Navigant is a consulting firm with a particular focus on the healthcare, energy and financial services industries. Publicly-traded competitors include FTI Consulting and Huron.
We like the stock/business because it generates significant amount of free cash flows, can be purchased at a low multiple and there are multiple ways to win either through optimizing the business (in particular, capital structure, balance sheet and margins) or selling it.
Our base case scenario is $28-$30 per share in one year, a 40% to 50% upside to current price.
The Company is under pressure by Engine Capital, a value-oriented activist firm to improve its performance or sell. In response to Engine’s public letter (issued last week), NCI issued its own press release where they shared interesting data about 2018 including improved margins, improved working capital, less capex and a $50 million share repurchase. We think this bodes well for 2018 numbers. The Company is also a direct beneficiary of the tax reform as they were a full tax payer (40% tax rate going to 25%).
Market cap is currently $940 million and EV is $1,100. We expect the company to generate a fair amount of cash in Q4 through cash from operations and working capital. In particular receivables were artificially high in Q3 because of a change in billings system and have come down in Q4 (as per the Company’s press release mentioned above). We expect the Company to generate at least $70 million in cash in Q4 reducing the EV to $1,030 million. We expect 2018 EBITDA around $145 million converting to around $100 million in unlevered free cash flow so we are paying 7.1x 2018 EBITDA and 10% free cash flow yield for this growing business. By comparison, FTI trades at 8.9x EBITDA and Huron trades at 11.4x 2018 EBITDA. M&A in the space has taken place at north of 10x EBITDA. A sale at 10x EBITDA at the end of 2018 would yield $31.40 per share, a premium of 53% to the last close.
Why does this opportunity exist?
NCI had to update its 2017 guidance when they released Q3 numbers and the stock came down. The company was growing fast in 2015 and 2016 and were hiring accordingly. Going into 2017, they assumed growth would continue and therefore continued to hire people. When growth slowed down in 2017, they ended up with too many consultants, utilization went down and margin also went down. For example, Q3 revenue grew 0.2% year over year while number of consultants grew 5.6%, number of people in their technology and data division grew 19.3% and the number of non-billable people grew 9.6%. These numbers highlight the disconnect. Now that they are under pressure to improve performance, we expect that they will realign their cost structure and go back to historical margin of around 15%.
How could the business be optimized?
In addition to the margin opportunity, we believe that the company could significantly increase its leverage as well as improve its capital allocation policy. Engine’s letter details these opportunities. The company seems to be moving in that direction now that they have indicated that they would buy back $50 million of shares in 2018.