CACI INTL INC -CL A CACI S
January 03, 2014 - 5:03pm EST by
can869
2014 2015
Price: 73.80 EPS $6.39 $5.73
Shares Out. (in M): 23 P/E 11.5x 12.8x
Market Cap (in $M): 1,729 P/FCF 7.8x 11.7x
Net Debt (in $M): 516 EBIT 271 260
TEV ($): 2,245 TEV/EBIT 8.3x 8.6x
Borrow Cost: NA

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  • Government contractor
  • Roll-Up Blow-Up
 

Description

CACI is a government services contractor with 75% of revenues coming from the DoD and 20% coming from US civilian agencies (5% international). The stock is at an all-time high, +33% last year, despite flat earnings estimates (EBITDA multiple expanded from ~5x -> ~6.6x). This is a ~$1.7bn market cap company with ~$600mm of debt that is adding ~$800mm in incremental debt to complete the biggest acquisition in its history (leverage going from ~1.5x -> ~3.5x). Pro-forma for the acquisition, the multiple will be ~7.5X 2014 EBITDA.

While the multiple is optically low, we think the company is overvalued for the following reasons:

  • End-markets extremely challenged due sequester and pressures on budgets/defense spending, leading to stiff revenue headwinds:
    • From CACI’s own 10K: “Spending by the U.S. government with contractors who provide services to the Department of Defense (DoD), is being negatively impacted by the country's fiscal shortfall. The Budget Control Act of 2011 (the Budget Act) established limits on discretionary spending, which will reduce planned defense spending by a minimum of $487 billion over a 10 year period that began with the government's fiscal year ended September 30, 2012.
    • In addition, the Budget Act included a sequester mechanism that imposed additional defense cuts of $500 billion, or approximately 9 percent, over nine years starting in the government's fiscal year ending September 30, 2013, if the Congress did not identify a means to reduce the U.S. deficit by $1.2 trillion. Because these means were not identified, the sequester mechanism took effect on March 1, 2013. In light of the Budget Act and deficit reduction pressures, it is likely that discretionary spending by the federal government will remain constrained for a number of years.”
  • CACI’s organic revenue has declined for 7 quarters, with total revenue negative for 5 out of the last 6 – and the decline is accelerating:
    • CACI has been buying revenue through acquisitions (more below), but organic revenue trends are very concerning and the decreases are accelerating (-9% in the most recent quarter)
    • In response, CACI announced in the most recent quarter that it would no longer report organic revenue growth – the reasons behind this are obvious and raises questions about management’s transparency with investors, as well as indicating that the trends are expected to remain negative for the foreseeable future
    • Comparable companies, including MANT and EGL, are seeing 20-30% peak to trough revenue declines
  • Until now, CACI has been able to partially offset revenue declines with SG&A cuts – but will start to lap this benefit in fiscal Q314 (calendar Q114)
    • EBITDA has declined each of the last 5 quarters (LTM $320mm vs. $356mm in FY2012), but would have been much more severe without SG&A reductions (SG&A down 9% in the last quarter)
    • Cuts began in earnest in fiscal Q313 (calendar Q113) – so will begin to lap benefit in 2 quarters
    • To some extent, this is a function of the asset-light nature of the business, but at some point the low hanging fruit will be exhausted (and yet revenue will remain under pressure)
  • CACI is essentially a roll-up, and a serial acquirer with mediocre return on purchases. The company touts a big “free” cash flow number that is double counting:
    • Over the past 8 years, CACI has spent $1.2bn on acquisitions, and EBITDA has grown from $183mm to $320mm – not a great return given the massive boom in spending on contractors by the DoD in the 2000s
    • Over this time, the company has actually generated only $200mm in real free cash flow, after acquisition spending
    • Despite spending $300mm on acquisitions in FY11-FY13, revenues and EBITDA have actually DECLINED for the past 4 quarters
  • ... and the company just levered up for its largest acquisition ever at 11.5x EBITDA!
    • CACI is acquiring Six3 Systems from GTRC for $820mm or 11.5x EBITDA – rather than repurchasing its own stock at 7x EBITDA
    • Leverage increases from ~1.5x -> ~3.5x
    • Deal will be ~5% accretive to EPS – but this is misleading given they expect to pay L+200 on an institutional TL A to finance the acquisition – it is actually massively dilutive from an enterprise perspective
    • Integration risk is always an issue, especially with an acquisition of this size

