TaskUs Stock: A Risky Play on Offshoring
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Here’s a question for all you ESG advocates out there. When you go through and run your numbers that show how “diverse” an organization is, do you classify the employees in emerging market centers as “Asian?” You should, because John in Mumbai and Rosie in Manila are indeed “Asians.” So, isn’t it a problem that these business process outsourcing (BPO) offices are entirely staffed with Asians? The truth is, nobody cares, because India and the Philippines contain a wealth of cheap labor. Well, they used to.
Multinational firms allocate annual compensation adjustments based on economic factors such as wage inflation data which helps make sure they’re staying competitive. The below chart from Statista shows the average increase in Indian salaries from 2018 to 2021.
Based on the above numbers, a Mumbai analyst who cost $40,000 a year in 2017 now costs $61,362 – an increase of more than 50% in five years. When that happens, you simply find countries where talent is cheaper – like the Philippines.
It’s More Fun in the Philippines
Running an operation in the Philippines is challenging because you’re not in Kansas anymore. From the rice allowances on paychecks, to the ladies taking days off around that time of the month, it takes some getting used to. During typhoon season, expect there to be days where Manila is flooded, and employees can’t get into the office. Even on normal days, Manila traffic will make sure nobody arrives at the office when they’re expected to. Working from home presents its own set of challenges – intermittent electricity, variable Internet bandwidth availability and quality, not to mention family emergencies will create problems. And this may piss some people off, but the truth is you’ll generally find the Filipinas more competent than the Filipinos.
As for labor laws, good luck trying to get rid of bad apples. Employment law in the Philippines is so demanding that your managers will spend a great deal of time just preparing documentation needed to show someone the door. And good luck getting your rock stars to stick around. Even in the face of automation tools like UiPath (PATH), the Philippines is facing a massive skill shortage when it comes to tech and middle management talent. So, when a firm says that 68% of their workforce is in the Philippines – 27,100 headcounts – we’re left wondering just how sustainable that plan is.
About TaskUs
Our paying subscribers are not only our favorite people in the world because they keep our fridges stocked with Milwaukee’s Beast, they also bring to our attention companies that haven’t crossed our radar. Several of you raised TaskUs (TASK) as a firm that’s worth looking at so we did. On the tin, it looks interesting enough. The company dabbles in three areas, one of which relates to artificial intelligence:
- Digital Customer Experience (CX) (64%) – describes omni-channel customer care services primarily delivered through digital (non-voice) channels
- Content Security (22%): Removal or labeling of policy-violating, offensive, or misleading content.
- AI Operations (14%): Principally consists of data labeling, annotation, and transcription services performed for the purpose of training and tuning AI algorithms.
While TaskUs provides typical software-as-a–service (SaaS) metrics to support the strength of their business, some of the commentary in their latest 10-K implies they’re hardly a typical SaaS firm. Check out this line:
Our clients’ ability to terminate engagements with or without cause, including for convenience, or opt for month to month contracts and our clients’ inability or unwillingness to pay for services we have performed makes our future revenues and profitability uncertain.
Credit: TaskUs
This is coming from a company with a $163 million accounts receivable balance (an amount that’s nearly doubled year-over-year). We’re not accustomed to hearing firms talk about not being able to make their customers pay the bills. There are also concerns around seasonality of this “cheap-humans-as-a-service” business which makes the following statement:
The inelasticity of our labor costs relative to short-term movements in client demand could adversely affect our business, financial condition and results of operations.
Credit: TaskUs
In other words, because it’s so difficult to ramp up staffing in these emerging market centers of excellence, they can’t exactly let people go when the work isn’t there. So, they end up paying the same costs while revenues dip, and this affects margins. It also points to the fact that this business can’t scale without throwing more bodies at it which isn’t a desirable business model. To achieve the 59% year-over-year revenue growth they realized in 2021, they expanded headcount by 70%. At some point, they’re going to experience growing pains expanding this quickly.
TaskUs talks about how they’re using technology to create “next-generation digital outsourcing” which could disrupt the traditional BPO model. Improved chatbots, RPA-enabled management tools, and browser plugins that help identify objectionable content, are all examples of how technology is being used to solve problems.
