GLOBANT BEMSA Financial Case

MARCH 15, 2019 MATTEO BERETTA, DANIEL WOORING, AND JOSEPH CRISTIANO PANZARELLA

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Overview:

Prepared by: Matteo Beretta, Daniel Worring, Joseph Cristiano Panzarella

Globant is a multinational digital consulting company, specializing in full stack IT and software development. Founded in Buenos Aires in 2003, Globant has expanded to 37 offices in 13 countries including Argentina, Uruguay, Chile, Colombia, Brazil, Mexico, Peru, India, UK, Luxembourg, Spain, Belarus and the United States. They claim a blue-chip client list, working with Coca-Cola, EA Sports, LinkedIn and American Express to name a few. It is clear from their past work that they collaborate with many diverse projects and industries. A short glance at their website will reveal their development with the Metropolitan Police in London, transforming public online access to police services, or their partnership with a major airline company, optimizing revenue management. They accomplish these projects with a team of 7,821 engineers, developers and designers from around the world. Globant won the 2016 International Design Award for the Pune Office in India and the Webby Award for the National Geographic Kids website, highlighting again their breadth of work.

Over their 16-year history, Globant has acquired a multitude of other companies along the way including software development firm Clarice Technologies in 2015, design firm WAE in 2016, and US growth strategy firm Ratio in 2017. CEO and co-founder, Martin Migoya, received a prestigious Argentinian Konex Award as an Innovative Businessman of the Decade in 2008 boasting a growth rate of 100% per year, estimating revenues of $40 million at the time of the ceremony. Having gone public on the NYSE (GLOB: +1.84%) in 2014, Globant was named a worldwide leader of digital strategy consulting services by IDC MarketScape report in 2016 and 2017. The stock has seen consistent growth over the past five years, opening at $10/share to now being $71.58/share. Noted in their 2018 annual report, revenues increased to $522.3 million, representing 26.3% year-over-year growth. Non-IFRS Adjusted Gross Profit

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was $212.0 million. The geographic revenues breakdown for the fourth quarter was as follows: 77.4% from North America (top country: US), 13.5% from Latin America and others (top country: Argentina) and 9.1% from Europe (top country: Spain). First quarter 2019 Revenues are estimated to be between $144-$146 million, implying 21.1% year-over-year growth at the midpoint of the range.

2019 Global Tech Trends:

Technology is advancing at an incredible rate and 2019 financial markets will depend on which companies can harness the winds of a changing technological landscape. As Globant is a full-stack marketing/software company, it is important to understand the future tech trends to understand how they will fit in that broad space. The technology sectors that Globant cited as most promising for growth in the near to distant future are IoT, AI, Intelligent Automation, Quantum Computing, 5G and Cloud Computing. The statistics below are just a glimpse into the predicted growth over the coming years.

Ø IDC (International Data Corporation) predicts that by 2020, global IoT (Internet of Things) spending will reach $1.29 trillion, a compound annual growth rate of 15.6 percent. ^1

Ø Forbes predicts 72% of businesses in the technology, media, and telecommunications industry expect AI to have a significant impact on product offerings in the next five years. ^2

Ø Forrester has projected that the RPA (Robotic Process Automation) market will reach $1.70 billion in revenue in 2019. ^3

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Ø During this forecasted decade, the global market for quantum computing is expected to expand exponentially: a whopping 30.9% compound annual growth rate, as per Persistence Market Research. ^4

Ø According to Forrester, nearly 60% of North American enterprises today rely on public cloud platforms. ^5

Digital businesses will be constructed from the ground up with the tools listed above. Paired with the big data revolution, it’s clear that the large growth of tech-focused companies has just begun to hit its stride.

