Globant S.A.: Beautiful Words, Ugly Decline Ahead
Globant S.A. is living proof of the old
adage, "Beauty is only skin deep." Just scratch the surface of this
Luxembourg company and you'll find enough Quasimodo-esque
characteristics to send this stock running into an ugly, rapid decline.
Indeed, Globant's SEC filings are unique as it conjures up beautiful - and vague - visions of the business: "Globant (
NYSE: GLOB
) is
a digitally native technology services company. We dream and build
digital journeys that matter to millions of users. We are the place
where engineering, design, and innovation meet scale."
Plow through all that dreamy wording and investors find a company with a bank of computer programmers and design support people primarily working out of the main office in Argentina.
Investors may find other viewpoints here . Meanwhile, diligent investors can see growing risks are tarnishing Globant's glowing digital dream, including:
* 1. Limited Recurring Revenue
Though it has attracted customers such as Coca-Cola and LAN Airlines, Globant must operate within an atmosphere of transient customers and short-term contracts.
What happens is that Globant wins these one-time projects but once they're done, they're done. The customer says "Thanks," pays up and takes the project in-house to save on costs. Globant clearly concedes that risk to revenue on page 21 as it describes "a decision by that client to move work in-house."
Alternatively, Globant says the customer may decide to move work "to one or several of our competitors."
Company filings describe the risky short-term nature of most contracts:
"... most of our client contracts are limited to short-term, discrete projects without any commitment to a specific volume of business or future work, and the volume of work performed for a specific client is likely to vary from year to year, especially since we are generally not our clients’ exclusive technology services provider . A major client in one year may not provide the same level of revenues for us in any subsequent year ."
Globant has been handling some Google projects, including the recent hardware related project trial called Project Ara. This trial has no time table attached and provides a pretty good example of how companies use Globant on a project basis.
In a recent note to BWS Financial investors, Hamed Khorsand beautifully explained Google's project-based use of Globant ... and the associated risk:
"The project based approach leads us to believe that the Street is not valuing the business risk concisely and leaves investors vulnerable to the downside especially when the competitive landscape is changing.
"It also does not mean GLOB would be able to sustain 20 percent or 30 percent growth in an industry that grows at less than 10 percent a year," wrote Mr. Khorsand.
So Globant's services, in our opinion, cannot generate the kind of recurring revenue that is so crucial to a viable future.
*2. Reinventing The Wheel
So the short-term nature of the technology services business is forcing Globant to find new customer after new customer.
Unfortunately, this constant grinding away each day to reinvent the wheel is beginning to show on the company.
Globant says so itself.
The company reported 344 customers in the fourth quarter. In the third quarter, it reported 343 customers. That means it took an entire quarter to add just one customer.
Meanwhile, Globant's competition is screaming and beating its chest like the well-financed gorilla it really is, knocking down hundreds of times greater revenue than Globant:
(Source: Morningstar )
Stacked against the competition, Globant costs about twice as much as IBM (NYSE: IBM ), Hewlett Packard Enterprise and other monsters - a 32.71 price-to-earnings ratio versus about 15 industry wide - despite offering far, far less in income and margins.
In brief, here's how those numbers break out. The industry's average income is $49 billion versus Globant's $31 million. Of 26 stocks selected by Morningstar, only nine rivals offer operating margins lower than Globant's 5.7. Yet 16 rivals offer superior operating margins. And a dozen of those competitors even offer double-digit operating margins.
And, in this environment populated by better-resourced, global IT and technology service providers, Globant may find each new customer will be more difficult to attract.
*3. Extreme Competition
And Globant's competition is growing. That competition comes from literally thousands of IT outsourcing companies working across the globe. These range from U.S.-based monsters like Cognizant Technology Solutions (NASDAQ: CTSH ) and Hewlett Packard Enterprise (NYSE: HPE ), to big Indian companies like Infosys and WiPro, to smaller regional companies.
But let's focus on one mighty rival.
Indian tech services giant Infosys ( NYSE: INFY, ~$18 per share) is a great example of an outsourcing firm that is one-upping Globant primarily through its investment in Internet of Things and digital engineering.
In early 2015, Infosys acquired an automation software maker. Then a few months later, Infosys jumped in to acquire Skava , a former gaming company that switched to a business like Globant's, helping big retailers such as Toys R Us, Gap and Staples make more money from their websites, mobile apps and in-store platforms. Infosys noted that Skava's business grew 300 percent in two years, settling in by 2013 to produce $22 million in revenue.
Meanwhile, the year-to-date stock chart indicates investors' confidence in Infosys:
(Source: Morningstar )
When we take a closer look at the numbers of both Globant and Infosys, we see Globant is inferior in virtually every meaningful metric.
(Sources: Morningstar here , here , SEC filings )
Indeed, we think both Infosys and Globant are absurdly overvalued. But Globant is worse:
*4. Recent Earnings Report Confirms Downside Risk
In the recent fourth quarter/yearly earnings call, Globant reported fourth quarter results were slightly ahead of consensus estimates and 2016 guidance in line with estimates.
