TDCX: Poor Visibility Into Near-Term Performance (NYSE:TDCX)

Summary

Readers may find my previous coverage via this link. My previous rating was a hold as I believed TDCX (NYSE:TDCX) was facing a very strong growth headwind, particularly from its largest digital advertising client. Indeed, the business continues to face growth headwinds. I am reiterating my hold rating for TDCX as I remain very negative about the business’s near-term outlook. I expect the market to continue discounting the stock as there is a lot of uncertainty, not only in the near term but also on the long-term growth runway of the business.

Financials / Valuation

Following up from 2Q23, TDCX continues to see revenue decline in 3Q23, as revenue falls by 5.1% on a sequential basis (-0.6% on a y/y basis), suggesting no signs of growth recovering. While management has specifically called out that y/y growth would be in the low teens if it excluded its top client, I don’t see this as a positive note at all. My view is that the top client is a key part of the TDCX business, and valuing the business growth of the ex-top client does not make sense. The fact that the top client can drag down the entire business clearly suggests growth headwinds still persist.

Based on my updated view of the business, I now expect weaker growth for TDCX in FY24 (FY23 to follow management’s revised guidance). The 5% assumption was half of my previous 10% growth, which is in line with the magnitude of the guidance revision in FY23 (from 3-8% growth to 2-4% growth). I do give credit to management for protecting margins; as such, I am revising my margin estimates to 16.6%, in line with consensus. However, I don’t think TDCX will be trading at 10x forward anytime soon, given the weak visibility into growth. This discount should continue to persist until TDCX shows that growth is not impaired.

Comments

The headline results do not showcase the full negativity of the business, in my opinion. Firstly, revenue growth, on a percentage basis, has dipped into negative territory despite 3Q22 being a softer quarter that only grew 10.2%. The same headwind continues to plague TDCX as it saw lower volumes from existing clients in the digital advertising & media and fintech sectors. Specifically, despite TDCX’s key client in digital advertising performing well, the positive performance does not translate into higher business volumes for TDCX. I find this disconnect weird as it suggests to me that the key client can operate at a higher revenue scale without a TDCX solution. This either means that TDCX was always an “extra” solution that was a want and not a need for them, or that the key client is simply delaying deployment to a later date as the macro situation has not stabilized. Either way, I see this as very bad news for TDCX. Furthermore, it appears that management has no idea why either, as they noted that they have limited visibility on potential turnarounds. In short, there could be a structural impairment to the TDCX business if the key client revenue contribution does not recover. As for the content monitoring and moderation segment, it continues to be a very volatile segment that fell by 26.4% on a y/y basis. The decline was, again, mainly due to lower volumes from its digital advertising and media clients. I believe the market is going to steer clear of being positive here as TDCX has only 2 clients here, which means high volatility is expected—something that I don’t think is welcome in this investing environment where investors want visibility. Looking ahead, I believe the near-term growth outlook remains very murky, and the market is likely to continue discounting the stock until things turn around. I highlight this part of the earnings call that effectively solidifies the fact that near-term growth is not going to see a strong recovery.

in terms of the second question about the digital advertising clients announcing better performance, yes, it’s good for them. And we’re very happy, of course, to see this. It’s — however, a bit difficult to connect and map this with us. We don’t own 100% of their business. We have 1% of it in specific service lines, specific geos. So from day one, and I think now we’ve been publicly listed for the past two years, we’ve had difficulties really connecting the dots between their performance, the macroeconomic performance, and our performance, because there’re a lot of things get in the way. But if you want to also look at the Q4 outlook, they’ve remained a little bit cautious as well. And so it’s not impossible that those clients are not pressing on the accelerator pedal right now, watching and planning for next year. So from quarter to quarter, I wouldn’t jump into making predictions. Source: 3Q23 earnings

On the brighter side, I thought that the improvement in EBITDA margins sequentially was a positive sign. It was great to know that TDCX was able to downsize its headcount in line with lower business volumes. This suggests that TDCX’s cost structure is flexible, as it is able to downsize its team to protect margins. The bad news is that it seems like this lever to protect margin is running out of gas as management expects overall headcount to be stable. I would also note that the more TDCX benefits from this short-term team resizing, the more it will be caught off-guard when the economy suddenly improves. TDCX will not have sufficient manpower to capture a recovery in demand.

Overall, I remain pessimistic about TDCX’s near-term performance, and I am now worried about the long-term growth profile of the business if the top client spending does not recover soon.

Risk & conclusion

My opinion on upside risk is that the economy goes into a full recovery mode. As the saying goes, rising tides raise all boats, and TDCX will definitely benefit from this. Spending from a top client could snap back immediately, driving a strong acceleration in growth. If this happens, the market is going to price in a growth recovery, which will drive the stock up.

My overall view is that TDCX faces significant challenges with poor visibility into near-term performance. Despite management’s efforts to navigate headwinds, revenue continues to decline. The reliance on its top client, impacting overall business growth, remains a concern. The disconnect between the key client’s success and TDCX’s business volume is alarming, suggesting potential structural issues. Moreover, the volatility in content monitoring and moderation adds uncertainty. While cost-cutting measures sustain margins, they may hinder TDCX’s ability to swiftly respond to a demand upsurge.