Charles River is a 50 year old company that is a decent business that has understated its EBITDA due to a concept called forgivable loans. Adjusted to our estimates, we believe the company is inexpensively valued at approximately 6.5x EV/EBITDA. For 2015, management has guided to $310-320M in revenues with 16.5% Adjusted EBITDA margins or approximately $50 million while we believe EBITDA will be approximately $38M. We believe the company will generate around $30M in FCF and if the company does not buyback stock, the company should end the year with ~$80 million in net cash or ~$9 per share (approximately 32% of market cap). Our investment thesis is based on CRAI reaching close to $5 in FCF per share over the next two years. This would require, a share count of 8 million (currently 9.2 million after repurchasing approximately 1 million shares in 2014) and FCF growing to $40 million. If this is achieved, we think the stock will be in the mid $50’s or upside of close to 100%. Finally, we believe the downside is well protected with no customer concentration, approximately 6.5x EV/EBITDA, a very aggressive share repurchase of 10% in 2014 along with a continued high interest to repurchase shares, and a stable business with adequate liquidity and high quality employees.
We believe the stock is significantly undervalued due to the stock not screening to the true economics of the business due to a scary sounding concept called: “Forgivable Loans.” In 2012 and 2013 CRAI issued $60 million in forgivable loans to senior “Rain Makers” which amortize over 3-8 years. This is an employee retention tool essentially whereby compensation is paid upfront, however if the employee leaves the comp package is pro-rated and excess returned to the company. We understand that the issuance of forgivable loans is a recurring compensation expense; however, in 2012 and 2013, the company had issued 20.7M and 38.8M respectively, which we believe is higher than normal. The large issuance of forgivable loans will overstate amortization and understate EBITDA by approximately 5-7M for the next couple years, assuming they continue to issue 11M in forgivable loans a year. Hence, we believe the current EBITDA of $30M is understated by 7M and the true earnings of the company are ~$37M and 12% EBITDA margins. With a current EV of ~$250 million, we think CRAI is fairly cheap. Essentially, the “Forgivable Loan” program understates EBITDA margins by 300 basis points over the amortization period.
On a ~$250 million EV, the company has $140 million in untapped lines of credit and nearly $20 million in cash. They have repurchased 10% of the company in 2014 or 971,515 shares at an average price of $26.27 per share. Furthermore, CRAI has another $20 million open to purchase additional stock in 2015 or approximately an additional 10%.
CEO October 2014:
Given our outlook for the business and the current valuation, quite frankly, it is sort of a no-brainer for us to be active purchasers for our shares. It's hard to find expected returns north of what we're experiencing through these share buybacks for shareholders. So we will continue to do that until we start seeing a closing of the value gap that can be observed in the marketplace.
CEO February 2015:
I think we were pretty aggressive throughout 2014 on the repurchase of those shares. Right there, our limit is really not as much on our appetite, as opposed to our ability given the trading restrictions on acquiring those shares. When we saw opportunities in the second half of 2014, we pursued them as vigorously as we could.There wasn't -- didn't have anything to do with limitations on capital or reluctance to use the remaining cash balances for those pursuits. We're going to approach 2015 in the same manner. What I see with what we've done, what I see in the prospects of the business, I still think CRA is a great value, and we're going to put our money behind that belief and continue to purchase those shares. Again, we face some restrictions given the general liquidity of the stock given what our repurchase ability is on a daily basis. But it has -- it really doesn't have to do with being capital constraint there. In 2014, we basically exhausted the cash generated by the business across the areas that were highlighted by Chad, both reinvestments in the business being able to drive growth there and the share repurchase. And I see a lot more of that in 2015.
While there is no investor presentation, the CEO hands out a four page flyer that he uses with clients. Top clients: Google (10+ projects going on currently), Pfizer, AT&T, CVS, Berkshire Hathaway, CAT, State Farm, Bank of America, Intel, Chevron, Best Buy, Valero, Apple, Amazon, Costco, Morgan Stanley, John Deere, Costco, GM, Wells Fargo, GE, Cisco, Oracle, HP, Wal-Mart, IBM, Exxon, Comcast, and Target.
No customer concentration over 5%.
The management team does not actively promote the company at conferences, in fact I can’t find a single investor presentation, however the company holds quarterly conference calls and is an aggressive buyer of their own stock:
The annual reporting is very clearly written. It is an easy and straightforward read. I do not want to paraphrase…a few key highlights:
We are often retained in high-stakes matters, such as multibillion-dollar mergers and acquisitions, new product introductions, major strategy and capital investment decisions, and complex litigation, the outcomes of which often have significant consequences for the parties involved.
These matters often require independent analysis and, as a result, the parties involved must rely on outside experts. Our analytical strength enables us to reach objective, factual conclusions that help clients make important business and policy decisions and resolve critical disputes.
Clients turn to us because we can provide highly credentialed and experienced economic and finance experts to address critical, tough assignments, with high-stakes outcomes.
Out of 451 employees, 75% have PHD’s or Master Degrees and are considered Senior Consultants which leads to revenue per employee of just under $700K or 2x industry comps.
The CEO is against acquisitions and the ability to internally innovate makes more sense than trying to integrate new people.
Given the quality of its employees, CRA is essentially launching an internal VC fund to invest in their employees most promising business ideas. I think this makes sense for several reasons.
A)They have some track record of success such as https://www.globaldairytrade.info/ an online auction platform for dairy products. This is around a $10 million business with margins that are 2x core EBITDA margins 15%. It is not only about, consulting as the Global Diary Trade platform has proved.
B)Second with utilization of just under 80%, employees bill 4 out of 5 days and are paid 5 out 5 days. So they have the time to potentially innovate.
C)The employee base are some of the most accomplished experts in their given fields (average revenue per employee just under $700,0000) and have significant industry knowledge and opportunities especially if CRA can provide start-up capital.
Employee turnover of "rain makers" is a risk...but fairly low given long term forgivable loans.
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.
Back to strong margins and annual cash flow
continued aggressive share repurchses (10% in 2014)
Potential to generate $5.00 a share in FCF in 24 months
Not interested in acquistions but internal innovation to growth