EXLSERVICE HOLDINGS, INC.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

EXLS provides data analytics and digital operations and solutions to businesses across various industries, using technology and automation.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

EXLSERVICE HOLDINGS, INC. (EXLS) is a global analytics and digital solutions company, providing a range of services including data analytics, operations management, and business transformation services. It caters to multiple industries with a primary focus on insurance, healthcare, banking and financial services, media, and retail.

Business Overview

  • Revenues: EXLS generates its revenue primarily through long-term contracts and project-based work with its customers. The revenues are categorized by its three main operating segments: Insurance, Healthcare, Emerging Business, and Analytics.
  • Insurance is the largest source of revenue for EXLS, accounting for 35% of revenues for 2022.
  • Healthcare is the second largest revenue segment with 24% of 2022 revenues.
  • Emerging Business comprises digital operations and solutions provided to other industries.

  • Analytics revenue is primarily from data management and analysis solutions.

  • Industry Trends: The global services industry is seeing a rapid shift towards digital transformation and the demand for data analytics and business intelligence has been growing rapidly. However, there is still a high amount of manual work present in the services offered. The company has stated that AI/ML has not yet seen wide adoption in their industry, thus they are investing and training themselves to lead that change.

  • The move toward automation and cost-reduction is also becoming more prevalent, pressuring service providers to reduce prices and increase efficiencies.

  • Margins: EXLS has had a fairly stable gross margin with it ranging between 30%-34% over the past few years, but has seen downward pressure on the operating margin, and an increasing dependence on low margin data projects. It is important to notice that management has pointed out in the most recent call that due to macro economic factors they are feeling pressure from higher employee costs, especially in high-demand roles in India and the Philippines, where most of their work is being performed.

  • The company’s most recent reported net profit margin is around 11%, with cost of services equal to around 69% of revenue.

  • Competitive Landscape: EXLS is a small player in an overall huge sector. They compete with both larger and smaller companies that offer services that directly or indirectly compete with EXLS’s offerings. This makes their competitive landscape fierce and hard to predict with new competitors and changes in technology always a threat.

  • These competitors can typically be broken down into three broad groups: Tier 1 IT Service companies which provide similar services but on a much larger scale; consulting firms which provide analytics and strategy support; and smaller more specialized firms that focus on single offerings.

  • What Makes EXLS Different: EXLS tries to differentiate itself through its domain expertise within its focus industries, its data-driven digital operations, its end-to-end service offerings, and its high specialization. It tries to become a leader in its chosen niche, rather than being everything for everyone.

Financial Analysis

  • Revenue Growth: EXLS has shown solid revenue growth over the years, albeit with some slight dips in growth.
  • For the year ended 2021, revenue grew by 19.6% compared to the year ended 2020.
  • For the year ended 2022, revenue grew 13.6% compared to the previous year, and 15.3% excluding the impact of currency fluctuations.

  • For the most recent quarter, Q3 2022, revenues grew by 11.5% YoY.

  • Profitability: As mentioned above, the net profit margin is around 11%. This is a very decent profit, but might be a little lower than those of software companies with a better moat.

  • The company faces pressure on its operating margins from higher compensation costs, but it remains above or near its historical levels.

  • Balance Sheet: EXLS has a relatively sound balance sheet, with a growing cash position and a low debt-to-equity ratio.

  • Cash and cash equivalents totalled over $200 million as of December 2022, up from the previous year.
  • Total liabilities are around the same amount as equity.

  • The company has used both debt and equity to finance its acquisitions and business growth.

  • Cash Flow: The company generates a stable and growing cash flow from operations.

  • CFO is consistently higher than the net income.

  • Share Repurchases: The company has been using some of its excess cash to repurchase its shares, albeit the amounts have been small, and could signal the management’s belief that the company is undervalued.

