April 10, 2013 - 4:33pm EST by
2013 2014
Price: 25.00 EPS $0.00 $0.00
Shares Out. (in M): 5 P/E 0.0x 0.0x
Market Cap (in $M): 133 P/FCF 0.0x 0.0x
Net Debt (in $M): 147 EBIT 0 0
TEV (in $M): 280 TEV/EBIT 0.0x 0.0x

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  • Government contractor
  • Illiquid
  • Underfollowed


We believe VSE Corp. (Ticker: VSEC) is worth 2x its current share price (based on conservative multiples and assumptions) – and perhaps more as the story evolves in 2013:

The Bad

  • Illiquid stock – average volume is about 13k shares per day which equates $325k in daily dollar volume.  Hence, the idea is appropriate for small funds or personal accounts
  • Government contracting is an out-of-favor sector.  We note though that VSEC is far less exposed to sequestration that your typical government contractor.  This the best house, at a cheap price, in a currently not great neighborhood.

The Good

  • Stock trades at a very attractive valuation
    • o   5.2x P/E (Trailing and Forward)
    • o   30% FCF yield to the equity
    • o   Would likely sell for 2x or more in an M&A transaction
  • A lower-than-typical percentage of revenues are in contract vehicles that are subject to sequestration
  • An illiquid/underfollowed stock in this out-of-favor industry could move up quickly with some attention, sentiment change, and interested buyers
  • Even in the absence of buyers waking up to VSEC - FCF alone should be enough to generate meaningful return for shareholders
  • There are a number of catalysts that could have a meaningful impact on revenues and earnings in the coming periods

Overview of Company Activities

In its just-filed 10k and investor presentation there is an extensive review of the Company’s activities.  The bullets below provide a very brief sample of the types of services the company provides to the DOD (57% of Revs) and Civilian Agencies (43% of Revs):

  • Service and refurbishment of end-of-life Navy vessels for sale to Foreign Militaries  (self-funding program that generates needed revenue for the Navy)
  • Manage inventory of parts necessary to maintain fleet of U.S. Postal Service Vehicles (USPS is self-funding so not subject to sequestration.  Also, this is not really a discretionary spend – vehicles must be maintained to keep fleet active)
  • Manage and auction property seized by Department of Treasury and ATF (self-funding program)
  • Maintenance and refurbishment of military vehicles (saves Army money as activity extends life of active vehicles)
  • Provide a broad array of Technical and Consulting services to a host of U.S. Government agencies (this is the type of work that would be more subject to sequestration and will face pressure similar to what other companies in the space are seeing)

Fears over sequestration have led to negative investor sentiment around the entire government contracting industry.  However, apparent from the above summary of VSEC activities – the company is somewhat shielded from these industry issues/risks.  About half of revenues (FMS, USPS, Seized Assets) are not subject to sequestration

We would argue that VSE’s mix of activities and contract vehicles warrant a multiple premium to the group – however, VSEC trades at a meaningful multiple discount (likely due to low liquidity and generally being underfollowed).

VSEC Capitalization and Valuation ($mm)

FD Shares   Out.   5.3    
Share Price   25    
Market Cap   132.5    
Cash   1.5   BS Cash
Total Debt   139.7   Effective Interest Rate of 3.1% - required amort. of $23.4 in 2013; $25.0 in 2014; $34.3mm in 2015
Earn Out   9.1   Earn out associated with acquisition of Wheeler Brothers
Capital Leases   n/a   There is a capital lease on VSEC headquarters – but for   valuation we impute the cost of rental payments and charge the income statement ($3.8mm annually(
Net Debt   147.3    
EV   279.8    
  2012 2013 Est.   Notes
EPS  $     4.85  $    4.81   Income from Continuing Operations adjusted for imputed rental costs in capital lease
Multiple 5.2x 5.2x   (tax adjusted imputed rent of 1.57 in 2012 and 2.36 in 2013)
EBITDA         70.5         69.2   EBITDA from Continuing Operations adjusted for imputed rental costs in capital lease
Multiple 4.0x 4.0x   (imputed rent of 2.53 in 2012 and 3.8 in 2013)
FCF to Equity         26.7         39.7   Net Income  + Goodwill Impairment + D&A - Capex - Imputed Rent (Note 2012 Capex was $21mm incl. new HQ  Normalized Capex is approximately $5.0mm which is what is assumed for 2013)
FCF Yield 20.2% 30.0%    


We argue that fair value at the end of 2013 is $50 – or a 100% premium to the current share price.  We triangulate on this price based on the following assumptions:
  • Net debt will be about $100 at YE based on meaningful FCF this year.  We project FCF in 2013 the $40mm range based on Net Income of $28mm + D&A of $22mm less Capex of $5.0mm less Imputed Rent of $3.8mm
  • We think VSEC should conservatively trade at a FCF yield of 15% ($40.0mm / 15% = $267 of Equity / 5.3mm shares = ~$50/share)
  • VSEC should trade at 5.25x EBITDA  (5.25 x $69mm EBITDA = $362mmof EV less $100mm YE net debt = Equity Value of $262mm = ~$50/share)
  • Roughly 10x EPS = ~$50 per share
  • Also note that historical M&A multiples in the space typically run much higher.  In this environment we are unlikely to see 10x EBITDA deals like the old days.  But, based on conversations with industry players we think VSEC could easily garner 6x implying even higher than our $50 price target.

Other investors may choose to haircut our multiples (although we see them as pretty conservative).   However, we find it hard to believe the VSEC warrants a 5x EPS multiple and a 30%+ FCF yield.


Catalysts - What Will Wake Up this Stock?  (beyond this write-up of course)

  • Obviously there are macro factors that could help – if/when we ultimately move beyond sequestration that could provide a boost to the space.  In addition, conversations with management suggest they will be more proactive about marketing the stock once we are in a more normalized environment.  Management does not even hold quarterly conference calls so there is room for improved investor communication.  However, we’ve have found them quite open and accessible to shareholders.
  • Most of VSE’s recent work in Foreign Military Sales has been, “follow on technical services work with very little ship reactivation” (Per page 20 of 2012 10k).  However, VSE just won the recompete on this contract for total value of $1.5bn over five years.  That means that at some point in the future – VSE’s revs are likely to accelerate meaningfully in this contract from $88mm in 2012 to a much higher number.  The timing is a bit hard to predict but we see meaningful upside in this contract vehicle – probably more of a 2014 revenue event seeing as some congressional actions are necessary to advance Foreign Military Sales.
  • The United States Postal Service (remember VSE provides parts USPS vehicles) is testing a VSE designed fuel-efficient engine.  If selected, over time this would replace the engines in the USPS fleet.  Depending on the rate of replacement this could be a $50mm-$100mm annual opportunity.  This evaluation is in process and although no determination date has been made we are hopeful we’ll hear something by Fall of this year
  • Free-cash-flow alone should be enough to move the stock price.   If VSE does $40mm in FCF in 2013 then that equates to $7.50 per share.  This value should accrue to equity holders assuming we don’t face multiple contraction


I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


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