I am recommending a long investment in CBIZ, a provider of professional services to small- and mid-sized U.S. businesses.  Before turning to a discussion of the business and valuation, it is worth considering some corporate history as summarized from the Company’s 2000 10-K:

Formed as a Delaware corporation in 1987 under the name Stout Associates, CBIZ was acquired by Republic Industries, Inc. in 1992. In April 1995, Republic spun-off its hazardous waste operations, including CBIZ's predecessor company to stockholders. Renamed Republic Environmental Systems, Inc., CBIZ began trading on the Nasdaq National Market under the symbol "RESI" until June 24, 1996, when it began trading under the symbol "IASI" in anticipation of the merger with Century Surety Company and Commercial Surety Agency, Inc., which resulted in a change of its name to International Alliance Services, Inc."  This name change signaled a move away from the hazardous waste business. CBIZ divested all remaining hazardous waste operations in 1997. On December 23, 1997, CBIZ changed its name to Century Business Services, Inc. and began trading under the symbol "CBIZ” [since changed to CBZ]

CBZ was backed and run by Michael DeGroote, whose background was in the garbage business having founded, grown and sold Laidlaw, a Canadian waste services business.  Through the garbage business, DeGroote developed a relationship with Wayne Huizenga.  Subsequent to selling Laidlaw, DeGroote worked with Huizenga on the Republic Industries roll-up, which ultimately spawned both AutoNation and Republic Services.  Indeed, CBZ began as a 1990s-style roll-up, completing 145 acquisitions between 1996 and 1999.  Like many other roll-ups of that vintage, the Company’s stock soared initially before both the Company and the stock hit the wall:  from its peak at a split-adjusted $25 in mid-1998, CBZ dropped to under $1 in late 2000 when Steven Gerard assumed the CEO position to clean up the mess.

Over the next few years, CBZ embarked on an integration of the acquired businesses; consolidated operations; divested or closed non-core businesses; built out the management team; tackled most of the litigation facing the Company (many owners who sold to CBZ took stock and were none too happy about it); and focused on generating cash and reducing debt.  After stabilizing the business at a lower, more sustainable level, the Company again resumed growth (including through tuck-in acquisitions), albeit in a more measured, deliberate manner.  Although the Company has resumed acquisitions, it targets only 3-5 annually and requires that deals be immediately accretive and fully integrated upon closing. 

Today, CBZ generates approximately $745 million and $85 million in annual revenues and EBITDA, respectively, with over 5000 employees (approximately half of whom are professionals) in 150 offices in 36 states.  CBZ generally targets mid-sized companies (100-2000 employees) in its served local markets.  The Company operates through three principal business units:  Financial Services (51% of revenues), Employee Services (24%) and Medical Management Practices (“MMP”--21%). 

Financial Services performs tax, accounting, valuation and financial consulting services through 35 offices with nearly 2000 employees.  This business unit is divided into three geographic regions (East, Midwest & West) and a National Services division consisting of those units that provide services nationwide.  Restrictions imposed by independence requirements and state accountancy laws and regulations preclude CBZ from rendering audit and attest services (other than internal audit services). As such, CBZ and its subsidiaries maintain joint-referral relationships and administrative service agreements ("ASAs") with independent licensed CPA firms under which audit and attest services may be provided to CBZ's clients by such CPA firms.  These firms are owned by licensed CPAs, a vast majority of whom are also employed by CBZ subsidiaries.  Under these ASAs, for a fee CBZ provides a range of services to the CPA firms, including: administrative functions such as office management, bookkeeping, and accounting; preparing marketing and promotion materials; providing office space, computer equipment, and systems support; and leasing administrative and professional staff.  CBZ earned approximately $93 million of fees under such ASAs in 2009.

Employee Services provides employee benefits consulting and procurement (insurance brokerage) of group health and P&C coverage, as well as payroll and some other business services.  MMP provides coding, billing, accounts receivable management and full practice management services for hospital-based physician practices in 24 states, with a focus on radiology, emergency and anesthesiology practices.  Set forth below is a summary of segment revenues and pre-tax income for the past three years: 

Between 2005 and 2008, CBZ grew revenues from continuing operations at approximately 10% annually with same-unit revenue growth of 5.7-8.2% annually.  Of course, the Great Recession took a substantial toll on CBZ’s mid-sized business customer base, which is reflected in the Company’s same-unit revenue contraction of 5-5.5% over the past six quarters through mid-2010.  Nevertheless, CBZ has managed to maintain flat revenues, EBITDA and EPS through this challenging time as a result of expense control and modest contributions from tuck-in acquisitions.  Importantly, same-unit revenue declines have been moderating:  Q3 same-unit revenue declined 2.2%, an improvement from declines of 5.1% and 5.6% in Q2 and Q1, respectively; and the more important Financial Services and Employee Services units each recorded same-unit revenue declines of less than 1% in Q3.  Although EBITDA was down approximately 1.2% YTD through Q3, all of that decline occurred in the seasonally stronger first half while the third quarter marked the first yoy improvement in quarterly EBITDA in over a year (up 26%).  In addition, the Company’s 2010 EBITDA forecast of $85 million (recently reiterated) implies a further small yoy increase in EBITDA in Q4, with more upside than downside according to management.  The latter point marked a subtle improvement to full-year guidance relative to management’s posture on the Q2 call.  In short, it appears that CBZ’s business has finally bottomed and perhaps is poised to resume modest growth again.  With the cost structure in good shape and the operating leverage inherent in the business model, even very modest top-line growth should drive decent cash flow and earnings growth.

