INFORMATION SERVICES GROUP III
September 14, 2012 - 12:49pm EST by
Saltaire
2012 2013
Price: 1.25 EPS NA NA
Shares Out. (in M): 39 P/E NA NA
Market Cap (in $M): 49 P/FCF NA NA
Net Debt (in $M): 52 EBIT 0 0
TEV ($): 101 TEV/EBIT 0.0x 0.0x

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  • Professional Services
  • Small Cap
  • Secular Growth
  • Underfollowed

Description

Snapshot:

Information Services Group (III, $1.25/shr) stock presents an attractive long opportunity with minimal downside risk. III is benefitting from a continued cyclical rebound in demand for outsourcing services and analytics as well as from continued secular growth. The Company is the largest independent third-party provider of outsourcing consulting.  In addition, the Company has made accretive acquisitions at attractive prices which have strengthened its global footprint.

Thesis:

• III is the leading third-party provider of outsourcing information, statistics, data and contract monitoring services for ITO (Information Technology Outsourcing) and BPO (Business Processing Outsourcing) contracts

o III is the only independent aggregator of data who provides a truly unbiased perspective

o III retains a proprietary database of outsourcing contracts, metrics and data spanning over 20 years with more than 12,000 unique assessments

• Increased sourcing complexity is driving demand for III services

o Number of vendors, increasing complexity of outsourced process, and shifting geographies of service providers drive demand for III’s services

• High failure rate post initial outsourcing driving demand for monitoring services - recurring revenue business

o Large percentage of outsourcing clients report problems after outsourcing services commence

• Well diversified blue chip client base

o III serves 75 of the Forbes Global 100 Companies

• Growing geographic footprint

o Revenues outside America grew to 53% for FY 2011 from 34% in FY 2007

• Expected cyclical rebound in global outsourcing spend will benefit III

o Global outsourcing spend projected to grow at 5%+ CAGR from 2008-2013 according to IDC-Nasscom Strategic Review 2010

• Valuation is extremely cheap due to lack of following by the street and small market cap size

o 2012E Management forecast reaffirms full year guidance for constant currency growth in revenue between 6-8% from 2011 and adjusted EBITDA growth between 10-15% from 2011

• Growing recurring revenue business – Managed Services revenue is 8MM and now 8% of total revenue (both figures YTD), up 50% from a year ago. 

• 2Q 12 Key Takeaways

o Key client wins: State Farm, Marriott, KFW, Australian government, the city of Fort Worth, Texas and CEMEX

o Expects that Europe will be stronger in 2H vs 1H of year due to strength in Germany and France

o Best quarter since launch of ISG services

o Hired more than 30 new consultants.  Company will hire in advance of an expected contract win

Company History:

III was founded in July 2006 as a Special Purpose Acquisition Company (SPAC) and raised approximately $255M through an IPO in February of 2007. In November 2007, the Company acquired privately held TPI for $230MM in cash and 5 million warrants, which have no value.

TPI Overview:

TPI is the pioneer in sourcing advisory services and is the market share leader. TPI has advised on over 25% of sourcing market since 2000 and over 45% of Global 500 companies. With ~450 employees globally ($300K+/employee) and operations in 15 countries, TPI is the world’s leading sourcing data and advisory firm.

Customers:

TPI has a diversified blue chip client base serving customers such as Volvo, MetLife, Zurich, AT&T, P&G, Kroger, Home Depot, Marathon Oil, Johnson & Johnson, Pfizer, Air Canada, Singapore Airlines, as well as state and federal governmental agencies.

Services:

1) Inform - Market-leading research and analysis along with practical experience and a market perspective, allows to help make informed decisions.  Includes Research & Insights and Events.

2) Assess – Provides strong rationale and informed change strategy to clients.  Evaluates all risks and opportunities and includes Benchmarking and Maturity Assessments.

3) Design – Design solutions tailored to client needs for operational optimization, driving improvement and minimizing risk.  Service Design and Sourcing Strategy are offered.

4) Execute – Support each transition phase when clients shift internal operations to new outsourcing providers. Includes Transition Services, Transaction Services and Transformation Management.

