INFORMATION SERVICES GROUP III
July 17, 2011 - 1:12pm EST by
maggie1002
2011 2012
Price: 1.41 EPS $0.00 $0.00
Shares Out. (in M): 36 P/E 0.0x 0.0x
Market Cap (in $M): 51 P/FCF 0.0x 0.0x
Net Debt (in $M): 52 EBIT 9 0
TEV ($): 103 TEV/EBIT 11.2x 0.0x

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Description

Information Services Group ("III" or the "Company"), the undisputed leader in the outsourcing advisory industry, is currently trading at less than 5x management's forecasted 2011 EBITDA (based on management's projected $180M of sales at ~12% margin).  This is a low capital intensive business; capital spending has averaged less than 1% of sales per annum.  Based on EBITDA guidance and assuming 1% of revenue is spent for capital expenditures, one has the opportunity to invest in III at just 5.2x forecasted EBITDA less CapEx. 

 

I believe investing in III provides at least a 50% upside opportunity in two years or less, and there are numerous scenarios for which more than a double will be realized, which is still less than what the CEO paid for his shares ($3.48) in May 2010 and what both the CEO and CFO paid for their shares ($3.17) in November 2009.  At $2.84 (100% gain), III's valuation at 7.2x 2011E EBITDA is still at a substantial discount to the Company's peer group which is currently trading at ~10.5x EBITDA with no peer trading less than 8.5x EBITDA.    Even if management were to miss its guidance by 20%, one is investing in III at less than 6x EBITDA.  Based on two recent bolt-on transactions that I believe are performing above expectations coupled with improvements in the Company's core business, I am confident that management will affirm its guidance when the Company reports second quarter earnings on August 8th and more importantly achieve its guidance despite the first quarter results which were deemed underwhelming on the surface. 

 

Although I assert current valuation as an important reason to consider investing in Information Services Group, we all know that a low absolute and relative valuation is neither the only nor often the best reason to invest in a stock.  I describe below numerous other reasons why I think III is an attractive longer-term investment, most of which is based on this being a high-quality company having strong relative market share operating in a relatively stable/growth industry and led by an experienced management team and Board.

 

A summary financial and current valuation summary follows:

                                    2007                2008                2009                2010                2011E

Revenue                      $173M             $175M             $133M             $132M             $180M

Adj EBITDA              $20                  $29                  $20                  $16                  $22

EBITDA Margin         11.6%              16.6%              15.1%              12.2%              12.0%

 

Note:  Actual years (2007-2010) are not pro forma for Compass or STA Consulting.  Adjusted EBITDA is adjusted to exclude non-cash stock compensation and deal costs (the latter amounted to $2.4M in 2010).  If 2010 were to be pro forma for the year ended Dec 2010 as if Compass and STA Consulting occurred at the beginning of the period, then Revenue reported would have been $186.75M and Adjusted EBITDA would have been $20.61M (a margin of 11.0%).  Based on management's comments for 2011 that frame Compass generating ~$35M in Revenue and $3.5M in EBITDA, and STA Consulting generating ~$15M in Revenue and $2.0M in EBITDA, the remaining TPI business is therefore forecasted to generate ~$130M in Revenue and ~$16M in EBITDA.

 

Shares outstanding:  36.37M

Current Stock Price:  $1.41

Current Equity Value:  $51.3M

Net Debt:  $73.1M

 

Current Enterprise Value:  $103.4M

           

Enterprise Value/2010 PF Revenue (see note above):  0.55x

Enterprise Value/2010 PF Adj EBITDA:  5.0x

Enterprise Value/2010 PF Adj EBIT:  12.6x

 

Enterprise Value/2011E Revenue:  0.57x

Enterprise Value/2011E Adj EBITDA:  4.8x

Enterprise Value/2011E Adj EBIT:  11.2x


Note:  Most of D&A is amortization

 

Peer Group's Enterprise Value/LTM Revenue:  1.6x

Peer Group's Enterprise Value/EBITDA:  10.5x

 

Note:  Peer group (per III 10-K) includes CRA Intl, Forrester, FTI Consulting, Gartner, Huron, and The Hackett Group

 

 

Information Services Group ("III" or the "Company") was formed as a blank check company (i.e., "SPAC") on July 20, 2006 to serve as a vehicle for the acquisition of a then-unidentified operating business within the information-based service industry. The SPAC raised over $250M largely based on the proven track record and experiences of the Company's management team and board.  As described in more detail below, the experiences of the management team and board includes numerous information-based services like Nielsen Media Research, AC Nielsen, Dun & Bradstreet, IMS Health, and Gartner Group. 