Longer term, CBZ targets 8-10% revenue growth comprised of 3-5% organic growth plus an incremental 3+% from each of cross-serving growth (selling incremental services to existing clients) and tuck-in acquisitions.  Management expects that, with operating leverage, 8-10% revenue growth should drive 20% EPS growth.  These longer-term targets no doubt are predicated on returning to a more normalized macroeconomic environment.  We are not optimistic that the environment for CBZ’s clients is going to normalize any time soon, but shareholders do not need growth anywhere near these targets for the stock to work.  Indeed, the current stock price would seem to discount virtually no growth, as indicated by the modest valuation discussed below.

CBZ is a large player in its key Financial Services and Employee Services markets, which remain highly fragmented.  With an established national platform and scale in its served local markets, it is well-positioned to execute on its plan of adding to modest organic growth with tuck-in acquisitions and cross-selling services to its served small- and mid-sized customer base.  Given the service nature of the business, capital requirements are quite modest, which facilitates relatively high rates of free cash flow conversion.  In terms of downside protection, the Company’s client base is large with little client, industry or geographic concentration or risk.  In addition, the preponderance of the services CBZ provides its customers is recurring in nature (e.g., annual tax compliance, group health benefits, P&C insurance, retirement plan advisory, medical practice management etc.).  The Company actually maintains that some 80% of its revenue is recurring in nature, though that figure seems a little high and in any event is not as high quality as the recurring revenue that comes with subscription-based businesses, for example.  Nevertheless, the business has demonstrated some degree of resilience through the recession and, as indicated in the discussion of financial trends above, would appear to have more upside than downside from a business perspective.

The Company has had material changes to its capital structure in recent months, which I believe is also notable because it highlights management’s views toward capital allocation and, in my opinion, its relative sophistication for a business of this small size.  On the latter score, CBZ’s board includes:  a former President (and previously a portfolio manager) at Dreyfus, the mutual fund business now owned by Bank of New York Mellon; a partner at a private equity firm who also previously served as CFO for Ron Perelman’s MacAndrews & Forbes; a CPA who was one of Huizenga’s chief lieutenants; and a senior partner at Akin Gump who has represented DeGroote and Huizenga entities for years and who serves on the AutoNation and Republic Services boards. 

The senior Mike DeGroote (his son of the same name serves on CBZ’s board), who is 77, had owned as much as 25% of CBZ until he agreed in September to sell the Company (i) half his stake (7.7 million shares) immediately at $6.25/share (roughly where the stock was trading the day the deal was announced), and (ii) a three-year option to purchase the remaining 7.7 million shares at $7.25/share.  CBZ paid $5 million for the option.  To finance this transaction and to refinance outstanding convertible debt due in June 2011, CBZ sold $130 million principal amount of 4.875% Convertible Senior Subordinated Notes due 2015 with a conversion price of $7.41 (up 35%).  CBZ’s new convert is an unusual security (at least to me) insofar as it contains a “net share settlement feature” that allows the Company, upon conversion, to settle the principal amount of the Notes in cash, and the additional conversion value, if any, in cash or shares of the Company's common stock, at the Company's election (thus it’s not dilutive to the share count).  The Company also purchased an additional 4.6 million shares in the open market for $25.1 million ($5.45/share), capitalizing on a 15% drop in the stock in the week leading up to the pricing of the convert.  With these repurchases, CBZ has now shrunk its shares outstanding by nearly half since 2002, at an aggregate cost of less than $6/share.

With the dust now settled on these significant capital structure events, I set forth below the Company’s current capitalization and associated valuation metrics.  Some clarification on these figures is in order.  For the valuation multiples below, I have used management’s full-year 2010 guidance ($85 million adjusted EBITDA, $0.52/$1 GAAP/cash EPS ex one-time items) as reiterated in the Q3 earnings call.  The net debt figure includes $28 million in respect of contractual earn-out payments in 2011.  I believe this is a conservative approach because these earn-outs typically require growth in the acquired business, which would imply (all else equal) that EBITDA and EPS will be higher in 2011 than 2010 to the extent that these earn-outs are payable in full.  In other words, I have included the full amount of the 2011 earn-outs in the TEV/EBITDA multiple even though EBITDA doesn’t yet include the benefit of improved operating results implied by full payment of the earn-outs.  For free cash flow (FCF) and the associated FCF yield, I have used management’s guidance of $50 million, which I have adjusted downward to impute an additional $1 million of cash usage attributable to $28 million of incremental draw on the Company’s bank facility, i.e. I have treated the earn-out as though it has already been funded with bank debt, the interest on which reduces FCF. 

Like most cheap stocks, CBZ is cheap for a reason.  The Company’s complexity, with three essentially different businesses, means there are no good direct comparables for the business as a whole and provides a disincentive to analysts who cover one of the three served industries to assume coverage.  Indeed, there are only a few secondary firms that provide research on CBZ.  Investors likewise have to work harder to understand the Company, and with a sub-$300 million market cap, it simply isn’t worth the effort to many institutional investors.  Of course, the Company’s sideways performance since 2008 has not helped garner interest either.  However, CBZ is demonstrably cheap on a sum-of-the-parts basis, an LBO-takeout basis, and a free cash flow basis.  For patient investors, it offers an excellent risk/reward proposition with limited downside risk and pretty reasonable prospects of a double within three years based on a return to very modest organic growth coupled with a slight increase in its multiple.  By way of context, CBZ currently trades at multi-year lows as a multiple of (cyclically depressed) earnings and cash flow.