|Shares Out. (in M):||12||P/E||0||0|
|Market Cap (in $M):||16||P/FCF||0||0|
|Net Debt (in $M):||10||EBIT||0||0|
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RCMT was last written up on VIC two years ago at $3.63/sh and a $73mm enterprise value by fiverocks19 (who we very much respect). We recommend reading that writeup for some additional background. A fair amount has changed over the last two years, some good (major progress on the balance sheet, which was part of fiverocks' thesis), some not so good (Covid-related). The business is the same, but now the enterprise value is $26mm.
Meaningful FCF Generation and Deleveraging
The most notable change is a significant reduction in net debt. At year-end 2019, RCMT’s net debt stood at $33mm. As of today, it is down to $18mm, but with an asterisk. Earlier this year, the company won a long-running arbitration dispute against a customer and was awarded $7.4mm that had not been collected prior to the end of 2Q.
The CEO discussed this on the second quarter conference call, saying, “Our second quarter cash flow does not reflect the $7.4 million arbitration award from the first quarter. We expect to collect 100% of the award this quarter [3Q 2020] and use those proceeds to reduce debt further.”
I believe the pro forma net debt is thus just over $10mm.
The net debt reduction YTD is therefore around $22mm, or $1.96 per share. That is well more than the entire market cap of the company! If this FCF generation had accrued to equity holders, it would have added $1.96/sh to whatever starting point you want to use.
Additionally, we would expect that a company de-levering from over 3x debt/EBITDA to closer to 1x on a normalized basis would lead to a multiple re-rating higher. That has not been the case here.
Large Buyback + Insider Buying
In early June, the company, the CEO, CFO, and a board member purchased a block of just under 3mm shares of RCMT from M2O, the family office that had previously been the largest shareholder of the company (and a backer of the CEO’s activism on the company). RCMT repurchased 1.86mm shares, the CEO purchased 850k shares, the CFO purchased 150k shares, and a board member purchased 100k shares. The price for all purchases was $1.20 per share.
We view this transaction – especially the insiders putting up more of their own money to buy shares outright – as a meaningful sign of confidence in the business and the valuation.
Company Overview – A Mini-Conglomerate of Three Unrelated Segments
Specialty Health Care
RCM Healthcare Services is a 40 year old healthcare professional staffing company. They provide nurses and other healthcare practitioners in a variety of settings, with school districts being among the largest customers. RCM employs just under 2,500 specialty health care services personnel, which are assigned to its customers.
While the industry has experienced healthy growth over the last decade, RCMT has been taking share. RCM has grown this business at a 19% CAGR over the past seven years through 2019. This business was impacted by Covid (school closures), but we believe should bounce back and Covid may prove to be a medium-term tailwind.
RCM Health Care Segment Results
The company pushes all corporate expense down into the segments. We believe the company is likely running $3-4mm of corporate through this segment, and a little bit of D&A, so EBITDA in Specialty Health Care is perhaps $6-7mm.
One comparable, larger competitor AMN, trades at 1.6-1.7x sales and 12-14x EBITDA, though it has a greater mix of technology/BPO services.
You can all use what kind of haircuts to AMN’s valuation you believe are warranted. I have been valuing this business at $60mm (2/3rds of sales or ~9-10x EBITDA, stripping out corporate). Some might argue 1x sales is more apt. To a strategic buyer, it could clearly be run at a higher margin; the high growth rate in sales is obviously attractive.
In addition to nurse and healthcare professional staffing, RCM is working on growing its telehealth offering. While it is still a small piece of the business, RCM has larger ambitions in the telehealth area.
“One silver lining as it pertains to the business is the rapid ascent of our nascent telehealth effort. We believe that telehealth platforms will become a more significant part of school services, both in the short and long term. Furthermore, we believe that we are ideally situated to leverage our leadership position in the school business to accumulate market share by providing a leading telehealth offering to this end market.” (2Q 2020 Conference Call)
The Engineering segment can be further broken down into three primary business units: Energy Services (serving utilities, including nuclear power plants, in both power gen and transmission and distribution), Aerospace Services, and Process and Industrial Services (industrial, chemical, etc).