Our recent discussions with defense contracting companies, consultants and government officials in the space give us further confidence:

  • Despite the recent fiscal deal reached to keep defense spending flat in FY14 vs. FY13, we believe FY 14 will be a tougher year for the services contracting companies:
    • The Pentagon initially reacted to the sequester cuts by instituting one time measures such as military and civilian hiring freezes; these measures cannot be repeated and thus further cuts will have to come from the R&D, procurement and O&M (operations & maintenance) budgets
    • There were a number of other tricks used in FY13 (such as using previous years unobligated funds) that will have less of a buffer effect in 2014
  • Within this context, long-cycle (procurement/weapons manufacturing) should continue to significantly outperform short-cycle (services)
    • Defense primes (Lockheed, Northrup, Raytheon, General Dynamics) should continue to have solid performance as they have multi-year contracts which are difficult to cut and when cuts are made, take longer to show up
    • Servicers (CACI, Mantech, Booze, SAIC) will continue to be under much greater pressure as these contracts are much shorter (~1 year) and easier to reduce/modify
    • There is also a perception that the servicing side is “where the fat is” – and events like the Snowden case and the Obamacare/healthcare.gov debacles only further the perception that these companies are overpaid and under-delivering
  • Price/margin pressure and commoditization of the service side will continue
    • Services companies have told us where 5 years ago they were seeing 3-4 bidders per contract, now they see 8-9, as smaller companies get in the mix and try to win based on price
    • The average recompete is being renewed at a 20% discount to the previous price!
    • Increasing focus on 1) LPTA (lowest price technically acceptable) and 2) small business set asides are further headwinds
    • The recent Ryan-Murray budget deal includes a ~50% cut to the per-employee compensation cap – while this will have a modest EPS impact, indicative of the attitude in Congress to contractors and their margins

What are the risks to the short?

  • Large institutional investor in Blue Harbour
    • Cliff Robbins pitched this at Ira Sohn in May 2013
    • Stock was under $60 then (now ~$74) and Robbins said he thought it was worth $75-$85
    • They have been in the stock since 2010
  • Recent sequestration deal
    • Congress recently reached a deal to offset the 2014 sequester and keep FY14 defense spending at constant levels with 2013
    • While this is a positive for the space, as indicated above, our research indicates that the long cycle/weapons systems programs will continue to be protected at the expense of short cycle, commodity type services work
  • LBO
    • Comp SRA was LBO’d in 2011 and CACI is a good size for an LBO (~$2-3bn EV)
    • This seems much less likely now given the run in the stock and the fact that a transformational acquisition is underway
  • High short interest:
    • Short interest is 22% or 19 days to cover
    • However, more than 50% of this is against the convert outstanding
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Revisions of earnings estimates lower
- Potential missing of a quarter (look at CACI's FY13 Q3 miss despite previously stating that 90%+ of revenues were locked in)
- Disappoinitng Six3 acquisition guidance
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    Description

    CACI is a government services contractor with 75% of revenues coming from the DoD and 20% coming from US civilian agencies (5% international). The stock is at an all-time high, +33% last year, despite flat earnings estimates (EBITDA multiple expanded from ~5x -> ~6.6x). This is a ~$1.7bn market cap company with ~$600mm of debt that is adding ~$800mm in incremental debt to complete the biggest acquisition in its history (leverage going from ~1.5x -> ~3.5x). Pro-forma for the acquisition, the multiple will be ~7.5X 2014 EBITDA.

