Charles River Associates CRAI
October 02, 2017 - 4:51pm EST by
zach721
2017 2018
Price: 42.25 EPS 0 0
Shares Out. (in M): 8 P/E 0 0
Market Cap (in $M): 345 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 330 TEV/EBIT 0 0

Sign up for free guest access to view investment idea with a 45 days delay.

 

Description

CRAI is a consistent and above average business with a low valuation. The company has 10% free cash margins, +30% free cash flow/tangible book value, and is valued at approximately a 12.5% operating cash flow yield. The company is aggressively repurchasing stock and has shrunk the share count from 10 million plus to about 8 million over the last couple years. Guidance is for mid-single digit revenue growth and better than 12% operating cash flow margins (our estimates are CAPEX 1-2% of revenue) with $365 million in annual revenue. We believe over the next 4 years aggregate revenue should total $1.6 billion in revenue with north of $160 million in free cash flow ($20 per share). In other words, the business should average around $400 million in annual revenue over the next 4 years.  The current EV is about $300 million and the business is valued at about .90 EV/sales and 8x EV/OCF. Additionally the company has $140 million in untapped lines (40% of the market cap).

 

Exponent (EXPO) executed a similar strategy of consistent revenue growth with big buy backs and good returns on capital. EXPO has increased in value by 7x since 2010 and now trades at 5.4x sales and 25x EV/EBITDA. CRAI has added new lines that require more capital to replicate and make it less likely that a consultant can start their own practice out of their house. Also CRAI’s increased size attracts a certain caliber of clientele that a smaller practice cannot compete with.  At the consultant level, working at CRAI increases the opportunity to work with other smart people and to work on interesting/complex projects.  CRAI has expanded into several new interesting business lines via the C-1 acquisition such as Life Sciences (commercialization, therapy, growth strategies, policies, litigation/IP rights, etc.) and Cyber-Crime investigation (CRAI eDiscovery & Structured data lab). Additional barriers are large engagements that require bench strength and one stop shop for multiple experts. CRAI’s competitive strengths have led to 98% of the top 100 US law firms and 81% of the Fortune 100 have used CRAI services over the last 24 months.  CRAI services include: Antitrust & Competition, Auctions & Competitive Bidding, Class Certifications, Cyber Crime Investigation, Damages & Valuation, eDiscovery & Structured Data, Financial Economics, Forensic Accounting & Investigation, Intellectual Property, International Arbitration, Labor & Employment, Management Consulting, Mergers & Acquisitions, Regulatory Economics & Compliance, Securities & Financial Markets, Transfer Pricing. CRAI capabilities are mainly focused on very significant economic outcomes for their clients which are typically very large corporations. CRAI is less sensitive to economic slowdown than expected as they have been profitable for more than a decade and many of their practices have a recurring profile.  CRAI average bill rate per consultant is over $600,000 (which includes 120 people in management/non-billable) and has been in business over 50 years. Recently, the CEO of of Franklin Covey, Bob Whitman was added to the board.

 

Management has codified a capital allocation policy with a focus on returning capital to shareholders (see below from most recent IR presentation):

 

 

Business momentum is strong as the company on the July earnings call increased their guidance for 2017.  CRAI has been going through an aggressive hiring spree adding ~150 consultants in the last three years, of which ~50 were added in just the 1H17.  It takes a couple of quarters for the consultants to ramp up, so with the current consultant base run-rate revenue is $375 million or above (up from $343 million LTM).

 

 

We believe the current $5.00 per share in operating cash flow could increase considerably over the next several years depending on: A) the stock trading at 10-12%+ operating cash flow yield resulting in meaningful stock repurchases and B) the company hitting its guidance (which we think is likely, given its historical track record). If A&B continue the company will likely be able to both substantially reduce its share count (denominator) while simultaneously growing the numerator which should lead to strong free cash flow growth per share.

 

CRAI is still trading at a discount to comps, even given its consistent growth/margin profile:

Over the last 5 years, EXPO allocated approximately 40% of operating cash flow to share repurchases, while the business consistently averaged 17% ROIC and 18% ROE. The plan worked well as the business is now valued at 5.3x sales and 20x EV/EBITDA. CRAI is executing a similar business plan from a capital allocation and strategy stand point. However, CRAI trades at only .9x sales and 8x EV/operating cash flow. We think there is room for multiple expansion for CRAI. We think both are good businesses as CRAI free cash flow/tangible book value is approximately +30% vs. EXPO’s +22%.  See below for the EXPO chart which many would deem a “boring business” with revenue growth from 2012-2016 of just 2-8% annually and Sell Side analysts are forecasting through 2019 5-7% annual revenue growth.  Currently, the average sell side analyst has target on EXPO -7% the current price and CRAI +30% above the current price. We think the upside maybe higher for CRAI.  With consistent execution and large share repurchases, however, the company has generated significant shareholder value.