But key factors behind the results further support downside worries.
Globant is having to add employees as it opens new offices, putting more pressure on its operating margins.
Those margins have plummeted:
(Source: Capitalcube.com )
Globant sustained a stunning drop in operating margins to 8.63 percent from 10.33 percent the previous year.
So management talked about hitting scale but the higher costs of adding employees in new offices are actually cutting into margins.
And those margins will probably sustain more whittling as additional projects produce additional costs.
*5. Peso Comments Support Rising Costs Theory
These additional operating costs were hidden by the devaluation of the peso in Argentina, where the vast majority of Globant's workers are based.
Here's a snapshot from the earnings call surprise that Globant sprang on analysts:
Citigroup Analyst Ashwin Shirvaikar
"My last question is - when you have the - the Argentine peso devaluation, is that a follow-through impact - or what is the follow-through impact with regards to [evaluation] and how we're thinking about this, as we approach this year?"
CFO Alejandro Scannapieco
"Hi Ashwin, this is Alejandro. That's still to be, to be seen. The way we see the impact of the Argentine peso devaluation - definitely very positive in terms of margins, gross margins, operating margins.
"Very positive in terms of having [motch] (Ph) interview of her analysis, now in the [indiscernible] is going to be a minimized or just going away. As for weight inflation, we know that the government is having, a tough fight with unions, in terms of setting up expectations, but they are also working on their monetary policy and the public expenditure in terms of controlling inflation . They are very vocal about lowering inflation, so I think in the long run it is going to be a positive.
"The scenario for 2016 is still going to be a shaky environment from a wage inflation perspective in Argentina . But we are very positive in - as I was saying we're very positive in terms of what is happening in the market, both in terms of the government change and what is happening in the FX market as well."
This peso impact didn't seem to be included in consensus estimates and indicates why the company offers only inline earnings guidance. So management's comments - indicating the devalued peso will boost profit - supports the indication that costs are rising and will continue to rise. Even if the peso strengthens by mid-year, that would remove the cost savings that would likely otherwise allow Globant to hit its numbers.
*6. Good-bye First Mover Advantage
Meanwhile, Globant appears to be going the way of former rock star BlackBerry (NASDAQ: BBRY ). Many companies initially whole-heartedly embraced the popular devices until Apple introduced iPhone and Google introduced Android.
But, writing in the New York Times , the words Robert Cyran and Peter Thal Larsen penned in July 2010 proved quite prophetic:
"The BlackBerry maker’s shares may appear cheap. They trade at 10 times estimated earnings for this fiscal year. Yet Apple and Google’s dominance in apps means they are becoming de facto standards in the smartphone market. Technology companies that lose such wars often suffer shockingly fast profit declines."
Indeed, BlackBerry enjoyed 55 percent of the U.S. market share in 2009. But competitors had begun jack-hammering the smartphone leader, ultimately crushing sales the very next year to only 41 percent market share.
Now BlackBerry is left with just 1.2 percent of the market share.
"We see no chance that BlackBerry will re-emerge as a leading smartphone maker," an analyst recently wrote.
It's no shock that BlackBerry stock plummeted from about $80 in 2009 to today's price of about $8:
(Source: Morningstar )
BlackBerry was trading at 10 times expected future earnings. Globant is trading at 22 times future earnings.
And, as we've shown, well-heeled competitors are catching up and pressuring Globant as customers demand ever cooler digital platforms - much like BlackBerry's experience. That first mover advantage is vanishing.
The fading advantage, on top of other building issues, may have influenced institutions' recent decisions to cut their positions in Globant. BlackRock Advisors reduced its position by 4 percent in the fourth quarter and Gilder Gagnon Howe & Co. trimmed its stake by 0.7 percent. Also, Sun Trust equities research analysts recently dropped the first quarter estimates for Globant from 25 cents per share to 24 cents per share.
*7. The Glitz Is Gone; Analyst Says Sell
While there have been buy ratings, BWS Financial initiated coverage of Globant on Feb. 8 with an unusual "Sell."
In fact, BWS, which typically goes long, warns there is no room for error with Globant:
"It seems investors have been bidding up the stock in hopes that there would be a continuation of multi-million dollar projects in an industry that is highly competitive not just with other companies, but also with in-house development teams," wrote Mr. Khorsand.
"With no room for error," he added, "investors could be paying a high price for a company that might not have the differentiating glitz that it once had."
*Conclusion
Just as various risks intensify, some analysts expect earnings to grow at a 20 percent clip in an industry that grows less than half that rate yearly. Meanwhile, Globant is trading at 30+ percent more than most peers. Something must give.
The market likely won't have to wait long. We think the stock price is poised for a screaming ugly drop to $17 per share - still an exceptionally fair valuation for no-longer-glitzy Globant.
* Important Disclosure: The owners of TheStreetSweeper hold a short position in GLOB and stand to profit on any future declines in the stock price.
* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to scolberg@thestreetsweeper.org .
