Description
Putting the stock’s liquidity aside, GPX meets important investment criteria for downside protection (at least as perceived, even though not based on TBV) and significant upside potential from an attractive FCF-generative business model that is growing (current FCF yield is ~11% and, based on assumed growth in 2007, 15%), a variety of likely positive catalysts, and several secular tailwinds (like Homeland Security services and business process outsourcing) that are favorable to the company and ultimately the investment. I think GPX is undervalued based on its current FCF yield and more importantly based on the Company's prospects. I derive a target price of $12.75 based on 14x tax-effected EBIT that assumes revenue grows 15% in 2007 and 10% in 2008 coupled with margin expanding 200bps in 2007 and 100bps in 2008 to 10%. This doesn’t include the $2 of cash per share our assumptions anticipate being generated in the next two years. At $12.75, the implied FCF yield is over 8% in 2008.
LONG Thesis – Summary of Key Investment Considerations (bullish arguments in more detail below)
1. Numerous changes at GPX, including the divestiture of non-core businesses coupled with a restructuring of its dual-class capital structure, position GPX well for growth and better positioning among public market investors
2. Below the radar with investors but an important “partner” to numerous Fortune 1000 companies and government agencies
3. Marketplace perception is that General Physics is differentiated
4. High retention of “Blue Chip” customers in diverse industries
5. Outsourcing trends are growing as customers seek a more variable cost base; outsourcing of training by major corporations is a significant growth trend (industry research suggests mid/high teens) and one for which GPX is well positioned to capitalize, with both incremental business from existing accounts and penetration with new accounts
6. Opportunity to expand services within existing accounts
7. New client wins continue at a rapid pace
8. Motorola business could be a significant inflection point
9. Heightened terrorist alert since 9/11 continues to be growth catalyst for GPX
10. International growth opportunities
11. Growth expectation for 2007 is significant at 44% EBIT growth but reasonable given secular trends and company’s likely success focusing on increased “wallet” penetration
12. Attractive valuation; FCF is very strong and growing
13. Return on capital improving, at 18% in 2005 compared to 3% in 2004
14. Attractive as MBO or for strategic consolidation
15. Management continuity coupled with alignment and pursuit of prudent share repurchases given current valuation and business performance/outlook
16. Management is prudent in allocating capital
17. Recent Quarterly Results Highlight Good Execution, Significant Growth in Operating Income, Bullish Outlook
18. Numerous catalysts/headlines should develop to drive increased visibility of strong performance and continued growth
2003 2004 2005 1H05 1H06
Revenues
Process, Energy & Gov't 76.9 84.2 86.0 42.1 38.9
Manufacturing & BPO 57.0 80.9 90.1 45.1 50.4
Total 133.9 164.5 175.6 87.2 89.3
Operating Income
Process, Energy & Gov't 7.6 9.0 10.4 5.0 3.4
Manfacturing & BPO -3.3 -0.2 3.2 1.2 3.5
Corporate -10.4 -6.5 -2.1 -1.2 -1.2
Total -6.3 1.8 11.0 5.0 5.7
Why is the attractive investment opportunity available?
- Opportunity exists because the stock is under-followed; company has little research coverage (boutique firms Sidoti, Barrington, and J Giordano) and therefore a deep-dive research approach can yield differences in traded value from intrinsic value.
- The stock is very illiquid and therefore most funds don’t have the duration of capital advantage to allocate time in understanding the GPX opportunity and to patiently buy GPX for significant future upside. Among the key reasons for the stock’s illiquidity is ~20% of the Company’s shares are held by Caxton and Pequot (the latter having purchased most of their shares after signing a non-disclosure statement in Dec/Jan).
- As much empirical data evidences, companies that undergo (or result from) a spin-off frequently provide an attractive investment opportunity. Despite this being a well-documented result among spin-offs, it still frequently occurs (i.e., hasn’t been arbitraged away). GPX’s stock illiquidity amplifies why the opportunity in the spin-off context might exist for VIC members.
