PM Summary

CACI is a dominant, non-cyclical business in an accelerating end market buoyed by several secular trends, led by an excellent, shareholder-friendly CEO trading at ~17x FCF (and P/E).  The margins, moat, and predictability of the business are all improving as mix shifts gradually from shorter duration services contracts to longer duration technology contracts.  With an under-levered balance sheet, strong FCF generation, and accelerating growth, we believe CACI is an under-appreciated, defensive "compounder" at an attractive price, with significant upside to Street estimates over the coming 2-3 years.  We think downside in the stock is dead money for 3 years, with a base case 16% IRR, and a realistic bull case for a 30% IRR which still assumes the company trades at a discount to the S&P and to BAH. 

Founded in 1962 and public for nearly half a century, CACI ($8.5bn market cap, $10bn EV) has revenue of ~$7.5bn vs addressable market of 250bn and a defense budget of >$1.5 trillion.  The business has really taken shape under CEO John Mengucci since 2012, with a focus on shifting from services to technology.  Since 2019, backlog has increased ~60%, margins have improved >100bps, and shares outstanding have been reduced by ~12% while also successfully integrating 10+ bolt-on acquisitions. 

While shares trade in line with other government services players (and a large discount to BAH), many of those are simply supplying bodies - staffing kitchens or TSA checkpoints.  CACI's "bodies" are less $15/hour labor but in many cases PhD engineers with security clearances.  CACI leverages these more complicated assignments to develop proprietary technology that is often re-usable and creates a higher level of margins and stickiness. 

Additionally, CACI leverages the services in the field to know what tech is needed months or years before RFP even arrives to competitors and even sometimes helps shape the RFP.  For example, CACI won a bid to manage a network operation center that was originally spec'd to provide 400 bodies to staff it.  Instead, CACI pushed the customer simply to spec the RFP to provide a specific up-time, which allowed CACI to win the business at an attractive margin by staffing it with fewer bodies but more technology whereas if they were simply bidding on providing 400 bodies they would have lost. 

Some other tangible examples of the type of work the company does is processing all of the signals that a Navy ship receives from 1000's of antennas into battlefield insights, software-driven signals intelligence and electronic warfare programs for the Army, and upgrading and securing the entire Air Force's IT network. 

Today, 55% of revenue is from technology and 45% of revenue is from service vs an 80-20 split in favor of services a decade ago.  ~30% of revenue comes from the intelligence community, ~50% from DoD, 15% from rest of government. 

Key Point 1: Attractive Secular Dynamics

CACI is a beneficiary of several large secular trends.  First, and most obviously, defense budgets are rising globally in response to significant geopolitical unrest, be it in Ukraine, the Middle East, or Asia.  Governments are also increasing their outsourcing for the most part, especially in

Second, the government's needs are becoming more technology oriented as cyberwarfare, intelligence, and electronic signals become increasingly important.  Maintaining and countering attacks on secure networks, wireless, and space-based communications has become a materially larger threat today than a decade ago.  To say it more cleverly (in the company's words), "bits and bytes" are becoming as important as "bullets and bombs."  These sub-focuses are perfectly in line with CACI's capabilities that they have spent decades building.  Additionally, software-based (or hybrid) solutions are becoming more relevant to government and intelligence agencies as opposed to hardware-based solutions, mirroring what the rest of the technology world has seen, albeit on a lag.   This advantages CACI vs competitors with more hardware-centric history. 

Lastly, CACI acquired significant photonics (efficient, optical space-based communications) via a couple acquisitions in 2021 and 2019 (SA and LGS Photonics).  Space is becoming an increasingly important domain from an intelligence perspective.  CACI's technology relevant across low earth, medium earth, and geostationary orbit and is allows for stronger security.  Importantly, CACI's technology is the only US-based (including manufacturing) offering available today that meets the stringent security and performance requirements.  This business has elevated capex and R&D investments right now which are set to wane as revenue begins ramping in FY'25. 

"Yes. We -- you'll appreciate we don't give kind of explicit guidance about the size, but the photonics business is a really exciting part of the portfolio. We are kind of nearing the end of the investment phase, the low-rate initial production. Some of the early contracts related to that are starting to deliver. We've opened a new facility that's focused on the production, and we're starting to deliver hardware. We have flying optical comm terminals on orbit and operating today.

And really an important part of our story over the next year, the balance of this fiscal year and without getting ahead of our fiscal '25 guidance sort of extending into next year, will be transitioning that area into some rate production levels. We won quite a few SDA jobs, which you're aware of, through where we're generally sub to primes. We have some contracts directly with SDA, and we also are -- some with DARPA. But it's a really exciting part of the portfolio."

Key Point 2: Growing Backlog, Duration, and Mix Shift Should Drive Upside to Numbers And Accelerating Revenue Growth

Backlog acceleration gives strong visibility into revenue and profit growth and acceleration.  Increasing coverage / mix of new biz.  Over the last several years, CACI's backlog has grown dramatically.  From 2012-2017, backlog was ~2-3x revenue.  Over the last several years, it has shot closer to 4x.   Additionally, the average duration of contracts in the backlog has increased from ~3 years to ~6 years.  These are longer-dated projects (read: higher margin and stickier) and the fruits of those wins have yet to fully show up in revenue/profits. 

