CRAI is a consistent and above average business with a low valuation. The company has 10% free cash margins, +30% free cash flow/tangible book value, and is valued at approximately a 12.5% operating cash flow yield. The company is aggressively repurchasing stock and has shrunk the share count from 10 million plus to about 8 million over the last couple years. Guidance is for mid-single digit revenue growth and better than 12% operating cash flow margins (our estimates are CAPEX 1-2% of revenue) with $365 million in annual revenue. We believe over the next 4 years aggregate revenue should total $1.6 billion in revenue with north of $160 million in free cash flow ($20 per share). In other words, the business should average around $400 million in annual revenue over the next 4 years. The current EV is about $300 million and the business is valued at about .90 EV/sales and 8x EV/OCF. Additionally the company has $140 million in untapped lines (40% of the market cap).
Exponent (EXPO) executed a similar strategy of consistent revenue growth with big buy backs and good returns on capital. EXPO has increased in value by 7x since 2010 and now trades at 5.4x sales and 25x EV/EBITDA. CRAI has added new lines that require more capital to replicate and make it less likely that a consultant can start their own practice out of their house. Also CRAI’s increased size attracts a certain caliber of clientele that a smaller practice cannot compete with. At the consultant level, working at CRAI increases the opportunity to work with other smart people and to work on interesting/complex projects. CRAI has expanded into several new interesting business lines via the C-1 acquisition such as Life Sciences (commercialization, therapy, growth strategies, policies, litigation/IP rights, etc.) and Cyber-Crime investigation (CRAI eDiscovery & Structured data lab). Additional barriers are large engagements that require bench strength and one stop shop for multiple experts. CRAI’s competitive strengths have led to 98% of the top 100 US law firms and 81% of the Fortune 100 have used CRAI services over the last 24 months. CRAI services include: Antitrust & Competition, Auctions & Competitive Bidding, Class Certifications, Cyber Crime Investigation, Damages & Valuation, eDiscovery & Structured Data, Financial Economics, Forensic Accounting & Investigation, Intellectual Property, International Arbitration, Labor & Employment, Management Consulting, Mergers & Acquisitions, Regulatory Economics & Compliance, Securities & Financial Markets, Transfer Pricing. CRAI capabilities are mainly focused on very significant economic outcomes for their clients which are typically very large corporations. CRAI is less sensitive to economic slowdown than expected as they have been profitable for more than a decade and many of their practices have a recurring profile. CRAI average bill rate per consultant is over $600,000 (which includes 120 people in management/non-billable) and has been in business over 50 years. Recently, the CEO of of Franklin Covey, Bob Whitman was added to the board.
Management has codified a capital allocation policy with a focus on returning capital to shareholders (see below from most recent IR presentation):
Business momentum is strong as the company on the July earnings call increased their guidance for 2017. CRAI has been going through an aggressive hiring spree adding ~150 consultants in the last three years, of which ~50 were added in just the 1H17. It takes a couple of quarters for the consultants to ramp up, so with the current consultant base run-rate revenue is $375 million or above (up from $343 million LTM).
We believe the current $5.00 per share in operating cash flow could increase considerably over the next several years depending on: A) the stock trading at 10-12%+ operating cash flow yield resulting in meaningful stock repurchases and B) the company hitting its guidance (which we think is likely, given its historical track record). If A&B continue the company will likely be able to both substantially reduce its share count (denominator) while simultaneously growing the numerator which should lead to strong free cash flow growth per share.
CRAI is still trading at a discount to comps, even given its consistent growth/margin profile:
Over the last 5 years, EXPO allocated approximately 40% of operating cash flow to share repurchases, while the business consistently averaged 17% ROIC and 18% ROE. The plan worked well as the business is now valued at 5.3x sales and 20x EV/EBITDA. CRAI is executing a similar business plan from a capital allocation and strategy stand point. However, CRAI trades at only .9x sales and 8x EV/operating cash flow. We think there is room for multiple expansion for CRAI. We think both are good businesses as CRAI free cash flow/tangible book value is approximately +30% vs. EXPO’s +22%. See below for the EXPO chart which many would deem a “boring business” with revenue growth from 2012-2016 of just 2-8% annually and Sell Side analysts are forecasting through 2019 5-7% annual revenue growth. Currently, the average sell side analyst has target on EXPO -7% the current price and CRAI +30% above the current price. We think the upside maybe higher for CRAI. With consistent execution and large share repurchases, however, the company has generated significant shareholder value.
Finally, CRAI has +50% higher revenue per head, is 20% larger in terms of revenue than EXPO, while EXPO has 600 bps better FCF margins the business is valued at 5X+ EV/SLS and 22X EV/OCF vs. CRAI at 0.9x EV/SLS and 8x EV/OCF. We believe both companies will grow revenue at comparable rates (maybe a slight edge to CRAI). We believe there is a strong runway ahead for earnings and multiple expansion at CRAI. One final note that we believe the market was thrown for a loop as CAPEX was elevated for new offices (NYC, Boston, and London)…CAPEX should be around 1-2% of revenue (which checks out with the last three quarters as well as long term back to 2000).
Disclosure: This does not constitute a recommendation to buy or sell shares of CRAI. We own shares in CRAI and we may buy or sell shares without updating this board.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
Consistent revenue growth and free cash flow
continued aggressive share repurchses share count down from 10 to 8.2
Multiple expansion given 12% operating cash flow yield
Focus on newer growth verticals Cyber Crime, eDiscovery, and Life Sciences