Summary Company Description
- For over 35 years, GPX has provided performance improvement products and services to Fortune 1000 companies, utilities, and government customers; the business name is General Physics Corporation
- Services include
- Plant, equipment and process launch assistance
- Technical support services include procedure writing and configuration control for capital intensive facilities, and plant start-up assistance, logistics support
- Plant and process engineering review and re-design
- Civil, mechanical and electrical engineers provide consulting, design and evaluation services regarding facilities, processes and systems
- General Physics believes it is a leader in the design and construction of alternative fuel stations, cryogenic systems, and high pressure systems
- Technical support products include General Physics proprietary EtaPRO ™ and Virtual Plant software applications that serve the power generation nad petrochemical industries
- Operations and maintenance practice training and consulting services
- Facility design and construction services, enterprise change and configuration management
- Domestic preparedness services and training
- Lean enterprise consulting
- Business continuity planning and support services
- Alternative fuels engineering consulting
- Curriculum development and delivery
- Business process and training outsourcing
- E-Learning hosting
- Consulting and systems implementation
- Development and delivery of IT training on an enterprise-wide scale
· General Physics consists of two reportable business segments: Process, Energy & Government and Manufacturing & Business Process Outsourcing
o Process, Energy & Government (PEG) provides engineering consulting, design and evaluation services regarding facilities, the environment, processes and systems, staff augmentation, curriculum design and development, and training and technical services primarily to federal and state governmental agencies, large government contractors, petroleum and chemical refining companies, and electric power utilities
o Manufacturing & BPO segment provides training, curriculum design and development, staff augmentation, e-Learning services, system hosting, integration and help desk support, business process and training outsourcing, and consulting and technical services to large companies in the automotive, steel, pharmaceutical, electronics, and other industries as well as governmental clients
Selected Specialty Areas
Chemical Demilitarization Training
- GP was awarded a contract in 1989 to construct and operate a Chemical Demilitarization Training Facility at US Army Aberdeen Proving Ground in Edgewood, Maryland
- Since the initial award, GP has secured two competitive re-competitions that extend through FY’09
- GP is responsible for design, development, and maintenance of the training program
- Developed more than 280 courses comprising more than 9,000 hours of curriculum
- Conducted more than 9,000 classes with a student throughput of more than 51,000
- Provided training for contractors, Government oversight, and international inspectors
Compliance Training
- Compliance training topics seek to comply with myriad of health, safety and environmental regulations/industry standards with regards to Process Safety Management, ISO-14000, FDA, HAZMAT, QS-9000, ISO-9000, OSHA, AC&R
Energy Web-based Training
- For over 35 years, GP has been working with power companies to provide workforce development solutions
- The GPiLearn portal provides users access to over 1,400 lessons
Fossil Fuel Power Plant
- Offers two series of workforce development courses for power plant personnel
- Operations Knowledge Series focuses on operations and maintenance of fossil and combined cycle power plants
- Performance Knowledge Series offers heat rate improvement courses to provide an understanding of the concepts behind fossil and combined cycle performance improvement for all levels of power industry professionals
· Customers: services provided to over 400 customers; government represented 40% of revenue in 2005 (perceived risk of such is low given that the 40% is across a diversified group of agencies; however, Department of Army was 20% of total Company revenue in 2005 but such was across a variety of contracts)
· Specific examples of services
o For client United Technologies, GPX offers a suite of services to support United’s Educational Assistance and Learning and Development programs; this includes training administration, logistics, tuition payment, vendor payment, and stock award processing for all United businesses
· Revenue is generated under three types of contracts: fixed-price (71%), time-and-materials (15%), and cost-reimbursable (14%)
· Principal resource is personnel; at end of 2005, GPX employed 1,380 people and over 200 adjunct instructors/consultants
· Competition is mostly from services performed internally by existing and potential customers (i.e., outsourcing is key growth dynamic); marketplace is very fragmented but competition exists from “mom and pops” with $10-20m in revenue (e.g., steel industry expert), government contractors (e.g., Raytheon in technical manufacturing), Accenture, Convergys, Price Waterhouse, Ernst & Young’s, IBM Learning, Exult, Intrepid Learning, plus others in attached exhibit
· Outside of the U.S., GPX maintains offices in Montreal, Mexico City, the UK, France, and Malaysia
Bullish Arguments
Numerous changes at GPX, including the divestiture of non-core businesses coupled with a restructuring of its dual-class capital structure, position GPX well for growth and better positioning among public market investors
- In January ‘06, GPX announced a capital stock restructuring that included the elimination of its dual-class stock structure, a large (and accretive) share repurchase (15% of outstanding) and the removal of a significant stock overhang
- GPX repurchased 2.1m shares of common for $6.80 per share, 0.6m shares of supervoting (Class B) for $8.30 per share, and exchanged 0.6m of Class B for 0.6m of common for an incentive payment of $1.50 per exchanged share