Moat Rating

3 / 5

  • Explanation: EXLS has a “Narrow Moat”, mainly due to switching costs, intangible assets and network effects. The client has often significant switching costs due to the complicated nature of integrations needed in order to change systems and providers, and with those systems also being highly integrated into the clients business. They also benefit from strong client relationships with their clients. They also rely on a proprietary AI/ML toolkit. However, the relatively commoditized nature of their service offering and the competition from several other providers limit the strength of their moat. The industry also isn’t as sticky as others. Their focus on specific industries is great, but may not be a large enough barrier to deter large competitors, hence my rating of 3.

Risks to the Moat and Business

  • Technological Disruption: Rapid advancements in technology, particularly in areas like AI and automation, could make the company’s current service offerings obsolete. They depend heavily on technology and any fast transition to new technologies can hurt their moat if they are unable to adapt quickly enough. They have been adapting slowly to new tech, according to earnings calls.
  • Increased Competition: As a market that is still evolving, new entrants could compete directly with EXLS and undermine its profitability.
  • Client Concentration: EXLS earns substantial parts of its revenues from a few large clients, and if some of these clients were to switch providers it could have a large impact on profits.
  • The Company’s top ten clients accounted for approximately 36.0% and 40.3% of their consolidated revenues for the years ended December 31, 2022, and 2021.
  • Economic Downturn: Because they provide services that companies might deem not important in tough times, a significant economic downturn might force companies to cut back on their services and consulting.
  • Acquisition Risks: As the company looks to grow through acquisitions, the management has to be careful not to overpay, and to make sure that acquired entities are well integrated into EXL.
  • They may also dilute their share structure through equity issuances.
  • Geopolitical Risks: The business operations in foreign countries are susceptible to regulatory changes, political and social unrest, and other conditions that could disrupt the normal course of operations. For EXLS this risk is quite prevalent since it has a large presence in the Philippines and India.
  • Data Security and Privacy: With the growing importance of data, risks associated with cybersecurity and data privacy are increasing, both for EXLS and for its clients.

Business Resilience

  • Strong Industry Position: EXLS has proven that they can consistently grow their revenues over time. They have a leadership position in their niche, but they need to focus on making their services indispensable to clients.
  • Repetitive Revenue: EXLS typically works on recurring long term contracts, which provides stability of revenue over time.
  • Diversification of Services: By working with clients across multiple industries, they are able to diversify their revenue stream and thus provide a backstop if any given sector goes down.
  • Global Presence: Although the company’s presence is mostly in the USA, India, and the Philippines, this does create opportunities to grow elsewhere, while limiting risk from any single region.
  • Strong Financial Position: As noted above, they have a strong balance sheet, which can help with periods of market turmoil.
  • Strategic Focus on Technology: EXLS focuses on digital capabilities, and is investing heavily in areas such as artificial intelligence and automation. This may mean that they will be better positioned to compete in the future as the industry shifts to these technologies.

Understandability Rating

3 / 5

  • Explanation: EXLS operates within the rather complex business services industry. However, their offerings are not particularly hard to understand, even if the more technical parts may require time to comprehend. The company’s operations are relatively straightforward, but how they implement their services is more complicated. Also the way they conduct M&A and consolidate subsidiaries can be complex to understand. Thus the rating of 3.

Balance Sheet Health Rating

4 / 5

  • Explanation: Their balance sheet is quite healthy as they have little debt and a growing cash position, and current ratio above one. This provides great financial flexibility. They have been acquiring other companies and they also repurchase their shares, which could hurt if their free cash flow declines, but given the low levels of debt that doesn’t seem to be a significant risk at the present moment. So the rating of 4.

Recent Concerns / Controversies

  • The company is facing margin pressure due to rising inflation and employee costs.
    • They are working on increasing efficiency and are also using various cost mitigation tactics to try to make up for the extra expenditure.
  • The market has somewhat soured on the company recently.
    • The most recent quarterly earnings missed the expectations of the market.
    • The company’s stock is trading almost 50% below its 52-week high, indicating that markets are expecting a slowdown in its financial performance and earnings growth, which might be related to some of the issues that the company is facing, or the overall market outlook.
  • Management has said that they will be focusing on sales, growing the company, improving margins, and are focused on maintaining operational efficiency to counter these recent issues.