    While the multiple is optically low, we think the company is overvalued for the following reasons:

    • End-markets extremely challenged due sequester and pressures on budgets/defense spending, leading to stiff revenue headwinds:
      • From CACI’s own 10K: “Spending by the U.S. government with contractors who provide services to the Department of Defense (DoD), is being negatively impacted by the country's fiscal shortfall. The Budget Control Act of 2011 (the Budget Act) established limits on discretionary spending, which will reduce planned defense spending by a minimum of $487 billion over a 10 year period that began with the government's fiscal year ended September 30, 2012.
      • In addition, the Budget Act included a sequester mechanism that imposed additional defense cuts of $500 billion, or approximately 9 percent, over nine years starting in the government's fiscal year ending September 30, 2013, if the Congress did not identify a means to reduce the U.S. deficit by $1.2 trillion. Because these means were not identified, the sequester mechanism took effect on March 1, 2013. In light of the Budget Act and deficit reduction pressures, it is likely that discretionary spending by the federal government will remain constrained for a number of years.”
    • CACI’s organic revenue has declined for 7 quarters, with total revenue negative for 5 out of the last 6 – and the decline is accelerating:
      • CACI has been buying revenue through acquisitions (more below), but organic revenue trends are very concerning and the decreases are accelerating (-9% in the most recent quarter)
      • In response, CACI announced in the most recent quarter that it would no longer report organic revenue growth – the reasons behind this are obvious and raises questions about management’s transparency with investors, as well as indicating that the trends are expected to remain negative for the foreseeable future
      • Comparable companies, including MANT and EGL, are seeing 20-30% peak to trough revenue declines
    • Until now, CACI has been able to partially offset revenue declines with SG&A cuts – but will start to lap this benefit in fiscal Q314 (calendar Q114)
      • EBITDA has declined each of the last 5 quarters (LTM $320mm vs. $356mm in FY2012), but would have been much more severe without SG&A reductions (SG&A down 9% in the last quarter)
      • Cuts began in earnest in fiscal Q313 (calendar Q113) – so will begin to lap benefit in 2 quarters
      • To some extent, this is a function of the asset-light nature of the business, but at some point the low hanging fruit will be exhausted (and yet revenue will remain under pressure)
    • CACI is essentially a roll-up, and a serial acquirer with mediocre return on purchases. The company touts a big “free” cash flow number that is double counting:
      • Over the past 8 years, CACI has spent $1.2bn on acquisitions, and EBITDA has grown from $183mm to $320mm – not a great return given the massive boom in spending on contractors by the DoD in the 2000s
      • Over this time, the company has actually generated only $200mm in real free cash flow, after acquisition spending
      • Despite spending $300mm on acquisitions in FY11-FY13, revenues and EBITDA have actually DECLINED for the past 4 quarters
    • ... and the company just levered up for its largest acquisition ever at 11.5x EBITDA!
      • CACI is acquiring Six3 Systems from GTRC for $820mm or 11.5x EBITDA – rather than repurchasing its own stock at 7x EBITDA
      • Leverage increases from ~1.5x -> ~3.5x
      • Deal will be ~5% accretive to EPS – but this is misleading given they expect to pay L+200 on an institutional TL A to finance the acquisition – it is actually massively dilutive from an enterprise perspective
      • Integration risk is always an issue, especially with an acquisition of this size

    Our recent discussions with defense contracting companies, consultants and government officials in the space give us further confidence:

    • Despite the recent fiscal deal reached to keep defense spending flat in FY14 vs. FY13, we believe FY 14 will be a tougher year for the services contracting companies:
      • The Pentagon initially reacted to the sequester cuts by instituting one time measures such as military and civilian hiring freezes; these measures cannot be repeated and thus further cuts will have to come from the R&D, procurement and O&M (operations & maintenance) budgets
      • There were a number of other tricks used in FY13 (such as using previous years unobligated funds) that will have less of a buffer effect in 2014
    • Within this context, long-cycle (procurement/weapons manufacturing) should continue to significantly outperform short-cycle (services)
      • Defense primes (Lockheed, Northrup, Raytheon, General Dynamics) should continue to have solid performance as they have multi-year contracts which are difficult to cut and when cuts are made, take longer to show up
      • Servicers (CACI, Mantech, Booze, SAIC) will continue to be under much greater pressure as these contracts are much shorter (~1 year) and easier to reduce/modify
      • There is also a perception that the servicing side is “where the fat is” – and events like the Snowden case and the Obamacare/healthcare.gov debacles only further the perception that these companies are overpaid and under-delivering
    • Price/margin pressure and commoditization of the service side will continue
      • Services companies have told us where 5 years ago they were seeing 3-4 bidders per contract, now they see 8-9, as smaller companies get in the mix and try to win based on price
      • The average recompete is being renewed at a 20% discount to the previous price!
      • Increasing focus on 1) LPTA (lowest price technically acceptable) and 2) small business set asides are further headwinds
      • The recent Ryan-Murray budget deal includes a ~50% cut to the per-employee compensation cap – while this will have a modest EPS impact, indicative of the attitude in Congress to contractors and their margins

    What are the risks to the short?

