Even with yesterday’s 17% rally on great quarterly results from Ciber, we think the stock is an attractive investment opportunity. Specifically, we think you’re getting Ciber - at yesterday’s closing price - at an EV/FCF (2013) of less than 10x with significant upside to that FCF number over the next 2 years in both the margin expansion and revenue growth departments. The thesis that follows is short and simple.

Company Description

Ciber is an IT Consulting company that generates a bit over $800M in annual revenue. The history here is important, as it’s a key part of what will drive Ciber’s margins in the future. The firm was founded in the 70’s by Bobby Stevenson, who is still the largest non-institutional shareholder, and owns about 8% of the outstanding shares (he currently serves no role at Ciber, and retired from the Board in 2010). In the 90’s, Ciber started on an acquisition binge that only ended in 2010, in the process acquiring 29 other IT services firms, and that’s in acquisitions that they consider material. One can imagine that a 30-company rollup in the IT services space might not be operating in the most efficient way given the dependency on multiple systems and multiple classes of consultants specializing in close to 50 different areas. Additionally, up until current management took over, Ciber’s acquisitions were not fully integrated into a coherent whole, and the company was operating at the branch level, with each branch running its own consultants and practice areas.

General Thesis

In 2010, with the limits to the acquisition strategy apparently reached, a new management team was brought in to clean up the mess, i.e., integrate the various independent pieces, cut costs, and maybe try to generate some organic growth. The CEO, David Peterschmidt, was previously the CEO an Inktomi when it was sold to Yahoo, and subsequently held the same post at OpenWave where things didn’t end as gloriously as they did at Inktomi (we’re hoping that CBR comes closer to resembling Inktomi than OpenWave). The CFO, Claude Pumilia, held various senior positions at much larger IT services firms before coming to Ciber, including CA and HP. Thus far, we’ve been fairly impressed with the job the two have done with the company. In no particular order, the major initiatives the new team has undertaken at Ciber included:

• Actually integrating the company. Instead of each branch operating independently, frequently because it was the headquarters or a major office for one of Ciber’s acquirees, Peterschmidt organized the company along the lines of the various practices so that if a customer in a particular region wanted to work on an ERP project, the project would belong to Ciber’s overall ERP team, not the ERP team in, say, Florida.

• Organizing the company around several major practices instead of the close to 50 different practices that Ciber officially specialized in previously. The number of specialties is now down to the single digits, and the vast majority of company projects can be assigned to one of three major buckets:

• ADM - Application Development & Management

• ERP - Enterprise Resource Planning

• Managed Services

• Cutting and selling businesses that were non-core to Ciber, including a division that dealt solely with government contracts, as well as the IT Outsourcing division.

• Delevering the balance sheet - buying companies over many years, Ciber of course accumulated a large debt load. Peterschmidt, through selling off assets, paying off debt, and renegotiating Ciber’s credit lines, has been able to cut the debt load by more than two thirds and interest expense by even even more.

The “dirty work” of consolidating both the back and front office and focusing on a few major specialties, was mostly taken care of in FY 2011. Over the past year, management has focused on selling the aforementioned ITO and Federal business, which did not generate much in the way of profits anyway, and more importantly, introducing an actual strategy that would see Ciber grow its revenue organically over the next few years. While not particularly earth-shattering, the strategy has Ciber concentrating on developing - and executing on - its strategic partnerships with the major enterprise software firms (such as Oracle, SAP, Salesforce, Infor, Microsoft, etc.). Normally, a firm looking to implement an IT enterprise solution from one of these aforementioned firms would go to an IT consultant like Ciber (or IBM or Accenture, depending on the size of the firm) to implement the solution, and before the current management team came in, Ciber’s strategic partnerships were flimsy at best (where they even existed). In 2012, Ciber concentrated on getting the infrastructure in place to implement - in its North American operations - the ability to provide IT solutions within the context of these strategic partnerships. The results for North America have so far been pretty good:

• Book-to-bill has consistently been above 1, and management has said that it has risen in each of the past 3 quarters.

• Organic YOY revenue growth, which has not been present for years, finally returned in Q3 and Q4 of 2012.

• Segment EBIT margin for North America have been on the rise, as management has - shockingly - been able to find lots of cost-cutting opportunities as it strives to focus the business on just the few things it can do really well.

So far, it is just North America benefitting from this strategic focus, and the sales engine has only really started to get going in the past two quarters. The real upside to free cash flow over the next two years is going to come from the following:

• Cost Cutting - management is implementing a cost-cutting restructuring program across both the International and North American operations, and expects to save $11M in costs over the next 12-24 months.

• Gaining momentum in North American sales - as the strategic vision of the current management team has only started to take root in the past two quarters, we expect North American sales to really gain momentum over the next 12 months. This should be manifested in mid-single-digit organic revenue growth, and operating leverage on both the gross margin and SG&A lines.

• Consolidating and bringing strategic focus to the international operations. Internationally, Ciber is not as disorganized as the North American operations were two years ago, but there is definitely the need to consolidate further and cut costs. This has started to be a focus for Ciber over the past few quarters, but will really come to the fore in FY2013. Once consolidation starts gaining traction, Ciber management expects to bring its strategic partnership concentration to Europe. We expect that executing on the consolidation and strategic clarity in Europe will lead to similar results as we’ve seen in North America - at least low-single-digit revenue growth and some operating leverage on the gross margin and SG&A line. Possibly, the results could be much better, but we wouldn’t use that as a base case just yet.

Valuation

For FY 2012 (the 4th quarter of which led to the enormous rally yesterday), Ciber generated $38M in EBITDA (we exclude stock-based comp, which is an amortization of previous years’ comp, which is actually worthless at this stock price anyway). For our 2013 base case, we give Ciber credit for the $7M in costs the company says the restructuring will save it in 2013, and come up with a base case 2013 EBITDA of $45M. Subtracting $5M in capex and $4M in interest costs, with less than $5M in cash taxes, gets us to a free cash flow of a bit over $30M, on today’s enterprise value of about $270M, for a FCF yield 11%.

This is, in our opinion, a low-end estimate of FCF, with significant upside. As Ciber generates cash in 2013, it should be able to delever to the point where it has no net debt, taking away the interest expense. On the other hand, as it becomes profitable, Ciber will also have to pay closer to 30% cash taxes on its operating income. In that case, we’d also give Ciber some credit for its $40M in domestic NOLs, making it a non-cash-tax-payer for probably two years or so in the US (the value of that, discounted, is probably in the $10M range). By the end of 2013 then, our bnormalized FCF scenario for CBR is as follows:

   $45M in EBITDA

-  $5M in capex

-   $12M in taxes

$28M FCF

On top of that, by the end of 2013 we should be able to add some revenue growth and some margin expansion beyond the restructuring. We should also be able to capitalize that FCF at significantly more than 10x given that organic revenue growth is likely, and the fact that Ciber’s focus on its strategic partnerships skews its revenue profile more toward long term sticky managed service contracts rather than 12-24 month ADM contracts. Today, you are paying $270M for an FCF stream where $28M is your low-end estimate, $35M is realistic within 18 months, and the multiple should expand to 15x (all in the context of a growing top line). That may be tough to stomach when as of yesterday, you only had to pay $240M, but we think the price is still incredibly attractive.