Description

Investment Summary: First Consulting (FCGI -$5.74, $140M mkt cap, $100M EV) is a cheap stock. We value the company at between $8-9 on either an ongoing or breakup analysis. (What can be done to realize this value is another question, as entrenched management is averse to buybacks, preferring instead to pursue an additional accretive acquisition). The key to the company achieving its margin and earnings goals for 2005 and beyond is to generate more revenue over a stable (but enormous!) operating expense structure. Nonetheless, we are inclined to give the company a few more quarters to show some growth, make an accretive acquisition, or sell itself.

Business Summary

The company essentially does 3 things:
1) IT outsourcing - they take over a hospital or health plan's IT department
2) Consulting on implementation/integration of a 3rd party (e.g. Cerner) system.
3) Clinical/Regulatory software package aimed at pharma/biotech (45 customers)

In general, a more complex IT environment within hospitals should be creating new business for FCGI. As a hospital's IT budget grows in size (above 3% of total), the 8-12% of savings that outsourcing might offer becomes more compelling. The company is targeting small to mid-size clients to avoid being priced out of the market by bigger players.

The company's strategy for getting earnings and revenue to break above the 5 ct / $70M per qtr level is to grow revenue through the Life Sciences practice and through outsourcing deals. The visibility on the Life Sciences business is minimal, and it seems non-core in nature (see below). We have a low confidence level that it can actually be achieved. The ability to grow through outsourcing deals would seem to be the highest probability...and that is where we should get some traction. The company is suggesting that we should get one meaningful outsourcing deal per quarter going forward so that will be the gauge of the tone of business going forward.

Valuation/Breakup Analysis:
FCGI's Life Sciences Business is a niche business: It targets regulatory filings and compliance software packages for pharmaceutical companies and biotech companies alike. It is on track to do $33-$35M in sales for '04. It is not currently a profitable business although the company hopes to achieve breakeven in the next few months. Comps like Dendrite (DRTE, $18.50) trade at 1.8x revenue currently. At 1.5X revs the Life Sciences business could be sold for $51M, or $2/share (The tax basis of the Life Sciences business is actually closer to $120 mln, which is what they paid for the unit in stock in 1998.That tells you something, too!) The FCGI Life Sciences business is negative to the tune of 3.5c per quarter. The company confirmed that they hope to break even by end of Q1 or close to that.


The Health Delivery/Outsourcing business can garner a .5x sales mutliple in our view, given that competitor PER trades at 1x and EDS trades at .55x.

Adding in the cash of $1.88 per share (25M shares) and you come to around $8.50 per share in value.

Breakup Value Analysis/Revs:
Unit Revs/Unit Multiple Value/Share
Life Sciences $34M 1.5 $2.00
Health Deliv/Outscourcing $160M 0.5 $3.20
Other Business Units $73M 0.5 $1.46
Cash 1 $1.88
Total $8.54


Alternatively, eps, ex-cash and ex-the loss-making Life Sciences business are running about $0.32, thus a modest 15X multiple = $4.80 + $1.88 in cash and $2 for Life Sciences = $8.88.



Management:
FCGI's Chairman and CEO, Luther Nussbaum, may have spent too much money on strategy consultants and not enough time close to the business. However, Luther's recent purchase of stock and the tone (relative to the past) on the recent (non-deal) IR roadshow, both point to an upward bias in fundamentals

Upcoming Catalysts
1 outsourcing deal per quarter....upside. $2-3M in first year, with $1-2M in following years.
The company hopes to achieve to UNLEASH ultimate annual earnings power of $0.60+, which in its own right at a 15x multiple = $9, although one could argue that with rising estimates a higher valuation could be justified. 1X revs or 20X eps = $12 but they are admittedly a long way from deserving either.
1)Life Sciences to Breakeven: .035 quarterly
2)Life Sciences to Normal Profitability: .025 quarterly
3)Infrastructure Underabsorption: .02 quarterly
4)Leverage G&A
5)Improvement of outsourcing business profitability: .025 quarterly

At this valuation, the downside seems modest and the upside attractive if somewhat uncertain in probability.

Catalyst