Highlights from Virtual Investor Meetings
We hosted virtual investor meetings with CTG Inc.’s (CTG) CEO Filip Gydé and CFO John Laubacker. Although the overarching story and financial goals remain consistent with what management has shared previously, we were struck by the high degree of confidence management expressed in achieving the aspirational targets contemplated in its 2023 Vision. Recall that CTG’s 2023 Vision calls for Solutions revenue of $250 million and adjusted EBITDA of $35 million by the end of 2023. With an enterprise value of just $90 million at present, simply coming within striking distance of these long-term targets would be a boon to shares, in our opinion. We continue to believe shares of CTG are undervalued, and our price target remains unchanged at $13.50, representing a FY ’22 EV/EBITDA multiple of 8x.
Of course, investors were focused on how exactly management plans to achieve its long-term targets given the significant ramp in revenue and adjusted EBITDA required to reach those levels. Regarding the top line performance, management indicated that achieving its goal of $250 million in Solutions revenue by 2023 will require a combination of organic and inorganic growth. Although specifics around the contribution from each were not disclosed, management expects organic growth to be the primary contributor. We note that this is consistent with our expectations for CTG to reach over $220 million in Solutions revenue in FY ‘23 on an organic basis, implying a three-year CAGR of 12%. Underpinning the strong growth trajectory is continued uptake of CTG’s digital solutions services. Per management, the COVID-19 pandemic has reduced resistance to technology adoption and has accelerated demand for digital transformation initiatives, particularly to support new paradigms for work and business process automation. CTG’s Solutions pipeline has increased accordingly, which combined with steady improvements in conversion rates should translate into strong organic growth moving forward.
From a M&A standpoint, CTG remains interested in expanding its footprint in North America, although management stressed that any potential deals must make sense both strategically and financially. CTG’s past three acquisitions were all in Europe, an outcome of the more attractive opportunities to be had abroad as opposed to management’s design. In this regard, management surmised that any deals in North America are likely to come at a higher valuation than the sub-1x revenue and high single-digit EBITDA multiples paid in recent years. Importantly, the company will remain disciplined from a valuation perspective and expects any acquisitions to provide the seeds for growth in new areas. Case in point, CTG first entered France via the acquisition of SOFT COMPANY and subsequently buttressed those operations with the acquisition of Stardust, a testing business with operations in France and Canada. Just yesterday, CTG announced an expansion of its strategic partnership with Micro Focus to include CTG France’s application testing solutions.
Whereas management remains focused on driving top line growth in the Solutions segment, the mindset and approach to the Staffing business is markedly different. Here, CTG continues to selectively disengage from lower margin arrangements as those contracts come up for renewal. Any efforts to retain Staffing business largely coincide with opportunities to develop a more strategic relationship on the Solutions side. Additionally, the company looks for opportunities to transition pockets of its Staffing work to managed services agreements, which provide greater value to clients and therefore come with higher margins. Regarding the customer concentration in Staffing, management noted that its largest customer, IBM, has been a client since CTG’s inception over 50 years ago and the associated revenues are spread across numerous contracts, spanning various business lines and requirements. Although management sees potential for some changes on the margin, by and large, the relationship is sound and does not appear to be a major risk or opportunity.
Considering the strong growth anticipated from higher margin Solutions engagements and an emphasis on driving gross margin expansion in Staffing, adjusted EBITDA should naturally increase in accordance. Aside from incremental revenue growth, however, management also sees opportunities to improve operating leverage arising from higher utilization of its service delivery centers, particularly those in lower cost geographies. That said, the expansion of CTG’s delivery footprint is not only a cost arbitrage play but also enables the company to pull together a multitude of resources and capabilities from across the globe to meet complex customer requirements, thereby producing higher value engagements. As we have not assumed any acquisitions in our model, we forecast adjusted EBITDA of $29.6 million in FY ’23 as opposed to management’s target of $35.0 million. Regardless, our current projection still implies a near doubling of adjusted EBITDA over a three-year timeframe. Also worth noting, the conversion of adjusted EBITDA to free cash flow has approximated 60% historically, and management believes that will remain the case as CTG approaches and eventually surpasses its targets for FY ’23.
Our report with model and disclosures is available here.
Disclosure(s):
K. Liu & Company LLC (“the firm”) receives or intends to seek compensation from the companies covered in its research reports. The firm has received compensation from CTG, Inc. (CTG) in the past 12 months for “Sponsored Research.”
Sponsored Research produced by the firm is paid for by the subject company in the form of an initial retainer and a recurring monthly fee. The analysis and recommendations in our Sponsored Research reports are derived from the same process and methodologies utilized in all of our research reports whether sponsored or not. The subject company does not review any aspect of our Sponsored Research reports prior to publication.