 

Finally, CRAI has +50% higher revenue per head, is 20% larger in terms of revenue than EXPO, while EXPO has 600 bps better FCF margins the business is valued at 5X+ EV/SLS and 22X EV/OCF vs. CRAI at 0.9x EV/SLS and 8x EV/OCF. We believe both companies will grow revenue at comparable rates (maybe a slight edge to CRAI). We believe there is a strong runway ahead for earnings and multiple expansion at CRAI. One final note that we believe the market was thrown for a loop as CAPEX was elevated for new offices (NYC, Boston, and London)…CAPEX should be around 1-2% of revenue (which checks out with the last three quarters as well as long term back to 2000).

Disclosure: This does not constitute a recommendation to buy or sell shares of CRAI. We own shares in CRAI and we may buy or sell shares without updating this board. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Consistent revenue growth and free cash flow

continued aggressive share repurchses share count down from 10 to 8.2

Multiple expansion given 12% operating cash flow yield 

Focus on newer growth verticals Cyber Crime, eDiscovery, and Life Sciences 

    sort by    

    Description

    CRAI is a consistent and above average business with a low valuation. The company has 10% free cash margins, +30% free cash flow/tangible book value, and is valued at approximately a 12.5% operating cash flow yield. The company is aggressively repurchasing stock and has shrunk the share count from 10 million plus to about 8 million over the last couple years. Guidance is for mid-single digit revenue growth and better than 12% operating cash flow margins (our estimates are CAPEX 1-2% of revenue) with $365 million in annual revenue. We believe over the next 4 years aggregate revenue should total $1.6 billion in revenue with north of $160 million in free cash flow ($20 per share). In other words, the business should average around $400 million in annual revenue over the next 4 years.  The current EV is about $300 million and the business is valued at about .90 EV/sales and 8x EV/OCF. Additionally the company has $140 million in untapped lines (40% of the market cap).

     

    Exponent (EXPO) executed a similar strategy of consistent revenue growth with big buy backs and good returns on capital. EXPO has increased in value by 7x since 2010 and now trades at 5.4x sales and 25x EV/EBITDA. CRAI has added new lines that require more capital to replicate and make it less likely that a consultant can start their own practice out of their house. Also CRAI’s increased size attracts a certain caliber of clientele that a smaller practice cannot compete with.  At the consultant level, working at CRAI increases the opportunity to work with other smart people and to work on interesting/complex projects.  CRAI has expanded into several new interesting business lines via the C-1 acquisition such as Life Sciences (commercialization, therapy, growth strategies, policies, litigation/IP rights, etc.) and Cyber-Crime investigation (CRAI eDiscovery & Structured data lab). Additional barriers are large engagements that require bench strength and one stop shop for multiple experts. CRAI’s competitive strengths have led to 98% of the top 100 US law firms and 81% of the Fortune 100 have used CRAI services over the last 24 months.  CRAI services include: Antitrust & Competition, Auctions & Competitive Bidding, Class Certifications, Cyber Crime Investigation, Damages & Valuation, eDiscovery & Structured Data, Financial Economics, Forensic Accounting & Investigation, Intellectual Property, International Arbitration, Labor & Employment, Management Consulting, Mergers & Acquisitions, Regulatory Economics & Compliance, Securities & Financial Markets, Transfer Pricing. CRAI capabilities are mainly focused on very significant economic outcomes for their clients which are typically very large corporations. CRAI is less sensitive to economic slowdown than expected as they have been profitable for more than a decade and many of their practices have a recurring profile.  CRAI average bill rate per consultant is over $600,000 (which includes 120 people in management/non-billable) and has been in business over 50 years. Recently, the CEO of of Franklin Covey, Bob Whitman was added to the board.

     

    Management has codified a capital allocation policy with a focus on returning capital to shareholders (see below from most recent IR presentation):

     

     

    Business momentum is strong as the company on the July earnings call increased their guidance for 2017.  CRAI has been going through an aggressive hiring spree adding ~150 consultants in the last three years, of which ~50 were added in just the 1H17.  It takes a couple of quarters for the consultants to ramp up, so with the current consultant base run-rate revenue is $375 million or above (up from $343 million LTM).

     

     

    We believe the current $5.00 per share in operating cash flow could increase considerably over the next several years depending on: A) the stock trading at 10-12%+ operating cash flow yield resulting in meaningful stock repurchases and B) the company hitting its guidance (which we think is likely, given its historical track record). If A&B continue the company will likely be able to both substantially reduce its share count (denominator) while simultaneously growing the numerator which should lead to strong free cash flow growth per share.

     

    CRAI is still trading at a discount to comps, even given its consistent growth/margin profile:

    Over the last 5 years, EXPO allocated approximately 40% of operating cash flow to share repurchases, while the business consistently averaged 17% ROIC and 18% ROE. The plan worked well as the business is now valued at 5.3x sales and 20x EV/EBITDA. CRAI is executing a similar business plan from a capital allocation and strategy stand point. However, CRAI trades at only .9x sales and 8x EV/operating cash flow. We think there is room for multiple expansion for CRAI. We think both are good businesses as CRAI free cash flow/tangible book value is approximately +30% vs. EXPO’s +22%.  See below for the EXPO chart which many would deem a “boring business” with revenue growth from 2012-2016 of just 2-8% annually and Sell Side analysts are forecasting through 2019 5-7% annual revenue growth.  Currently, the average sell side analyst has target on EXPO -7% the current price and CRAI +30% above the current price. We think the upside maybe higher for CRAI.  With consistent execution and large share repurchases, however, the company has generated significant shareholder value.