The engineering segment has been consistently profitable (I assume $3ish million of corp is being run through this segment as well), though sales have been volatile given the timing of large projects coming in and rolling off.
There may be some tailwinds that are not yet showing up in the numbers. As the CEO stated on the last conference call, “Our Engineering segment expect to see sequential growth in the second half of 2020 as compared to the first half based on our current backlog and pipeline. We have recently won several meaningful projects in both transmission and distribution and our industrial processing groups. At this time, we are optimistic about these 2 groups for the second half of 2020 and into 2021.” (2Q 2020 Conference Call)
I value this business at $30mm (0.5x sales and 5-6x EBITDA ex corp – inline with a peer like HIL), though if the revenue trajectory turns back to the positive in the coming years it could be worth more.
This is the smallest segment and has been under pressure the last few years, though the company is trying to turn it around. The company provides outsourced IT solutions and services primarily to middle market customers. As RCMT describes it, “These companies commonly require sophisticated, experienced IT assistance to achieve their business objectives and often rely on IT service providers to help implement and manage their systems. RCM is structured to provide middle-market companies a single source for their IT needs.” I value this segment at $0-10mm. Perhaps a comp would be something like Computer Task Group (CTG), which trades at 0.15x sales.
Here is one potential stab at the break-up value of the company:
To be clear, the above table ignores corporate expense of what I estimate is ~$8mm per year (hence “break-up value” and not ongoing trading value). If we capitalize that corporate overhead at the same 6x implied EBITDA multiple that the $95mm in total value uses above, that would remove $48mm from the value, and put our estimate of value at $2.40/sh or just 75% upside.
I think the right analysis is somewhere in the middle. Hopefully management realizes that the company, despite having close to $200mm of sales, has sub-scale profitability relative to the size of its G&A/corporate overhead, and that the best course of action is likely to sell the segments/business. Of course, the company received similar pressure to sell its segments several years ago, and in the interim has grown its Health Care segment meaningfully over that time period. I believe that management is aligned and believe that they are being thoughtful about how and when to monetize the pieces.
What would RCMT look like after selling IT and Engineering? It would be a ~$100mm topline specialty health care business with a growing telehealth business with ~$10-25mm of net cash, running at around breakeven, with a double-digit (perhaps high-teens) sales growth trajectory. Might that business not trade for $100mm (~8.75/sh)?
Another way of looking at RCMT is to assume that it can get back to its 2017-2019 levels of profitability ($7-9mm of EBITDA with an average of $8mm per year) fully loaded for corporate expenses. If so, then RCMT is trading at ~3x EBITDA right now. At 8x EBITDA (again, fully loaded for corporate costs) it would trade for $4.70/sh (~3.5x upside).
- I think RCMT could sell either the engineering business or the specialty healthcare business tomorrow for more than the entire enterprise value of the company.
- The balance sheet is in very good shape, and the company was fairly close to breakeven even during 2Q 2020 when the worst of Covid school closures were occurring. While priced like a bankruptcy stub at $15mm equity value, I believe the company will be able to endure a long period of market weakness if necessary.
- There is no imminent/obvious catalyst, but insiders own ~20% of the company, the majority purchased with their own money at prices not too far below current levels, so they should be incentivized to create/unlock value.
- We are getting ~$200mm of sales (2018/2019 levels), with consistent profitability, and a 19% 7-year topline CAGR in their best busines for just $26mm EV.
- Bottom line, I think there is limited downside, with a range of upsides from ~75% to several hundred percent.
- Customer concentration. 3 main school districts are meaningful customers in Health Care. Engineering has customer concentration as well at any given time.
- Additional school closures due to Covid.
- Failure to collect $7.4mm arbitration award in a timely fashion (again, it was expected to be collected in 3Q 20).
- Collection of $7.4mm arbitration award and further deleveraging.
- Return to something close to 2019 sales levels post-Covid.
- Progress on telehealth initiative.
- Backlog/momentum in engineering.
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