Warren Buffett famously wrote that "'turnarounds' seldom turn" in his 1979 letter to shareholders. It is easy to agree with Warren Buffett on investing and I agree on turnarounds. The most common outcome with turnarounds seems to be that they fail to turn. In order to increase the odds, it is great to find a turnaround that has already started to make the turn, but hasnt yet seen the share price respond. Atento (ATTO) may be one of those companies.

Atento was created when Telefonica (TEF) spun out its call center business in 1999, and for many years, Telefonica was the primary customer. Atento has suffered from customer concentration, a lower tech product offering and margin issues. However, the company is addressing each of these issues. CEO Carlos Lpez-Aada took the reins at the end of 2018 and set a path forward with the companys Three Horizons Plan.

Atentos turnaround is characterized by several important areas of focus: customer diversification, product offering growth, geographic expansion and EBITDA margin expansion. Each of these have shown important improvement and are evidence of a company actually turning.

Given the companys origin, it is not surprising that Atento began as a company hugely reliant on Telefonica. Way back in 1999, Telefonica represented about 90% of Atentos business. So far in the first three quarters of 2020, Telefonica has accounted for 32% of Atentos business. That leaves Telefonica as an important customer, but Atento is no longer a single customer company. The company has made progress in the recent quarters as in Q3 2020, multi-sector accounted for 67.7% of TTM revenue, versus 60.7% of revenue just prior to the start of the Three Horizon Plan.

Atento reports results grouped by three regions: Brazil, the Americas and EMEA. Brazil is Atentos home country and its largest and most important single market. As of last month, Atento had 27.9% market share in Brazil, well ahead of any other competitor. Having a dominant base is important and the Brazilian market produces the companys best margins. I expect Brazil to remain Atentos most important market and hope for growth there. In fact, having by far the largest market share in the country should only be supportive of the growth through scale advantage.

However, it is also important that Atento grows and expands in other countries. Obviously, the more markets, the more opportunities for growth. Additionally, geographic expansion may help with currency risks. Atento trades in the US and has US dollar denominated debt and so can be affected by currency fluctuations, particularly declines of the Brazilian real.

Atento has been working to diversify from a pure call center company to a more diversified customer support company with a better customer service support product. The transformation provides Atento with the opportunity for increased margins and a growing moat. The more advanced the services, the more value that Atento provides and the greater the moat and margins. Atento calls their more advanced product offerings next generation services and the next generation services have accounted for 50% of new sales in 2020 versus 42% in 2019. The more this continues, the stronger the margin and moat trends.

Flowing from the client diversification, product offering and costs controls, Atento has started to show improving margin. EBITDA margins were 12.7% in Q3 and Atento is targeting 14-15% margins. Atento has dramatically improved cash flow metrics in 2020. Through the first 9 months of 2019, Atento had operating cash flow of negative $29 million and free cash flow of negative $88 million. Both of those have dramatically improved in 2020 and the company has had positive operating cash flow of $40 million and positive free cash flow of $9 million through the first 9 months of 2020. Further improving margins and a focus on costs should continue to improve these metrics.

The risks and catalysts here are inter-related and so Ill address them together. Debt and refinancing is the big one. Atento has a net debt position of $514.2 million as of the end of the third quarter. About $500 million of that debt is due in August 2022. The company announced that they were going to refinance in September, but called off the refinancing by October due to market conditions. It was not a confidence inspiring move. However, conditions may be improving and Atento may be in a better position to refinance the notes next year than they were this fall. In particular, the Brazilian Real has been strengthening and Atento has been reporting improved EBITDA. Along with that, the current notes are trading more strongly. If waiting a couple quarters allows Atento to secure the new financing at better terms such as a lower rate and longer term, then waiting will be well worth it. I would hope, however, that next time they attempt a refinancing the company be sure they can complete it.

Atentos reliance on Brazil and the Latin American market is another risk. Atento borrowed in US dollars but most revenues are not in US dollars. When local currencies decline, Atentos revenues decline in US dollar terms.

The Brazilian real to USD ratio started the year at just over 4 and moved to over 5.8 in the spring. The real has now recovered some and is trading at 5.06 as of December 12. If the real continues to recover, that will help Atentos financial results, but the opposite is true as well and the setup of borrowing in a different currency than most revenues inherently introduces some risk due to the mismatch.

The turnaround seems to have started, but it is still in its early stages. Even with the large improvement in FCF, it has only been $9 million for the first 9 months of 2020. Continued improvement in revenues, mix and margin should bolster the FCF number, but it is currently only tenuously positive. A small stumble could take the company back to a negative FCF situation.

Atento has an Enterprise Value of $703 million and a market cap of only $188 million, so the stock price is leveraged to small changes in the value of the company. A doubling of the EV would lead the market cap, and thus the stock price, more than quadrupling.

Is a doubling of the EV possible? I think so. Atento had EBITDA of $44.8 million in the most recently reported quarter. EBITDA trends are favorable with the increasing margins and improving currency situation. If these continue, I think that yearly EBITDA could reach $200 million by 2021 or 2022. A 7x EBITDA multiple on $200 million of EBITDA would lead to a doubling of the EV, and as discussed above, a more than quadrupling of the stock price to about $60.

A 7x multiple to EBITDA wouldnt be unreasonable if Atento is able to execute a favorable refinancing, the company is able to continue to improve margins and execute other components of their Three Horizon Plan, and the Latin American markets and currencies continue to stabilize. That is a number of conditions and present very real risks, but some of the turn already appears to be in progress.

Turnarounds may rarely turn, but every now and then one does.

Disclosure: I am/we are long ATTO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Atento: Turnaround In Progress With 100%+ Potential Upside And A Catalyst - Seeking Alpha