 

On November 16, 2007, the Company completed the acquisition of Technology Partners, Inc. ("TPI").  TPI, which was founded in 1989, is the largest sourcing data and advisory firm in the world with more than 50% market share.  Management estimates its relative market share is 2:1.  TPI was recently ranked, by the International Association of Outsourcing Professionals, number one in the 2010 Global Outsourcing 100:  World's Best Outsourcing Advisors.    

Clients are primarily major corporations, including having advised 75% of the world's largest 500 companies.  Among TPI's clients are all of the top ten pharmaceutical companies, eight of the top ten food/beverage/tobacco companies, and eight of the top ten aerospace companies.  Over 75% of TPI's business is repeat or referral.  Client relationships often last approximately four years.  TPI is forecasted to generate ~$130M in sales this year, slightly less than the $132M and $133M generated in 2010 and 2009, respectively.  In 2008, TPI generated ~$175M in sales.  Over 40% of TPI's sales are generated from outside North America.  Last year, Asia-Pacific sales grew by almost 50%, but Europe was down almost 12%.  Business in North America was down 1%.

 

TPI assists its clients with reducing their cost structure through outsourcing in IT (what is characterized as "ITO") and other business processes (or "BPO") by evaluating, implementing and monitoring programs in business process improvement, shared services outsourcing and off-shoring.  TPI essentially created the industry for advising companies to optimize their outsourcing.  Their services typically will include constructing a RFP, conducting a cost/benefit analysis, guiding vendor selection and program implementation, and monitoring the compliance among its clients' selected vendors across the implemented programs.  Bill rates average more than $300 per hour and utilization has stabilized at around 70% (III management targets 75%) for the approximate 330 billable staff.  Pricing for TPI's services varies by client but on average the assessment portion cost ~$250,000, the strategic development / negotiation / implementation phase typically costs ~$1M, and the governance / monitoring component typically costs ~$500,000.  This latter business mix was started by TPI in 2008 and is already generating close to $10M in annual sales. 

 

The outsourcing advisory industry is of course competitive but pricing realization at 90% relative to rate card is indicative of a relatively rationale competitive industry.    Competition includes Equaterra (recently acquired by KPMG; terms are not disclosed but I have been told the transaction valued Equaterra for substantially more than 5x EBITDA), Everest, Alsbridge/TAG, Deloitte, PwC, and the traditional consulting firms like McKinsey, Booz, and Bain.  TPI of course also competes, and primarily so, with the choice among many potential clients to address their outsourcing needs solely from internal resources working directly with the service providers (e.g., IBM, ACS, EDS, Accenture, Infosys).  However, for those seeking advisory services, TPI has assembled the most experienced professional staff globally (advisors are typically second-career former CIOs) which has fortified their leading advisory position with ~50% share.

 

Selected client quotes from TPI's clients are as follows:

  • From Procter & Gamble: "TPI has been a valued strategic adviser since 2001. Their industry knowledge, technical expertise and business acumen have been key drivers in our successful efforts to build a multi-billion dollar portfolio of IT and business process outsourcing partnerships."
  • From United Technologies: "We repeatedly seek TPI's advice in our six-year relationship. Time and again, they have helped ensure that we realize the value of our sourcing relationships. We view TPI's involvement in every stage of the sourcing process as critical."
  • From Burlington Northern Santa Fe: "Without TPI's extensive assistance and guidance throughout our sourcing process, we would have been like lambs to the slaughter."
  • From McDonald's: "We sought to leverage TPI's knowledge and intellectual property. TPI enabled us to expedite our decision-making process."

 

TPI is the most-widely quoted source on the outsourcing industry and based on its credibility and dominance in the outsourcing advisory industry, TPI publishes the definitive source of quarterly metrics for the outsourcing industry.  It's called the "TPI Index" and addresses well-over 80% of the industry's contract value.  The TPI Index is the authoritative source for marketplace intelligence, related to outsourcing transaction structures and terms, industry adoption, geographic prevalence and service provider metrics.