With 90% of their employees working from home, the cloud-based infrastructure they’ve built to run their operation is a key part of the business. One can imagine that the 4,800 employees working in the United States are building all this stuff (along with their Indian counterparts) because tech talent in the Philippines is extremely lacking.
Customer Concentration Risks
Ten clients accounted for 62% of 2021 revenues for TaskUs with two companies – Facebook and DoorDash – accounting for 27% and 11% respectively. When 38% of your revenues come from two firms, that’s just too much customer concentration risk for comfort. Also consider just how controversial the content moderation functions at Facebook have become. We’ve experienced the joys of Facebook’s recipe-driven approach to content moderation and it’s anything but effective. How long will it be before Facebook brings this function internally and automates it using AI algorithms that simply learn from all the big data being generated by TaskUs?
As TaskUs continues to grow, their reliance on key customers will decrease. In 2021, 62% of revenues came from their top-ten customers, down from 68% in 2020. It’s important to spread their revenues out because when a client accounts for more than 10% of revenues, they have all the power at the negotiating table. Good luck trying to pass on increased labor costs to Facebook when they’re responsible for more than 25% of revenues.
Our Take on TaskUs
The BPO theme has been around since the dot-bomb era and using cheap labor to perform process-driven tasks is business as usual. Repackaging outsourced customer support functions as “omni-channel digital CX customer support” isn’t revolutionary. While TaskUs is enjoying strong revenue growth, it’s dependent on their ability to scale headcount at the same pace. Increasing inflation in emerging market centers will eventually erode their cost advantage and passing that on to customers will decrease the demand for their services.
- Digital CX – They might bring in a firm like UiPath to start automating some tasks, but customer service functions will usually always require a human on the other end at some point. The extent to which automation can be applied seems limited for customer support functions.
- Content Security – Growth in 2021 was confined to existing customers, and we can imagine Facebook was responsible for a good chunk of that. Eventually, AI algorithms will be trained to perform these tasks. And the same holds true for our next category.
- AI Operations – If you’re helping AI algorithms learn, you’ll eventually work your way out of a job. this is precisely why we exited our position in Appen which – at least so far – seems to have been the right thing to do.
One appeal of SaaS companies is that the more clients you bring on, the higher your margins become. That’s not the case with TaskUs. In fact, one might argue that the bigger they get, the more overhead they’ll need to manage the whole operation. This business will scale as fast as the availability of cheap labor, and this isn’t an appealing business model based on our experiences of building teams in emerging market centers. If you’re still keen on BPO as an investment theme, there may be better options out there.
Other BPO Stocks
Earlier this year, Spruce Capital Management produced an 80-page report on why they believe TaskUs isn’t a smart investment to make. We didn’t even read a page of this report until after this article was produced, and it expresses some of the concerns we’ve raised today along with loads of other bits. If you’re an investor in TaskUs, you’ll probably want to give it a read, but here’s the executive summary.
TASK trades at a rich premium to BPO peers on the belief its margins will increase and it can sustain 25%+ revenue growth. With both of these goals at risk, we see 25% – 50% downside risk to ($18 – $27 per share). We are long Concentrix (Nasdaq: CNXC) and Majorel Group Luxembourg (MAJ NA) as we believe they are favorably positioned to succeed against TASK and trade at material valuation discounts as a result of being under-covered in the BPO space.
Credit: Spruce Capital Management
Since shares of TaskUs now trade at $23.61 a share, the price target was hit, and the overvaluation concern is somewhat alleviated. If you’re interested in BPO as an investment theme (we aren’t), then take a look at the other two firms mentioned above – Concentrix and Majorel Group – and see if they provide a lower-risk way to play BPO. Just remember that eventually cost advantages will be eroded, and robotic process automation will be increasingly viewed as a viable substitute for emerging market labor pools.
Conclusion
We’ve always emphasized the importance of revenue growth, and TaskUs checks the boxes in that respect. But when we peek under the kimono, we see a company that can only scale based on the availability of cheap labor. They’re heavily exposed to the Philippines, a rather risky place to be operating. They’re also reliant on several firms for 38% of their revenues. Despite the strong growth the firm has been realizing, this is a stock we would avoid based on the reasoning presented in this research piece.
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