Takeaways from Virtual Non-Deal Roadshow

We hosted a virtual non-deal roadshow with CTG Inc.’s (CTG) CEO Filip Gydé and CFO John Laubacker. At a high level, the meetings were largely focused on CTG’s ongoing evolution from a staffing company to a digital solutions provider, and how this transformation ultimately manifests in the financials and stock price. For those investors that have previously followed CTG, the shift from staffing to solutions sounds all too familiar and begs the question, “what has really changed?” We think the operative word this time around is digital but the more comprehensive answer is a proven track record, a new market tailwind and a clear long-term vision that is driving demonstrable changes in the company’s engagement with clients.

Since taking the helm just over two years ago, CEO Filip Gydé’s mandate has been to replicate the success he had in leading the company’s European operations for two decades, a tenure which culminated with solutions comprising 50% of sales in the region and fueling much of the company’s growth. Of course, the time frame for achieving similar success in North America has been significantly condensed as evidenced by management’s recent 2023 Vision targets for solutions revenue of at least $250 million by the end of FY ’23; a solutions revenue mix of at least 50%, which implies a revenue base of $500 million; and adjusted EBITDA of $35 million, or a margin of 7%. Worth noting, CTG posted $166 million in solutions revenue, $376 million in total revenue and adjusted EBITDA of $16 million (4% margin) over the last 12 months. Clearly, CTG must sustain robust growth in its solutions business and perhaps pursue one or more strategic acquisitions if its vision is to become reality.

Simply put, everything hinges on CTG’s ability to grow its digital solutions business. Although the company has often referenced its solutions business throughout its history, the services provided under this moniker have often been adapted to the times, meaning Y2K compliance was once a major growth driver and federally mandated initiatives to drive meaningful use of electronic health records following the Great Recession were a boon for business. Between a spate of acquisitions in Europe over the past three years and a concerted focus on hiring practice leaders well versed in areas like data and analytics, cloud migration, Internet of Things, robotic process automation and security over the past several quarters, CTG is now poised to ride the wave of digital transformation, a market opportunity management believes will persist for at least five to seven years. Importantly, many of the services provided to aid customers in accelerating their digital transformation journeys tend to drive more repeat business (e.g. DevOps implementation) or to reduce CTG’s own costs to deliver outsourced services (e.g. leveraging bots to automate the provision of certain help desk services). Considering CTG’s gross margin for its solutions business sits in the low-30% range, a higher mix of revenue here naturally lifts the company’s overall gross margin, currently in the low-20% range.

Perhaps equally critical to changing investor perception is what the company is not doing. Historically, even as CTG spoke of a shift towards solutions, initiatives to grow the staffing business received equal billing given the desire to show positive trends on the top line. Throughout the past two years, management has consistently expressed a willingness to walk away from staffing engagements where CTG has been unable to re-bid at higher rates or where an opportunity to provide higher margin solutions services is nonexistent. In terms of staffing business that is desirable, management appears amenable to engagements that produce gross margin in the low- to mid-20% range while re-bidding or disengaging from opportunities that fail to meet that threshold or where strategic considerations do not apply. Although a specific amount of these commoditized staffing revenues has not been disclosed, we surmise just under half of the staffing revenue base, or roughly $100 million, may be under review as the associated contracts come up for renewal. In other words, we believe that over the next few years, CTG has the potential to dramatically improve the margin profile for a sizeable portion of its staffing business but could just as easily shrink the low margin book of business if appropriate terms are not achieved. While the former scenario is likely the better financial outcome, investors could very well prefer the latter given that the exposure to staffing has seemingly had an anchoring effect on CTG’s valuation. Interestingly, management was not at all dismissive of the potential to divest the staffing business. For the sake of clarity, however, we do not believe any dramatic undertaking of that nature is in the offing but the willingness to entertain the notion further suggests the company is “all-in” on solutions growth.

Rounding out the discussion topics was management’s interest in pursuing acquisitions to accelerate the company’s transformation. Management made clear that no acquisitions on the staffing side are or will be considered. On the solutions side, however, there is certainly interest in increasing the company’s scale and capabilities in North America. Although valuations remain elevated in many instances, management believes there are opportunities to be had in the range of 1x-2x revenue. Of course, any deals the company would pursue must bring an established book of business and expand the scope of digital solutions offered. In terms of size, our sense was that something similar to the company’s recent acquisitions, say $10-$15 million in revenue, is well within the comfort zone. Across the pond, CTG is open to opportunities but with the past three acquisitions occurring in Europe, the emphasis is primarily on unlocking synergies from those transactions as opposed to bolting on more.

All in all, management expressed confidence in achieving the aspirations set forth for FY ’23 and provided its roadmap for value creation. Near-term, sales cycles remain somewhat elongated but between a robust pipeline and go-to-market investments made in the past two quarters, management anticipates delivering solid growth in FY ’21. We suspect there is upside to our current estimates for FY ’21, which include revenue of $386.4 million (+5.6% Y/Y) and adjusted EBITDA of $16.4 million (4.2% margin). That said, with the pace of a global economic recovery still to be determined, we prefer to err on the conservative side and are therefore leaving our estimates unchanged at this juncture. Our price target remains $11.00 based on a FY ’21 EV/EBITDA multiple of 8x.

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.