    • Large institutional investor in Blue Harbour
      • Cliff Robbins pitched this at Ira Sohn in May 2013
      • Stock was under $60 then (now ~$74) and Robbins said he thought it was worth $75-$85
      • They have been in the stock since 2010
    • Recent sequestration deal
      • Congress recently reached a deal to offset the 2014 sequester and keep FY14 defense spending at constant levels with 2013
      • While this is a positive for the space, as indicated above, our research indicates that the long cycle/weapons systems programs will continue to be protected at the expense of short cycle, commodity type services work
    • LBO
      • Comp SRA was LBO’d in 2011 and CACI is a good size for an LBO (~$2-3bn EV)
      • This seems much less likely now given the run in the stock and the fact that a transformational acquisition is underway
    • High short interest:
      • Short interest is 22% or 19 days to cover
      • However, more than 50% of this is against the convert outstanding
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    - Revisions of earnings estimates lower
    - Potential missing of a quarter (look at CACI's FY13 Q3 miss despite previously stating that 90%+ of revenues were locked in)
    - Disappoinitng Six3 acquisition guidance

    Messages


    SubjectRobbins
    Entry01/04/2014 12:46 PM
    Memberjgalt
    What was his bull case and could this transformational deal provide further upside estimates for the bulls?

    SubjectRE: Robbins
    Entry01/06/2014 10:47 AM
    Membercan869
    Unfortunately, I was not at Ira Sohn and have not been able to find a deck or a lot of details from his pitch, but from my understanding he spoke on CACI for 3 minutes and his main points were that the company has strong FCF (we don't think that cash is actually "free" as I point out above), is a potential M&A target (think less likely now due to major acquisition currently being digested), and that the stock was worth $75-$85 (currently $73.96).
     
    This has been a great call for Robbins/Blue Harbor but we think the thesis has played out and risk/reward is not attractive from here, especially given the Six3 acquisition (my guess would be Robbins would have preferred to see them return cash through dividends/buybacks rather than buy something at 11.5x EBITDA).
     
    In terms of accretion from Six3, the company will announce guidance inclusive of the acquisition when they announce earnings at the end of the month, but initially stated they expect it to be 5% accretive to GAAP earnings and 10% accretive to adjusted earnings.  We view this accretion as not particularly impressive given the company is borrowing at L+200 to finance the acquisition - and from an EV/EBITDA perspective, the acquisition is actually quite dilutive, taking EV/EBITDA from 6.6x -> 7.6x (see detail below, sorry for formatting).  One final point is that growth at Six3 seems to be slowing, as initial guidance was for ~$70mm in EBITDA for 2014 vs. $67mm in 2013.  This is understandable as 10% of Six3's business is from Afghanistan which is likely going to zero in short order.
     
    Six3 Acquisition PF Earnings & Multiple
                     
            CACI   Six3   Pro Forma
                     
    Market Capitalization   $1,843.0   $0.0   $1,843.0
    + Debt       331.3   800.0   1,131.3
    - Cash       (102.7)   20.0   (82.7)
      = Enterprise Value   $2,071.5   $820.0   $2,891.5
                     
    LTM Revenue       $3,615.0   $437.0   $4,052.0
                     
    LTM EBITDA       $321.1   $61.0   $382.1
    Margin %       8.9%   14.0%   9.4%
                     
    LTM EV/EBITDA   6.5x   13.4x   7.6x
                     
    2014E Revenue     $3,477.0   $500.0   $3,947.0
                     
    2014E EBITDA   $312.1   $70.0   $379.1
    Margin %       9.0%   14%   9.6%
                     
    2014E EV/EBITDA   6.6x   12.2x   7.6x
     
     

    SubjectGD guidance for IS&T division
    Entry01/22/2014 06:30 PM
    Membercan869
    GD guided for IS&T revenues down 20% in 2014. 