 

TPI should benefit from a cyclical rebound in outsourcing and continued secular growth.  Global outsourcing spending is projected to grow at a 5% CAGR through 2013.  Increased sourcing complexity (e.g., number of vendors and outsourced processes) drives demand for III's services.  Among the structural industry dynamics in the outsourcing industry is that large contracts are now being disaggregated into smaller pieces.  Management at III believes this enables TPI to provide more value in assisting the decision-making process.  As additional evidence for the important role TPI occupies as the leading advisor in the outsourcing industry, the Company recently attracted nearly 250 clients and service providers to its annual Americas conference to discuss innovation and transformation taking place in the IT, Business Process and Sourcing industry.  There will be additional conferences later this year for Europe and Asia-Pacific.

 

An additional key driver of III's potential longer-term value creation is the likelihood that more bolt-on transactions will be prudently executed to leverage III's platform and shared services.  Management is focused on seeking complementary firms with proprietary data or new capabilities that have strong brands that can be purchased attractively and integrated effectively.  After a year of discussions, in January, the Company acquired Compass--a leading provider of business and IT benchmarking, performance improvement, data and analytics--and in February, the Company acquired STA Consulting-a premier information technology advisor to the public sector. 

 

The acquisition of Compass was predicated on uniting TPI's sourcing insights with a content database of best-performance and industry-specific assets.  Since 1980, Compass has assisted its more than 250 clients (predominantly in Europe) with improving their business operations through the application of Compass' proprietary database of critical benchmarking metrics in cost efficiency, productivity, and service.  Prior to the economic slowdown, Compass was growing its top-line by double-digits.  Growth is expected to be in the mid-single digits, primarily driven by the overall increasing demand for benchmarking services coupled with growth for Compass outside Europe.  Gartner (which incidentally trades at over 14x 2011E EBITDA) is Compass' main competitor and in the past TPI would mention Compass and Gartner as the two benchmarking companies to include in the client's overall outsourcing assessment/execution/monitoring phases.  Now that TPI owns Compass, it is almost certain that any business Gartner received with TPI's services in the past will be displaced in favor of Compass' benchmarking services.  Compass was acquired for ~5.5x EBITDA.  Substantial cost savings exist from the consolidation of shared services.  For example, almost immediately after the closing of the transaction, III management sought to improve the cost of insurance at Compass. This was an easy $150,000 of savings and there are many other low-hanging opportunities through shared services and leverage of the III platform.  Furthermore, top-line revenue synergy is already developing.  Compass' leadership and former private equity investor (Candover) own more than 10% of III's shares including shares acquired in the open market by the private equity investor.  Compass is forecasted to generate ~$35M in sales and $3.5M of EBITDA this year. 

 

STA Consulting specializes in information technology strategic planning, and in assisting public sector clients in the acquisition and implementation of ERP systems.  STA Consulting appealed to III as an avenue to strengthen TPI's public sector vertical.  The two companies had worked together on prior engagements.  Excluding earn-out potential, STA was acquired for ~4.5x EBITDA.  Bill rates at STA Consulting average ~$175 per hour and utilization rates have been over 80%.  More than 70% of the business is characterized as recurring.  STA Consulting is forecasted to generate ~$15M in sales and $2.0M of EBITDA this year.  

 

Among the reasons to consider investing in Information Services Group is the level of relevant experiences at both the senior management and board level for executing improvements at TPI, for effectively integrating the acquisitions of Compass and STA Consulting, plus the ongoing likelihood for identifying attractive acquisitions of complementary businesses.  A brief summary of executive management and Board background is noted below:

  • Chairman / CEO Michael Connors was previously the Chairman / CEO of VNU's Media Measurement and Information Group (2001-2005) which included Nielsen Media Research and NetRatings, Vice Chairman of AC Nielsen, and SVP of Dun & Bradstreet. He is currently also a Director of Eastman Chemical.
  • CFO David Berger was previously the Controller at the Nielsen Company
  • Lead Independent Director Robert Weissman was previously the Chairman / CEO of IMS Health, Chairman / CEO of Cognizant (the former parent company of IMS, Nielsen Media, and Gartner Group), and Chairman / CEO of Dun & Bradstreet. He is currently also a Director at Cognizant Technology Solutions, State Street, and Pitney Bowes.
  • Director Gerald Hobbs was previously Chairman / CEO of VNU (now The Nielsen Company) and is currently an Operating Partner at Boston Ventures
  • Director Kalpana Raina was previously in charge of European Country Management and Corporate Banking for the Bank of New York and now the Managing Partner of an advisory firm. Also a Director of Real Networks and John Wiley.
  • Director Donald Waite III is Adjunct Professor at Columbia Business School and was previously at McKinsey for over thirty-five years. He is currently also a Director of Presstek and The Guardian Life Insurance Company.
  • Director Neil Budnick (most recent addition to replace Director Robert Chrenc who passed away) was former President of MBIA

