of India and the Indian state governments in the states in which we operate which are designed to promote foreign investment generally and the business process services industry in particular, including significant fiscal incentives, relaxation of regulatory restrictions, liberalized import and export duties and preferential rules on foreign investment and repatriation. Source: 10-k
The company was incorporated in Bermuda, where securities law is different from that in the United States. I believe that minority investors may be less protected in Bermuda:
Our shareholders may have more difficulty protecting their interests than would shareholders of a corporation incorporated in a state of the United States. As a Bermuda company, we are governed by, in particular, the Companies Act. The Companies Act differs in some material respects from laws generally applicable to U.S. corporations and shareholders, including the provisions relating to interested directors, mergers, amalgamations, takeovers, and indemnification of directors. Source: 10-k
Genpact Limited appears to be trading undervalued as compared to peers. Besides, the company has cash in hand to acquire new businesses. The company’s net debt is equal to only 1.4x forward EBITDA. Thus, the company can obtain more debt financing to buy more companies. It is not ideal that Genpact is incorporated in Bermuda. However, with all the risks in mind, everything indicates that there is upside potential in the stock price.
Discloure: We don’t hold G shares, and we were not paid to write this article.