Description

Computer Task Group (CTG)

Summary

We focus on smaller companies with “Ft. Knox” balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions.  Obviously, it is important we have a management team that cares about shareholder value.  We focus on small-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.

Computer Task Group (CTG) is an undervalued information technology services company in North America, South America, Western Europe, and India.  It provides business process solutions, which include strategic advisory, data strategy, digital workplace, enterprise platforms, information disclosure, and regulatory and compliance services.  The Company also provides IT and other staffing services, including managed staffing, staff augmentation, and volume staffing services.  CTG serves the financial services, healthcare, manufacturing, and energy industries, as well as technology service providers.

CTG has gradually transformed itself from a staffing services company into an IT solutions company with higher margins and more stable performa.  Adjusted EBITDA has increased from $9.5m in 2018 to $12.5m in 2019 and $15m in 2020.  nceCTG performed well during the pandemic and its business showed strong resilience as work from home requirements drove increased demand for its technology services.

CEO Filip Gyde ran CTG’s European division successfully for many years and was made CEO in early 2019 and has pursued an aggressive program to exit lower margin staffing services and grow higher margin and more resilient solutions services since taking over.  This is the same strategy Gyde executed in Europe for CTG which resulted in profitable growth for nine consecutive years.  We believe Gyde has a laser-focus understanding of which specific solutions services are most critical to existing and potential customers and is carefully building a strong and resilient solutions business across all of CTG.  Non-GAAP operating income and non-GAAP operating margins have consistently improved as IT Solutions continues to become a large share of total revenues for CTG.  CTG’s European operations currently provide a dominant share of total operating profits even though they are only about 40% of total revenues.  This is due to Gyde’s strategy in Europe which has been executed for many years there.  Further, CTG is under intense pressure to achieve continued improvements given an aggressive position held by an activist group, which made offers to purchase the company in mid-2019 and early 2020.

CTG’s long-term targets include solutions revenue of over $250m by 2023 and adjusted EBITDA of $35m.  While we are not convinced CTG can achieve these aggressive targets, we believe CTG will move aggressively towards them and, as a result, drive strong shareholder value.  CTG has a highly cash-generative business model with limited capital expenditure requirements and a “Ft. Knox” balance sheet with a net cash position of about $33m at Q1 of 2021, or about 20% of total market value.

CTG’s shares currently trade at about $10 per share with about 15m shares outstanding for a market cap of $150m. 

CTG has a “Ft. Knox” balance sheet with net cash position of about $33m as of 3/31/21 for a total enterprise value (EV) of about $120m.  LTM EBITDA is about $16m.  LTM free cash flow (FCF) is about $12m.  CTG is currently trading at about 7.5x adjusted EBITDA and a 10%+ unleveraged FCF yield.  CTG trading volume is light, so this idea is likely appropriate for PA accounts or small- and micro-cap funds. 

CTG’s strategy is to grow its IT solutions business to $250m of revenue by 2023.  As indicated below, IT Solutions is growing and becoming a larger part of CTG’s overall business, as CTG is concurrently exiting less profitable IT Staffing business.  CTG owns or leases a total of 25 facilities throughout the world, including North America, Europe, South America, and India. 

CTG has grown EBIT from $6m in 2017 to $11m in 2020.  Adjusted EBITDA grew from $8m in 2017 to about $16m for LTM ended 3/31/21.  We think adjusted EBITDA can grow significantly by 2023 to $25m or more via modest organic growth in revenues, improved margins due to increased emphasis on IT Solutions, and strategic, targeted acquisitions to add services and geographies required by customers.  CTG has completed three small acquisitions recently, one each in 2018, 2019, and 2020, and these have helped to drive growth.

We believe CEO Gyde is carefully assessing which services are most critical to existing and potential customers and using this to target accretive bolt-on acquisitions. 

We believe CTG can sustainably generate $10m+ of FCF with current operations for an unleveraged FCF yield near 10% which we believe is attractive with 10-year treasury rates near 2%.  We believe CTG will use its free cash flow and “Ft. Knox” balance sheet to grow organically as well as inorganically via bolt-on acquisitions.  As IT Solutions continues to become a larger share of total sales and profitability, we expect CTG’s valuation multiple will increase.  Based on 10x adjusted EBITDA of $25m by 2023 plus $50m in estimated net cash, CTG would have a market cap of $300m or about $20 per share vs. the current $10 share price (+100%).

Business Description

Computer Task Group (CTG) is an information technology (IT) services company in North America, South America, Western Europe, and India.  It provides business process solutions, which include strategic advisory, data strategy, digital workplace, enterprise platforms, information disclosure, and regulatory and compliance services.  The Company also provides IT and other staffing services, including managed staffing, staff augmentation, and volume staffing services.  CTG serves the financial services, healthcare, manufacturing, and energy industries, as well as technology service providers.