5) Operate – Effective oversight of service delivery and monitoring of sustained business benefit for clients.  Governance Services and Project Management Services offered.   

Pricing for services varies client to client, but on average the assessment portion costs $250K +, the strategy development, negotiation and implementation / execution piece normally costs $1M+ and the service governance / monitoring piece generally costs $500K+. The service governance / monitoring piece of the business has significant value as it has grown from startup to $8M YTD 2012 revenues since 2008.

In addition to these services, III provides proprietary databases of sourcing-related market intelligence that are the product of extensive market research and client engagements derived from assignments that the Company has conducted over the last 20+ years.

Competition:

The competitive landscape is fragmented by industry as well as by geography. The purest competitors are two other independent sourcing advisors, Everest (privately held) and EquaTerra, recently acquired by KPMG in February 2011 (terms undisclosed.) On the research side, III competes with Forrester and Gartner as well as the strategy consultants such as Booz Allen, AT Kearney, Bain & McKinsey. III also competes with the service providers such as Infosys, Capgemini, Wipro, IBM, ACS, EDS, Accenture, Deloitte, & PWC.

Acquisitions:

III executed two strategic tack-on acquisitions which fit nicely into their operations. The first acquisition (January 2011) was Compass, a premier independent global provider of business and IT benchmarking, performance improvement, and data and analytics whose clients include large MNCs in Europe, Asia and the U.S. III acquired this business for 0.5x revenue and 5.5x adjusted EBITDA at a price of $19.5MM. The second acquisition (February 2011) was STA Consulting, which advises clients on IT strategic planning and the acquisition and implementation of new Enterprise Resource Planning (ERP) and other enterprise administrative and management systems. STA provides increase penetration into the public sector industry vertical and was acquired for 0.6x revenue and 4.5x adj. EBITDA at a price of $9.0MM in cash with an additional $8.0MM earnout over the next five years.

The acquisitions provide strategic value for III, as Compass provides entry into 6 new geographies – Brazil, Finland, Italy, Korea, South Africa, and Spain. In addition, Compass provides further penetration into blue chip clientele and the combined companies serve 75 of the Forbes Global 100. STA provides further penetration into the public sector vertical, where III has witnessed early success and sees future growth. Combined, III now will have ~700 employees and operate in 21 countries and truly be the largest global independent sourcing data and advisory firm.

The 40% increase in 2011 revenues is attributable principally to an increase in European and Asia Pacific revenues, primarily due to the acquisitions of Compass and STA Consulting.

Price Target:

Implementing a 2012E Forward EBITDA multiple of 8.0x, fair value for III is approximately $3.00/ share, or +~140% from the current share price. The 8.0x multiple is a conservative multiple considering the most relative public comparables in the space (Forrester Research & Gartner) trade at an average 2012E multiple of 10.0x and the Informational / Professional Services universe trades around 10.0x.  

For 2012E, we have assumed 7% revenue growth and 12.5% EBITDA growth from 2011 (both the midpoint of Management’s guidance - full year guidance of constant currency growth of revenues between 6-8% and Adjusted EBITDA growth between 10%-15% for 2012) and have assigned a more reasonable 8.0x multiple to derive our $3.00/share price target.

Variant View:

Risks:

1) Competition is increasing as traditional management consultants and outsourcing providers offer analytics

2) As clients become more experienced, they may use less advisory services

3) Clients continue to postpone large outsourcing projects

Mitigants:

1) III is the third-party market share leader and is the largest unbiased, independent provider

2) As different functions and new geographies are evaluated, independent third-party advisory services are required and in demand

3) Expect cyclical rebound and secular growth

Catalyst

 

Above and beyond continued performance and integration of the before-mentioned acquisitions.

As the Company approaches $25MM of EBITDA it would become more attractive to research analysts and the investor community.

Continued deleveraging of the balance from free cash flow will reduce the risk profile of the opportunity and further enhance its suitability for a broader class of investors.

Carlson Capital, the largest shareholder, received a board seat in return for a standstill agreement.  That standstill agreement will expire March 26, 2013 at which point they can potentially increase their ownership and/or push for a sale.

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