Argentinian Economy:

Although the economic crisis in Argentina is far from over, 2019 is expected to be the transition period towards the beginning of a recovery in 2020. Despite the election of reformist, pro-trade President Mauricio Macri in 2015 that led to an economic boom in 2017, Argentina fell into a recession in 2018. Investors’ concerns about inflation, high external government debt and current account deficit, paired with interest rate hikes from the US Federal Reserve, led to a plunge in the Argentinian Peso against the dollar. Inflation reached 48% (CPI) last year, which combined with rises in interest rates to tackle it and the worst drought in decades (which slashed the harvests of soybeans and corn) depressed private consumption and investment, causing an economic downturn. Real GDP is forecasted to have contracted by 2.8% (OECD) during 2018. Nevertheless, 2019 is expected to be a “better” year for Argentina, which received an IMF bailout loan for $56 billion last October, the highest in the IMF’s history. Faster fiscal consolidation and tight monetary policy are expected to keep the economy in recession in 2019, with a projected growth of negative 1.8% (OECD). However, a low exchange rate and

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IoT Future Projections

IoT Global Spending (RHS) IoT Connected Devices (LHS)

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a better harvest will support exports, and thanks to the IMF package, Argentina should not need to issue fresh dollar debt, and will also replenish foreign currency reserves. Inflation is also expected to fall by about 20% this year. Various reforms (i.e. tax) will be beneficial in the long term, with the economy recovering in 2020, projecting growth of 2.7% (OECD). Political risks, however, loom over Argentina given the presidential elections in October 2019. Polls suggest a negative financial markets reaction, especially in the exchange rate, were Macri’s main opponent, former president Cristina Fernández de Kirchner, will prevail.

Economic developments in Argentina had little impact on Globant’s performance and financial position though because the company has a globally diversified client base with most of its revenues being denominated in USD. They are also listed on the NYSE in the US, having access to global capital markets for financing.

Ratio Analysis:

Liquidity

Liquidity ratios indicate a company’s ability to meet its short-term liabilities, i.e. by converting assets into cash. In the following, we only analyzed the Quick Ratio as the company does not have any inventories by the nature of its business.

Globant has an overall solid liquidity. Although the Quick Ratio has fluctuated between 2.11 and 2.43 over the past three years, the current assets are still enough to easily pay off the current liabilities (usually a Quick Ratio between 1 and 2 is considered healthy). Compared to the industry, Globant has a slightly lower Quick Ratio. The movements in the ratio can mainly be attributed to changes in Trade Payables and Receivables as well as the Cash Balances. While the high ratio ensures a strong liquidity,

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decreasing it to a lower level might allow for a more efficient use of the resources as less capital is bound in current assets.

Ratio 2018 2017 2016 Globant Industry Globant Industry Globant Industry Quick Ratio 2.29 2.62 2.11 2.72 2.43 3.49

Duration

The duration ratios indicate how long it takes a company to collect money from its customers and to pay its suppliers. For this ratio category Days Receivable and Days Payable have been calculated, while Inventory Days and Net Trade Cycle have been omitted since they do not provide a meaningful interpretation given the service-provider nature of the company.

Both Days Receivable and Days Payable are relatively stable over the years, while Days Payable is significantly lower than Days Receivable with 20.14 and 77.50 days in 2017, respectively. This indicates that Globant pays its suppliers extremely fast, while it takes considerable time to collect money from customers. On the one side, the fast payment of suppliers is positive since it fosters a good supplier relationship. On the other side, the high negative difference between the two values means that Globant misses considerable cash amounts that are bound within the accounts payable and cannot be used otherwise. Considering that sales grew from $254m to $413m in the last two years, the high amount of Days Receivable compared to Days Payable might be explained by the desire to keep a good customer relationship by allowing long payment deadlines.

Ratio 2018 2017 2016 Globant Industry Globant Industry Globant Industry Days Receivable 77.50 70.70 61.24 Days Payable 20.14 16.14 10.69

Solvency Ratios

Solvency Ratios indicate the company’s ability to meet its long-term financial obligations. In the following, Debt Ratio and Debt-to-Equity Ratio will be analyzed.

The Debt Ratio and Debt-to-Equity Ratio both indicate that Globant has a very high solvency. Both ratios have low values of 0.23 and 0.31 in 2017, respectively, and are showing a slight downward trend over the last years. Compared to the industry average, the Debt-to-Equity Ratio is considerably lower, as the industry had a roughly five times higher ratio of 1.52. The low values might enable the company to issue cheap debt that can be used for the future growth. After the current high growth phase, increasing the debt levels might allow Globant to improve their efficiency through a higher leverage that tends towards the industry average.

Ratio 2018 2017 2016 Globant Industry Globant Industry Globant Industry Debt Ratio 0.23 0.26 0.27 Debt-to-Equity Ratio 0.31 1.52 0.36 1.17 0.37 1.22

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Growth Ratios

Growth ratios are an indicator for the degree in which the company is increasing or decreasing in size. In the following, we are analyzing Revenues Growth, Total Assets Growth and Total Equity Growth.