The charts below help to give an overview of CTG’s business model.

Below is a chart that shows CTG’s shift into higher margin IT solutions segment over the past few years.  This has resulted in improved profit margins and cash generation at CTG.

Below is a chart that shows CTG’s total revenues by industry focus and that CTG is focused on industries which have higher growth potential for IT services, like financial services, healthcare, and manufacturing.

Below is a chart that shows CTG generates revenues primarily from lower-risk time and material contracts.

The chart below shows the geographical breakdown of CTG’s total revenue and profitability bases.  It shows how European operations are currently more profitable than U.S. operations and contribute the lion’s share of overall profitability.  The current CEO ran CTG’s European operations and was promoted to CEO in early 2019 due to the strong performance in Europe during his tenure.  We believe that over time he can bring similar improvements to U.S. operations as well with the strategy of increased focus on IT Solutions.

Strong Management and Ownership Oriented Towards Disciplined, Long-Term Value Creation

CTG’s CEO is Filipe Gyde.  He has been CEO since early 2019.  He was previously the leader of the European operations of CTG which has successfully grown profitability over the last several years.  A major part of the strategy in Europe was to focus on higher-margin, more value-added IT solutions services.  As can been seen from the chart above, European operations are the most profitable part of CTG’s overall business.  Filipe Gyde was promoted to CEO based on his success with European operations and he is executing that same strategy today across the entire company.  European operations under Gyde had nine consecutive years of profitable sales growth based on his strategy of focus on IT Solutions.  CTG has made three modest size acquisitions over the past three years which provide services and capabilities which customers require and will pay for.  We believe CTG will continue to conservatively make small acquisitions and continue to build up its IT services revenues and profitability over the next few years.

Attractive Valuation with Large and Sustainable Free Cash Flow Yield

CTG is currently trading at about 7.5x adjusted EBITDA, which is attractive for a IT services business that can grow mid-single digits organically with modest capital investment needs and strong free cash flow.  We believe CTG can sustainably generate free cash flow of $10m+ per year as compared to its current enterprise value (EV) of about $120m for an unleveraged FCF yield of 10%+.  We believe this is attractive when compared to 10-year treasury rates near 2%.  We describe below some reasons why CTG’s results might be more sustainable than its current market valuation would indicate.

Steady Shift into Higher Margin Solutions Under New CEO 

Under its IT Solutions centric strategy, CTG has gradually shifted its revenues into higher margin, more value-added IT solutions services for its end market customers.  IT solutions sales as a percentage of total sales has gradually increased over the past few years.  Back in 2010, CTG was almost entirely an IT staffing services company but the company has gradually shed less profitable and sustainable staffing revenues projects which has resulted in depressed revenues but higher margins.  CTG has a target of reaching $250m of IT solutions revenues by 2023.  We believe as CTG continues to increase its IT solutions business and shed lower-margin staffing IT services, its profitability and cash flow generation will continue to increase.  We believe this will eventually result in a higher multiple for CTG as it becomes recognized as primarily an IT solutions company.  Currently, IT Solutions contribute close to 60% of CTG’s overall profitability and we expect this to increase further over the next few years.

Growth in IT Services Markets, Accelerated by the Pandemic

CTG serves end markets which are expected to have strong growth over the next five years.  The IT services capabilities that CTG provides are extremely high priorities for organizations who are expected to continue to invest in these areas even in a recessionary environment.  The work-from-home trends driven by the Pandemic have only accelerated these demands.  Further, CTG appears highly focused on specific urgent needs required by these organizations with regard to IT services.  These include the following areas: Internet of Things (IOT), Agile and Dev Sec Ops, Intelligent Automation, Cloud Computing Platforms, Automated Testing, and Data and Analytics.

Strong Cash Flow Generation and Cash-Generative Business Model

CTG has generated strong cash from operations and FCF for LTM 3/31/21.  LTM cash from operations is $17m and FCF is almost $12m.  Absent a severe recession, we believe these strong levels of cash from operations and FCF can be sustained and can grow over the next few fiscal years.  These results reflect CTG’s highly cash-generative business model, which has limited working capital and capital expenditure requirements.  CTG believes maintenance capital expenditures are about $2m per year.  This compares to almost $16m in LTM adjusted EBITDA.

CTG has several tools at its disposal to drive long-term shareholder value. We believe CTG is likely to use its strong cash generation to drive shareholder value over the next few years via accretive acquisitions, special dividends, or share repurchases.

