It’s time to look at Atos (OTCPK:AEXAF) (OTCPK:AEXAY). If there’s one thing I’m content about, it’s not going all that much deeper into Atos here, because it’s held my current negatives within reason. My position in the company remains small.
There is a truly massive potential to Atos – and I’ll get into that and show you what I mean – but there is also the question of what will be the catalyst for a reversal in this company.
Let’s update the thesis here and look at what we have for Atos.
Revisiting Atos and the down/upside
I’ve reviewed Atos before. It’s a multinational French IT consulting company, which was originally formed from a merger of a French and a Netherlands giant a few years back.
Headquarters are in France, and while many US investors may not have heard of the company, it’s a 21-year-old business with annual revenues of over €11B, an annual income of €500M, and over 50,000 employees across the world.
The legacy of the company is part of what appeals to investors here. The company includes at this stage, former divisions of Siemens (OTCPK:SIEGY), Bull S.A, Xerox IT, Syntel, and others. The company has been growing primarily through acquisitions, and initially prior to its current iteration, consumed a number of appealing peers. What makes up Atos are qualitative businesses with legacies in other qualitative businesses. There is nothing wrong with the company’s segments from a high level.
The company has been an investment horror show for about a year or so at this point, down 50-70% depending on where you look at historically. There are reasons for this. The company’s credit rating has deteriorated from BBB+ to BBB-. The issues come not from what the company does, but how it does its work. The company gave a massive profit warning in 1H21 and downgraded the entire forecast around the time I published my first piece. This was then followed by a long-awaited CEO’s resignation, replaced with Rodolphe Belmer.
The massive reorganization may have generated some results, but is far from over. The company is massively hiring, increasing its headcount by 16,000 in 1H22 alone. Atos ascribes 1H22 fiscal results to seasonal and market factors, including macro.
Book-to-bill factors have never been Atos’s problem. As of 2Q22, it’s back up to 101%, indicating very clearly that yes, indeed, customers are ordering work done by Atos.
However, customers ordering work isn’t enough.
It’s not enough when on 6 months of revenue, the company is making an 1.1% operating margin, and negative half a billion worth of FCF. Not even book-to-bill improvements and order entry improvements aren’t promising massive upsides – least not immediate ones.
In 1Q22 we saw confirming of its “2022 objectives”, calling for a flat revenue (0-1% growth), and an operating margin of 3-5%, which is one of the less impressive in the industry. However, you’ll note that for 1H22, the company is well below this target.
The company seems able to attract talent and has a massive headcount rotation at this time. 16,089 new hires, with 12,370 leavers, with everything resulting in a net headcount of just above 112,000.
Atos is envisioning splitting its business in two – with Digital, Big Data/cybersecurity, and the “new” Atos being the digital infrastructure and workplace contracts. The latter is the traditional Atos, the former is the “growth company”.
Generally speaking, I’m a fan of spin-offs, as it makes things and appeals for a company a bit more logical. It also enables me to invest in what I want. Take AT&T (T) for instance. I’m thrilled to have sold off WarnerMedia at a high valuation post-IPO and reinvested most of it into AT&T, where it currently generates impressive yield.
Atos has been able to secure financing for its transformation plan – it’s now fully financed, which is also part of the explanation for BBB-. Atos has reset its debt target to 3.75x net debt/OMDA, which is high for the sector. Another explanation for the performance.
The company targets a legacy operating margin improvement of 600 bps by 2026. This is a lofty target, and well into the future. So far, and with the current geopolitical backdrop, I would consider these supposed targets as less than visible.
The company has confirmed its 2022E downside by updating its full-year target – expecting the lower 3%-end of its OM guidance range. Essentially, everything in the company is guiding for is coming in at the lower end of the range, including a negative FCF of €150M.
What’s going to be the turnaround here? What will drive operating margin improvements for Atos?
A few things, I would expect. Seasonality and macro are currently opposed to Atos. Supply chains are strained – and can be caught up. The company can work with price actions to improve its margins, unwind its Spring program, be more selective in hiring, and have ongoing cost discipline. This will result in an expected 3.5% OM for 2022.
This will, in turn, result in FCF. But not to a real “positive” or impressive level as of yet either.
The company still can’t guide for a positive FCF. Current expectations go from negative €150M to around €200M, at least potentially, which again isn’t all that impressive, reflecting the current share price and valuation deterioration.
Still, with these trends, any improvement is a good improvement. However, these trends do mean that there’s no real visibility of when there will be any sort of fundamental improvement or turnaround, at least not from the company itself.
I wrote in my last article that I expect 2023E to be the turnaround year, seeing a reversion in EPS of at least half of the 2020 level of €5/share. This would constitute a 150% growth in EPS, continued by EPS improvements in 2024.
The corresponding increase in valuation and price would then bring about returns in the triple digits in this now BBB- rated company.
There is no question that this is a dicey forecast and expectation. That is also why I’m still not pouring money into Atos at this particular time. It’s a high-risk investment in the sense that we don’t know when a reversal will come – though I think it’s well-established that it will come.
My valuation models for Atos continues to show a massive potential upside in every perspective except P/E and dividend yield. This continues to make a lot of sense, because P/E is dependent on earnings, of which the company had very little in 2021A, and yield is dependent on, you know, dividends, which the company has cut.
The potential upside for Atos here is absolutely massive – well over 200% in the case of even a small sort of normalization, even when impairing the company by 40-50%. The same is true for EV/EBITDA. More importantly, any sort of non-trough, non-impaired EPS numbers and actual earnings call for a triple-digit upside in my DCF model.
That DCF model is now based on normalized earnings with a growth of no more than 0.5% in sales and EBITDA, and a WACC of almost 10%. The implied EV/Share is well above €32/share here, implying significant upward potential, despite impairing the company by more than 2% growth since my last article.
Breaking the company apart and studying the individual components gives us a similar view pre-split/spin-off.
We value the company’s parts – Infrastructure, Big Data, Business, and the Worldline asset – at either listed or sector-relevant pre-tax earnings multiples, and this calls for total gross assets of no less than €8B, even impaired by another 20%. This brings us, net of debt and payables, to around €5B of NAV, which on a per-share basis comes to ~€40/share.
You can discount this NAV, the DCF or the EV/EBITDA however you want. You won’t reach the company’s current share price of €10/share unless you completely abandon logic and fundamentals.
Atos has made plenty of mistakes, and it’s currently being hawked at a street corner for around a fourth or fifth of its actual value – a third if you impair the company very conservatively.
I wrote in my last article that the only reason and I do mean the only reason I’m not pouring money into this company with a massively high conviction is the very poor forecastability of that turnaround. I continue to hold this stance.
The main reason for this continues to be that the company’s own guidance and history are of no help. I can do guesstimates based on history and revenue trends, but in the end, there is a lot going on that makes this a hard-to-forecast business at this particular point in time.
The only thing I can say with certainty is that Atos is worth a lot more than it’s currently being traded for. This is, after all, the essence of being a dividend investor. For that reason, I consider the company as a “BUY”, but a very speculative one.
My thesis for Atos is as follows:
- Atos is a fundamentally questionable company at this time – but the substance is solid, once the company gets its flow from top to bottom line under control. I see no scenario where Atos, the 11th largest IT business in the world, is worth 7.5X P/E long term, in one of the best industry situations for decades.
- The question is how long this will take. When FCF turns positive and when operating margins tick up above 3% for more than a quarter at a time, I would be seriously interested in this company.
- For now, it’s a rare “Speculative BUY” with a PT of around €25/share for the native share.
Remember, I’m all about :1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (bolded).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.