All three of the aforementioned values have shown a strong growth in the last three years, mostly between 25 and 30%. While the Total Assets Growth has slightly declined from 27.75% to 23.51% from 2016 to 2018, Revenues Growth and Total Equity Growth have not shown a clear trend. The declining Total Assets Growth might be due to the nature of the IT service sector as PPE and Inventories are not growing as strongly as in other sectors. The increase of Revenues Growth and decrease of Total Assets Growth furthermore indicates that the Revenues per Asset, indicating the efficiency of the company, is slightly improving. Overall, Globant has a strong, healthy growth that does not show signs of decaying soon. Moreover, the Revenues Growth clearly exceeds the industry average that lied between 6.8% and 15.8% over the last three years, emphasizing the strong growth course of Globant.

Ratio 2018 2017 2016 Globant Industry Globant Industry Globant Industry Revenues Growth 26.33% 12.54% 28.06% 15.8% 27.21% 6.8% Total Assets Growth 23.51% 25.44% 27.75% Total Equity Growth 28.31% 26.28% 30.20%

Profitability

The profitability ratios indicate the company’s ability to turn their assets and equity in returns. We looked at ROE, ROA, and Net Profit Margin.

All three profitability ratios show a slight fluctuation as the 2017 values are lower than in 2016 and 2018. While they shrunk considerably from 2016 to 2017, Globant could improve their profitability in 2018 albeit not catching up to the 2016 mark quite yet as ROE lies at 15.27% compared to 17.20% in 2016. The main reason for the sharp profitability decline in 2017 can be found in the over proportional increase of the cost of revenues and SG&A compared to the revenues with simultaneously strongly growing Total Assets and Equity values. In 2018, the cost increase could be lowered, thus leading to the improved profitability situation. Taking a look at the entire industry, it can be noticed that the profitability ratios strongly vary over the years. Nonetheless, Globant’s ROA has constantly stayed slightly above the average, while it’s ROE has been below average. For the Net Profit Margin on the other side, we cannot find a clear trend.

Ratio 2018 2017 2016 Globant Industry Globant Industry Globant Industry ROE 15.27% 20.60% 11.57% 15.16% 17.20% 22.53% ROA 11.70% 10.64% 8.53% 7.98% 12.59% 11.29%

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Net Profit Margin 9.88% 8.74% 7.37% 8.14% 11.11% 10.26%

Valuation & Assumptions:

For the valuation of the company we employ the Free-Cash-Flow-to-Firm (FCFF) model, whereby estimated future cash flows to the firm are discounted at the cost of capital to arrive at a present value of the enterprise, in particular the value of the operating assets of the firm. We use the 3-stage version of the model given the high estimated growth rate in EBIT in the high growth (first) stage.

• Cost of Capital: To calculate the (adjusted) Beta of Globant to use in the cost of equity (Ke) calculation (CAPM), we implement the bottom-up approach in which the levered beta is estimated for 8 of Globant’s competitors against the S&P 500 over the past 5 years of weekly stock returns. The average levered beta is then unlevered using the average net D/E ratio and then re-levered using Globant’s corresponding ratio. The tax rate used in our valuation is Luxembourg’s current marginal corporate tax rate of 18%, as Globant is incorporated in Luxembourg. Given that the average net D/E ratio amongst the competitors, as well as Globant’s, is negative, we cap it at zero, hence Globant’s beta is effectively calculated as the plain average competitors’ (adjusted) betas (1.12). In the CAPM formula, we use the current US 10-year Treasury yield (2.64%) (CNBC) as the risk-free rate and the annualized return of the S&P 500 (8.66%) (Globant is listed on the NYSE), calculated using the past 5 years of weekly returns to derive the equity risk premium (ERP) (6.02%). In the calculation of the cost of equity we also add a country risk premium (CRP) (0.56%), calculated by weighting region risk premia (Damodaran, NYU) calculated using the hybrid approach (with default spread and relative standard deviation), by Globant’s revenues by region. We apply a coefficient of 1 to the CRP. The CAPM then produces a cost of equity of 9.95%, which we apply to our model. For the same reason mentioned above, the weight of debt in the cost of capital (WACC) calculation is capped at zero, and in absence of any hybrid securities, the cost of capital is just equal to the cost of equity.