    From GD's website: The Information Systems and Technology group provides solutions that support a wide range of networked communications, cyber security, and information-sharing and enterprise technology needs.


    SubjectLMT guidance
    Entry01/23/2014 05:25 PM
    Membercan869
    LMT's services division guided down revenue growth 9% for 2014.  Wells Fargo (admittedly a bear on the space) said the following:

    READ-THROUGH. 2014 outlooks confirm our prior view that organic revenue for government services providers is likely to remain under significant pressure. LMT's $195MM goodwill write-down relating to in-theater support work focused on the Army (included in its Technical Services business) could suggest a greater headwind for services providers, as LMT noted in-theater pricing (already competitive) was seeing intensified pressure. While operating margin performance remained strong for both, we remain cautious on the 2014 outlook for the pure-plays, as we believe there to be a more limited scope for additional cost reduction, rising overall price competition, and the lack of platform sales and lower pension funding.


    SubjectCACI FY Q214
    Entry01/29/2014 05:13 PM
    Membercan869
    Quarter was fine, but in my view, updated guidance including Six3 is disapponting.
     
    These numbers require some math/backing into:
     
    - Raised total revenue guidance by $100-$150mm, but this includes a Six3 contribution of $275mm-$325mm, so actually lowered organic revenue guidance by $125mm-$225mm (4-6%)
    - Kept net income guidance flat at $142-$152mm, but this includes Six3.  If we add back the $10mm in one-time costs in the quarter, this means that the $835mm acquisition is only adding a run rate of ~$20mm in net income a year (it is likely higher than this but offset by lowered implied organic earnings guidance).
    - EPS guidance LOWERED from $5.70 - $6.10 to $5.59 - $5.98 when including the acquisition - can't imagine this is what bulls had in mind.
     
    PF I have the company now trading at 9x EBITDA ($1,150mm in debt ex. converts, $1.9bn market cap, $100mm in cash vs. $335mm in FY14 EBITDA) which seems awfully expensive.

    SubjectCACI comments from JPM Conf (3/11/14)
    Entry03/17/2014 07:18 PM
    Membercan869

    So we do have more certainty today than we had a couple months ago. Our understanding is that some of those high-level appropriation and allocation decisions are being worked at a higher government level and then being pushed down to various program offices and individual customers. And so, as of yet, we haven't seen any material change in the pace of award decisions or funding decisions or proposals, because we anticipate some of that to be forthcoming, but this type of lag in the appropriation process is not unexpected.

     

    Our fiscal year 2015 begins in July, in the early midst of our planning process to determine what 2015 looks like. Unfortunately, we had a few quarters of negative organic growth. This past quarter was approximately 10%. The question is have we hit bottom yet, and when will we see either a stabilization or a turnaround. And we had this conversation a few times on some one-on-ones this morning, and it's hard to know when you hit bottom, except retroactively, and then you know when you hit the bottom, and you start coming out of it.


    SubjectLDOS Q4 Report
    Entry03/27/2014 03:33 PM
    Membercan869
    LDOS, a comp, reported 2015 guidance that was disappointing to the Street ($2.35 - $2.55 of FY15 EPS vs. $2.85 estimate).  Stock is currently -18%.
     
    In their comments, they said: As we look back at fiscal 2014 and into the future, it is clear that we continue to see pressure from our largest customers, including the Department of Defense, the federal government, and more recently the intelligence  community. The impact of sequestration and the resulting lack of clarity in committing funds to programs, delayed decisions, and the high level of protest activity continue to weigh on our results.
     
    This seems contrary to a lot of the bullish buzz around activity picking up over the next couple quarters in the space.
     
    Note that the Six3 acquisition by CACI was in the intelligence space.