Expansion Potential Via Focused Niche Acquisitions

We believe CTG has significant potential to expand via niche acquisitions companies that provide incremental service capabilities for customers and incremental geographic capabilities and that cross-selling opportunities have strong potential.  CTG has been highly focused on the niche capabilities that recent acquisitions has provided based on the demand requirements that it receives from its end user customers.  We believe CTG can continue to profitably add small acquisitions that are strongly accretive over time and that this can be a major contributor to long-term growth in adjusted EBITDA over time.  Over the past three years, CTG has completed three small acquisitions, including Soft Company in 2018 (data analytics and software development in Europe); Tech-IT in 2019 (government financial services in Europe); and Star Dust in 2020 (retail and technology and financial services in Canada and France).  We expect these focused and careful types of acquisitions to continue over the next few years and, along with steady organic growth, build CTG into a larger, more profitable, more resilient company.

High Returns on Invested Capital

CTG’s information technology services business results in a business model with limited working capital and capital investment requirements.  Capital expenditures over the past few years have averaged $2m or less.  As a result of these limited capital requirements, CTG has been able to earn high returns on invested capital and generate substantial free cash flows over the last several years.  To evaluate return on invested capital or ROIC, we like to look at operating earnings (EBIT) or free cash flow (FCF) compared to the net investment in tangible assets which is the investment in: (a) net-working capital excluding cash, plus (b) net PPE.  These are the tangible assets the business requires to generate the EBIT or FCF.  At 3/31/21, non-cash working capital for CTG was about $20m and net PPE was about $5m for a net investment in tangible assets of about $25m.  This compares to LTM EBIT of about $9m+ or about a 35% return on invested capital (ROIC), which we think is attractive for a growing IT services business with increasing focus on the more profitable IT solutions segment.

Steadily Improving Profitability

CTG has show consistently improving profitability over the past few years under CEO Filip Gyde.  This has been driven by increased focus on higher margin IT Solutions services, reduced focus on lower margin IT Staffing services, accretive and strategic acquisitions, investment in sales and marketing, and strong cost controls and expense management.  Adjusted EBITDA has increased from $9.5m in 2018 to $12.5m in 2019 and $15m in 2020.  We expect continued improvement in profitability over the next few years as CTG uses the multiple tools in its playbook to drive improvement over time. 

“Ft. Knox” Balance Sheet Reduces Risk and Creates Opportunities

CTG has a “Ft. Knox” balance sheet today with a net cash position of about $33m at 3/31/21.  We believe the Company’s strong balance sheet substantially reduces risk and gives the Company opportunity to take advantage of strategic opportunities which are both organic and inorganic.

Conclusion and Target Price

At 10x our adjusted EBITDA estimate for 2023 of about $25m plus $50m of net cash, CTG would have a market value of close to $300m or about $20 per share (+100%).   If CTG’s management team continues to execute and its IT services business continues to grow, including strategic and accretive bolt-on acquisitions, we think our target prices could be achieved. 

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              Quarterly Consolidated Results

Catalysts

1.       Strong free cash flow of $10m+ per year or close to 10% unleveraged FCF yield.

2.       Bolt-on accretive acquisitions of essential IT Solutions services and geographies help grow total revenues and adjusted EBITDA over time.

3.       Modest valuation of 7.5x LTM EBITDA and 10%+ unleveraged FCF yield for a niche IT services business with mid-single digit organic revenue growth over the long term.

4.       Growth of IT Solutions as % of total revenues results in higher multiple over time.

5.       CEO Filip Gyde has an excellent track record executing his strategy of “IT Solutions First” business model over many years in Europe – Europe is the dominant profit driver for CTG today as a result.

6.       CTG has a 2023 target of 50% of revenues from IT Solutions ($250m) and $35m in EBITDA.

7.       “Ft. Knox” balance sheet with net cash position of $33m at present and we estimate $45m by year-end 2021.

8.       Recognition of CTG’s growing IT services end-markets and its specialized value-added services focused on those attractive end-markets. 

9.       Recognition of CTG’s high ROIC, non-capital-intensive, cash-generative business model.

10.    Major share re-purchase program and/or large special dividends.

11.    Acquisition by a larger player in IT Services industry.

Risks

1.       Economy turns down sharply, and/or IT industry spending is curtailed.

2.       IBM contract (20% of total revenues) is cancelled or changed adversely for CTG.

3.       CTG misallocates capital into a poor acquisition.

4.       CTG is unable to execute on its plan to drive higher margins via expansion of IT solutions segment.

Disclaimer

Disclaimer:  We own shares of CTG.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but readers should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.

Catalyst

See above.