 

It's worth noting that CEO Connors was part of AC Nielsen which executed over twenty acquisitions.  At the beginning of his AC Nielsen tenure, the company traded at ~6.5x EBITDA and was ultimately sold to VNU for 10x EBITDA.  It is highly likely that the Board of III will ultimately realize a control premium for its shareholders but I do not think one should expect such in the near-term.  However, I do believe that the recent acquisition by KPMG for TPI's competitor Equaterra is demonstrative of the likelihood of acquisitive interest for III if/when the Board decides to explore strategic alternatives.  PwC which acquired Diamond Management and Technology last Fall for almost 16x EBITDA would likely be among the interested suitors.  Note that the private market EBITDA multiple for consulting businesses is ~12x EBITDA.  I think the current valuation of III provides its own source of downside protection but also notably the likelihood of acquisitive interest at a substantially higher value relative to where III trades today.

 

There are of course numerous risks to this investment.  The primary risks are the following:

  1. Deals across both ITO and BPO have become smaller in scope as transformative outsourcing transactions have slowed.  Management believes this is primarily the result of global economic uncertainty which causes client management teams to defer any transformative changes to their business models. 
  2. Enterprise clients have become increasingly more familiar and knowledgeable about outsourcing and contract renewals have become a larger percentage of the overall outsourcing mix, thereby marginalizing the magnitude of third-party advisor involvement.
  3. The outsourcing advisory business, like any consultative-driven business model, is mostly driven by the utilization and billing rates of talented people leveraging their experiences and relationships.  TPI's voluntary turnover has ranged from 9-15% annually.  According to management, this is not a high turnover rate compared to other consulting firms and is consistent with their expectations.

 

I believe the risks noted above are more than discounted by the current valuation.  Furthermore, since management has not forecasted for any growth in the core TPI business this year, I assert that guidance is consistent with an assessment of current industry-related risks.  Management is forecasting ~12% EBITDA margin.  This compares with the "peer group" at ~15%. 

 

I am not asserting that III should trade at a Gartner-like EBITDA multiple of 14.2x.  Gartner clearly has many more business advantages, including a more recurring revenue base.  However, I do think III is more akin to the utilization/billing drivers inherent within companies like The Hackett Group, FTI Consulting, Huron, CRA International which are trading at 8.5-10.5x EBITDA, or Diamond Management & Technology (recently acquired by PwC for 15.8x EBITDA).  Furthermore, the Board and executive management team at III have strong relevant experiences to improve current margins as very much evidenced by them in their first full year of controlling TPI in 2008. 

 

The management team and Board have substantial industry credibility as evidenced by the abundance of interest from the investment community to invest in III when it was a blank-check company.  The economic crisis and some structural industry headwinds definitely compromised management's timeline and the current equity price reflects a need for management to restore its credibility with the investment community.  Management commented earlier this year at DB's small/mid cap conference that their guidance was set to "under promise in order to over deliver".  I think III's equity has recently suffered too severely from the lack of adequate "research sponsorship", the typical issues associated with a relatively thinly-traded stock, and the poor technical trading pattern that has reinforced the decline.  However, for those of you who assert being longer-term fundamental investors, I strongly advocate III for consideration to generate at least 50% upside in two years or less and possibly more than a double.  This will happen through management's execution.  That is the key catalyst.  Furthermore, there is a $10M outstanding share buyback authorization that some investors are prodding management to advance.  You are likely to hear such advocacy on the upcoming call on August 8th.  No valuation screen is likely to currently advance III for consideration given the recent acquisitions, the large goodwill impairment, and the adjustments to reported results that are part of my fundamental thesis.  Even in the absence of any multiple expansion or growth in the business, the pay down of debt over the next two years makes this a relatively attractive investment.

Catalyst

The primary catalyst is executing the current plan for achieving this year's guidance.  I anticipate management will affirm such in the upcoming earnings release/call on August 8th.  I also anticpate a high likelihood that investors will prompt management to advance their $10M outstanding buyback at the significant discount to intrinsic value.  Furthermore, I envision that the Company will grow in 2012 as management continues to advance its market share through its new verticals, geographies, and the synergies driven from Compass and STA Consulting.  I ultimately believe a control premium will provide a substantial reward to longer-term shareholders beyond today's price.
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