    SubjectCACI lowers FY14 guidance (again)
    Entry04/02/2014 04:55 PM
    Membercan869

    So company is lowering guidance AGAIN after lowering on the Q2 earnings call at the end of January.  Not a huge surprise perhaps because LDOS was down ~20% last week after lowering FY guidance and the IR guy was apparently very negative in meetings with Wells Fargo (they released a note), but the stock never reacted.

    The numbers are a little messy because of the Six3 acquisition, but if we back that out, here is a comparison of current guidance vs. original guidance:

     

           

    Low

     

    High

    Oct. rev guide

     

    $3,500

     

    $3,700

    Current rev guide*

     

    3,225

     

    3,275

    % change

         

    (7.9%)

     

    (11.5%)

                 

    Oct. NI guide

     

    $142

     

    $152

    Current NI guide*

     

    120

     

    130

    % change

         

    (15.5%)

     

    (14.5%)

                 

    * Excludes Six3

           

     

    So since original FY guidance on 10/29/13, they have lowered organic rev guidance by ~10% and NI guidance by ~15%.   Since that time the stock is +5% at today’s close.

    New multiples for 2014 using the closing price of the stock ($74.56) are 14x P/E and 9.3x (!) EV/EBITDA.

    FY15 numbers seem way too high.  Consensus has $6.14 of EPS next year and $370mm of EBITDA, which implies +18% growth.  Earnings are likely to decline in FY15 (as they will in FY14, despite three quarters of Six3 non-organic growth).

    At $68, stock is still 12.8x new EPS for this year and more importantly 8.8x EV/EBITDA.  This seems way too high for a bad business with flat to declining earnings.

    Next catalysts are: 530am call tomorrow, Q314 earnings on 4/30, and FY15 guidance at the end of June.


    SubjectRE: RE: CACI lowers FY14 guidance (again)
    Entry04/03/2014 07:28 PM
    Membercan869
    Yes, very surprised the stock wasn't down more today (lowered EPS guidance by 8% and stock down 4.2%).  Comp MANT was down 6.3% on no news.  CACI now trades at 9.3x 2014 EV/EBITDA and 8.6x forward EBITDA which has ~10% growth baked in, which I think will prove to be way too optimistic.
     
    The call was negative, I thought.  Analysts kept trying to get them to say this was just a delay in awards/revenues but they didn't seem willing to say it.  The only positive was that they maintained CFO guidance, but as I have pointed out, the FCF isn't worth much when you are constantly making acquisitions just to keep earnings flat (or declining, this year).

    SubjectCACI Q3 Earnings
    Entry05/01/2014 07:17 PM
    Membercan869
    CACI was up ~4% today on in-line Q3 earnings and reiterated guidance for the full year (which ends 6/30 - they had lowered a month ago).  Cash flow was better than expected based on working capital (but I believe this is a timing difference on A/R) and orders were up but book to bill was still 0.8x indicated further revenue declines.  Most importantly in my view, organic revenue growth was -12%, an acceleration from -9% in Q214. 
     
    This name really comes down to full year FY15 guidance given at the end of June - the Street has EBITDA +9% in FY15 - if guidance is for EBITDA to decline, which we expect given the constant headwinds in the space, we think the 8.5x forward multiple is at risk in addition to estimates.

    SubjectCACI comments from RBC conf (5/14)
    Entry05/14/2014 04:43 PM
    Membercan869
    Below is from RBC's note, presented without further comment:
     
    Rick Dansey noted that despite the optimism towards the end markets at the beginning of the year, they really have not seen it play out in awards. Val Lyons reiterated that it was still a difficult environment, using an example of a project that has slipped on awards for several quarters now. They noted the government is being a little tighter because they are not sure whether they should be awarding projects at this juncture due to future budgeting decisions as well as possible volatility from events like Crimea. There is a lot of variability across customers and agencies, but the overall outlook is still bearish at this point. 

    SubjectRE: RE: Author Exit Recommendation
    Entry06/27/2014 01:34 PM
    Membercan869
    This was catalyst we were waiting for and stock still not reacting - been three negative events (guidedowns/disappointing guidance) and stock hasn't really moved, although underperformed mkt meaningfully.  Taking our cue from the price action and moving on here now that expectations have been lowered for FY15.
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