Company Adj Beta Net D/E (%)Cognizant 1.02 -33Epam Systems 1.23 -59Accenture 1.05 -47Oracle Corp 1.07 -14DXC Technolgy 1.08 39Luxoft 1.18 -23Insight Enterprises 1.21 6Average 1.12 -19

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!"#$:'( = *+,-./00 + 2 ∗ (5*#) + !*# = 9.95%

• FCFF and Growth rate: To derive the FCFF for the year 2018 ($21.58 mln) we start from EBIT(1-t) ($54.77 mln), and subtract the reinvestment needs, i.e. Net CAPEX (CAPEX + Acquisitions - D&A) (smoothed 5 years) and change in non-cash working capital. Subsequently, we estimate future cash flows. For the first stage (high growth stage) of our model, we use a period of 5 years. For the estimated future growth rate, we use the average historical growth rate in EBIT over the past 4 years; 41%. This reflects momentum and the potential for Globant to expand its market share, as well as the growth potential of the digital consulting and software development industry, as companies pursue increasing digitalization in their services and platforms. In the second stage, the transition period of 5 years, we assume the growth rate to decrease linearly towards our estimated value for the final stage of the model (stable growth period). Here we assume the growth rate to align itself with the US risk-free rate in the long-run. Given the high portion of revenues which are denominated in foreign currency (not Argentinian Peso), we do not consider the economic situation in Argentina into our valuation assumptions.

• Equity Value: Given our assumptions, the three stage FCFF model produces an enterprise value (EV) of $2.53 bn (Value from explicit forecasting period + Terminal value). We then add to this the value of non-operating assets and then subtract net financial debt, pension provisions and other debt-like provisions, to arrive at an equity value of $2.56 bn. By dividing by the number of outstanding shares (36,343,000), we derive an intrinsic value per share of $70.49.

2019 2020 2021 2022 2023 2024 2025 2026 2027 2028Growth Rate 41% 41% 41% 41% 41% 35% 28% 22% 15% 9%FCFF ($ '000) 30,421 42,894 60,481 85,278 120,242 161,853 207,517 252,798 291,796 318,155 PV of FCFF ($ '000) 27,667 35,480 45,498 58,345 74,819 91,595 106,806 118,333 124,224 123,184

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• Final evaluation: The intrinsic value per share from our valuation is currently below Globant’s share price ($69.86) at the time of writing (11/03/19). Based on this, the solid fundamentals of the company, analyzed above, and the growth potential both in the company’s market share and the software development industry, we believe it is a good time to buy the share.

Sources used for data: Globant, Bloomberg, Datastream, CNBC, CNN Business, Yahoo Finance, Marketwatch.

EV 2,536,107,268 Net Financial Debt 62,574,000 Pension Provisions (48,636,660) Debt-like provisions (2,346,840) Non-Operating Assets 14,057,000 Minority Interests - Equity Value 2,561,754,768 Shares Outstanding 36,343,000 Value per share 70.49$

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Citations:

1. https://www.visioncritical.com/blog/internet-of-things-stats 2. https://blog.zoominfo.com/statistics-about-artificial-intelligence/ 3. https://venturebeat.com/2018/11/06/forrester-10-of-u-s-jobs-will-be-lost-to-

automation-in-2019/ 4. https://www.marketwatch.com/press-release/quantum-computing-market-emerging-

trends-and-will-generate-new-growth-opportunities-status-2025-2018-09-06 5. https://go.forrester.com/blogs/predictions-2019-cloud-computing/ 6. 7. https://www.reuters.com/article/us-argentina-economy/argentinas-economic-crisis-explained-

in-five-charts-idUSKCN1LD1S7 8. https://www.bbc.com/news/business-45451208 9. https://www.ft.com/content/5e6a3642-1b0e-11e9-9e64-d150b3105d21 10. https://www.ft.com/content/f9a8565e-dead-11e8-b173-ebef6ab1374a 11. http://www.oecd.org/eco/outlook/economic-forecast-summary-argentina-oecd-economic-

outlook.pdf 12. https://www.morningstar.com/ 13. https://www.nasdaq.com/