     

    Finally, CRAI has +50% higher revenue per head, is 20% larger in terms of revenue than EXPO, while EXPO has 600 bps better FCF margins the business is valued at 5X+ EV/SLS and 22X EV/OCF vs. CRAI at 0.9x EV/SLS and 8x EV/OCF. We believe both companies will grow revenue at comparable rates (maybe a slight edge to CRAI). We believe there is a strong runway ahead for earnings and multiple expansion at CRAI. One final note that we believe the market was thrown for a loop as CAPEX was elevated for new offices (NYC, Boston, and London)…CAPEX should be around 1-2% of revenue (which checks out with the last three quarters as well as long term back to 2000).

    Disclosure: This does not constitute a recommendation to buy or sell shares of CRAI. We own shares in CRAI and we may buy or sell shares without updating this board. 

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Consistent revenue growth and free cash flow

    continued aggressive share repurchses share count down from 10 to 8.2

    Multiple expansion given 12% operating cash flow yield 

    Focus on newer growth verticals Cyber Crime, eDiscovery, and Life Sciences 

    Messages


    SubjectAnswer
    Entry10/03/2017 03:03 PM
    Memberzach721

    The bump in PPE for 2015/2016 was to upgrade/enlarge their offices, however part of the PPE is/was offset by tenant improvement allowance that don't show up in the capex line.  For example, in 2016 they spent ~$11 million in capital outlays for real estate (out of $13 million in total capex) offset by ~$2 million in allowances.

    The bump in office upgrade capex is over and the 1H17 is more indicative of capex going forward.  The company tends to update their offices every decade or so.
    Forgivable loans are mostly used as an acquisition tool but also a retention tool, for consultants (more details below from 10K).  Hence a consultant is paid cash upfront in form of a lump sum 'loan' - if the consultant leaves before the term of the agreement then he/she will need to pay back the remaining part of the loan.
     
    10K:
    In order to attract and retain highly skilled professionals, we may issue forgivable loans or term loans to employees and non-employee experts. A portion of these loans is collateralized. The forgivable loans have terms that are generally between three and eight years. The principal amount of forgivable loans and accrued interest is forgiven by us over the term of the loans, so long as the employee or non-employee expert continues employment or affiliation with us and complies with certain contractual requirements. The expense associated with the forgiveness of the principal amount of the loans is recorded as compensation expense over the service period, which is consistent with the term of the loans.
     

     

    SubjectFair value = $105 (+70%)
    Entry08/27/2018 12:25 PM
    Memberengrm842

    We pencil in 2019 adjusted FCF of $7/share after $15mm capex, $22mm forgivable loan issuance, $40mm share repurchases, and $5mm dividends. HURN/FCN/NCI trading at 15x trailing FCF despite (a) lower organic revenue growth and (b) less shareholder friendly management team w/ return of capital. 15x our 2019 estimate of $7/share is a $105 stock vs. ~$59 today. Plan is to continue buying back stock and generating boatloads of cash for shareholders. Surprised the discount to fair value is this wide given the quality vs. peers.

    CEO is a rainmaker and wants to compound shareholder capital - we've met with mgmt. several times as our office is located around the corner from company HQ. They have been hitting the road hard and pitching the story as to why their cash flow doesnt screen well given how the forgivable loan issuance is treated vs. outright LLC acquisitions.

    Bottom line: the market rewards public consulting firms w/ higher stock prices that return capital back to shareholders via share repos and dividends.

     


    Subjectquestions
    Entry09/10/2018 11:59 AM
    Membermpk391

    engrm: how are you calculating FCF?  When you say "after" it sounds like you're taking OCF then subtracting capex, forgivable loans, buybacks, and dividends.  if so, why would you subtract buybacks and dividends when calculating valuation multiples?  Also, while I agree that some portion of forgivable loans should be subtracted to get FCF, don't we need to consider adjusting these numbers for maintenance vs growth?  i.e. is $22m just enough to offset attrition of consultants or is some of this spend going to allow them to grow?  I'd assume that when CRAI is in growth mode, forgivable loan issuance is going to understate the true "steady-state" FCF power of the firm.

    zach: I realize the valuation comps in your writeup are a bit dated at this point (perhaps you could update us), but isn't EXPO kind of an outlier here?  Just looking at FCI, NCI, and HURN, CRAI doesn't look terribly mispriced.  Could EXPO be overvalued?  EV/OCF of 22x for mid-single digit revenue growth sounds a bit pricey unless there is some margin expansion story going on, but with margins already 6% higher than CRAI it seems unlikely.  Also, now that EXPO is trading at these levels, its ability to grow FCF/share will be more limited than in the past.

     

      Back to top