Another benefit of the the longer duration contracts means you are losing less business annually to re-compete.  Think of it like longer contracts stacking on top of each other or churn falling in software.  The company wins ~90% of its re-competes.  Encouragingly, organic revenue has begun accelerating - from ~6% in FY'23 to >10% in each of the first 3 quarters of FY'24.  Consensus revenue growth for FY'25 and FY'26 assume a mere 3-4% revenue growth.  The company has raised guidance 3 times YTD. 

Importantly, as the revenue mix has shifted from 80-20 services (vs technology) to closer to 45-55 services, this has driven accelerating incremental margins.  I prefer to normalize over rolling 3-year periods to smoothe year-to-year volatility, but you can observe the trend however you like.  I'd note the recent step back in incrementals vs peak of 16% is related to the aforementioned timing gap between the large recent contract wins and them hitting revenue as well as some of the technology and photonic related investments. 

Key Point 3: Attractive Valuation vs BAH and S&P 500; Asymetric Risk-Reward

Relative to both BAH and the S&P 500, CACI is trading near its lowest ratio.  This is primarily driven by multiple expansion in both the broader market and BAH that CACI has not participated in.  Our hope is the acceleration/capital returns will drive CACI's valuation multiple to converge towards BAH and the S&P as it historically has traded in line with both, but only underwrite a partial conversion in the bull case and no expansion in the base case. 

If I am right about revenue merely growing HSD organically (though it's possible it grows faster), combined with capital return/accretive M&A, FCF per share can grow to $45+ by FY'28. 

Our bear case is dead money for 3 years vs a pretty conservative base case of mid-teens IRR assuming no revenue acceleration (in fact deceleration from current) and no multiple expansion.  Bull case feels reasonable and could actually come out better on organic growth, capital deployment, and multiple if accelerating revenue growth drives the valuation back closer to BAH/"compounder" stocks. 

Lastly, in terms of downside protection, I like to think of how much cash the company could reasonably return to shareholders over the coming 3 years.  Between FCF and taking leverage to ~3x (future) EBITDA, the company could return 30-47% of its market cap in the coming years.  To be clear, this is more of a straw man concept- I don't expect them to lever up and do a giant ASR, but simply a framework for thinking about downside.  I would also note that there are several PE owned asset light E&C, especially government-focused, platforms running at higher than 3x leverage.  Given the capital light and steady nature of the business, I could see it attracting PE bids if the shares languish or run into issues. 

Appendix: Good Management

CEO is straight shooter with track record of delivering his self-described primary objective of growing FCF per share.  CACI has outperformed the S&P by ~300bps per year since he joined in 2012.  I'll simply leave you to be the judge with some fun quotes from him, but feel free to search how frequently he talks about FCF per share. 

"We don't buy revenue. We'll never buy revenue. I will beat you in the open marketplace mercilessly because I trusted a deep bench business development team, a great set of solution architects, investing ahead of customer need, letting the customers say what are their preference, write the RFP angle more towards me than everybody else, may not be fair, or I'm good by not being fair and we'll win the majority of things we have to go out there and bid on. "

"What does that mean? We sit with our customers 2 to 3 years before a request for proposal comes out. And we're that company, the only company that sits with them and walk through art of the possible. In our marketplace, when you show the customer the art of the possible and they get to see what they can do, they actually shape the request for proposal to be more like what we showed them versus something they're not sure is available or not. And that is why win rates in CACI are so high. That is why I hate to say we dominate, but we win a hell of a lot more than we lose. And we win our recompete work because we're always bringing additional work to bring in into that fight."

"And the second part to the equation is your recompete business. So we've got an above 90% recompete win rate. That is work that comes up for a bid after a number of years, 3 years, 4 years, 5 years, where the government rebids that work. So the quickest way to not grow, of course, is to lose the book of business you already have."

"We're a long-term M&A company, but we buy capabilities and customer relationships. We don't buy revenue. So I can tell you, we have never bought $1 of revenue. If I'm going to buy something that looks like I am, I'll just beat you in the marketplace. It's just easier, and it's actually more -- it's more fun, frankly. "

"So we differentiate within our market space. We are software-based. So all the technology that we deliver has a very long shelf life. And by the way, better than the hardware refresh cycle, software refreshes in some of our systems every week because the world is a dangerous place in a very different manner. And that's that everybody is changing how they operate every 48 hours. So the software upgrade market is large for us. We are very, very focused on a strategy, a strategy in place where we come from. We're a very free cash flow per share centric. We're going to make absolutely certain that we can deliver a predictable or organic revenue growth, margins that also allow us to continue to invest. We're not a 0.25-point company that's got a short arm investment to meet 1 single quarter point. We're going to make sure that we are CapEx light and very cost conscious and make absolutely certain that we deliver what the best workforce there is."

"In fact, we're the company that was 6 years ago using version 2 of ChatGPT with a lot of our customers that we don't actually talk about. So is it a great technology? Yes. Is it uberly new? No. About 100 of our 200 programs involve AI in one way, shape or form. We never thought about making a major deal out because the technology part of our companies are to support national security, and there's a lot of customers who do that for that we don't openly talk on."

"But what's most important is all of the tech that we're out there delivering so differentiates us within this marketplace. And it actually allows our company to focus on good revenue growth and ever-increasing margins, making sure that we're relevant to the fight, making sure the programs that we win in this sector are much longer term, therefore, I can spend less money winning the work that's in my current book of business today, take that money and go out and generate new awards that are even longer term. And that's the growth cycle we're on, which is why it's really unique in the sector. If we get the sector to value both free cash flow per share and we get them to value top and bottom line growth, I'm absolutely convinced that we're the best company out there."