- Since the Class B had 10 votes per share, the holders of the 1.2m shares (approximately 6% of the outstanding) controlled ~41% of the aggregate voting power of GP Strategies
- Transactions were result of Company’s initiative to improve corporate governance and to effect a significant share repurchase; fairness opinion was provided by Baird & Company
- The repurchase and exchange, which totaled $20m, was funded with cash on hand at ~$7.65 per share
- In September ’05, GPX completed a taxable spin of its 57% interest in GSE Systems through dividend to Company stockholders; GSE Systems, in which GPX has no ownership interest, trades under ticker symbol GVP ($30m equity cap as of 4/28/06)
- As an additional sign of confidence by the Company (to the $20m spent by GPX in January to repurchase stock of control shareholders at $7.65 average), GPX authorized the repurchase of an additional $5m of common
Below the radar with investors but an important “partner” to numerous Fortune 1000 companies and government agencies
· Long-established history of technical training providing and fostering workforce development needs
· For over 35 years, GPX has provided performance improvement products and services to Fortune 1000 companies, utilities, and government clients that include the Army (14% of revenue YTD), Cisco (7% of revenue YTD), Agilent, Anheuser-Busch, Bechtel, Boeing, Chevron, Coca-Cola, Computer Sciences Corp, Corning, Doubleclick, Eli Lilly, ExxonMobil, Ford, General Electric, General Motors, Honeywell, IBM, International Paper, Lockheed Martin, Merck, Motorola (potential 10% customer if high end of the $5-25m range is pursued), Northrop Grumman, Pfizer, Qwest, Texas Instruments, United Technologies, US Air Force, US Navy, US Postal Service, US Steel, Washington Group International
Marketplace perception is that General Physics is differentiated
· A lot of companies provide training and e-learning but General Physics is highly regarded for the strong technical abilities it has developed over the past thirty years
· The company has a strong military background with a large proportion of the Company’s personnel from the Special Forces of the Army and also from the Navy Nuclear Program; 80% of the Company’s twenty-five business unit heads and officers have a military background
· In the training industry, General Physics is a brand name and the Company’s reputation gives it the ability to attract the highest-quality personnel; employee churn is below industry norm and voluntary attrition is most frequently to GPX clients
High retention of “Blue Chip” customers in diverse industries
· 60% of top 25 customers have been a customer for five or more years; this is despite the fact that it is not typical for contracts in the commercial segment to be documented for the long-term
· Revenue composition is diverse across industries: 38% government (across numerous agencies except Army 20% but across numerous contracts), 19% electronic/semiconductor, 12% manufacturing, 8% energy, 7% life sciences, 5% automotive, 3% aerospace, 2% process, 6% other
· Services provided to over 400 customers
o Energy / Process: ExxonMobil, Chevron, Citgo, El Paso, Public Service, Duke Energy, Bruce Power, Mid-American, Entergy
o Life Sciences: Lilly, Abbott Laboratories, Wyeth
o Technolgy: Texas Instrument, Cisco, Agilent, KLA-Tencor, Motorola, Unisys, Perot
o Automotive: GM, Ford, Daimler Chrysler, BMW
o Government: Army, NASA, Air Force, USDA, Department of Treasury, IRS, Social Security Administration, Office of Personnel Management
o Other: United Technologies, Siemens, Boeing, Gerdau Ameristeel
· No “significant terminations of the Company’s contracts have occurred over the last five years”
· Though US Army accounted for 20% of revenue in 2005, it was across numerous contracts (i.e., different decision makers); no other customer accounted for more than 10% of Company revenue
Outsourcing trends are growing as customers seek a more variable cost base; outsourcing of training by major corporations is a significant growth trend (industry research suggests mid/high teens) and one for which GPX is well positioned to capitalize, with both incremental business from existing accounts and penetration with new accounts
· A recent study appearing in Fortune magazine showed that outsourcing among US companies is up 50% from four years ago and this is growing at 15-20% annually. Top functions for outsourcing include payroll, HR management, customer service, call centers, technology and now corporate training.
· Outsourcing of training functions is a hot topic these days; companies like DuPont, Nortel, GM and Motorola have committed to major outsourcing approaches.
o Training Outsourcing is often traced to 1986 when the General Physics Corporation was signed by GM to become a full service provider of certain employee learning services
· Why outsource training? In short, it’s more effective and at a lower cost. Training is one of the most multi-disciplinary functions in corporations. For corporate training departments that have yet to outsource, a small group of people is expected to build, deliver, measure, and manage a wide range of training—covering topics from field repair, sales skills, IT technology, new manager training, new hire training, all the way to executive education. New initiatives, continuing product and service introductions, new competitors and ever-growing regulatory requirements can overwhelm in-house training resources. Outsourcing of many functions is necessary to deal with the wide range of training demands. Clients benefit from provider of outsourced training services managing all areas of training to optimize provision of best-of-breed training at reduced cost (i.e., by aggregating buying power). Services that are managed include strategy, competency assessment, curricula design, development, delivery, evaluation and measurement, print and fulfillment, vendor management, and technology management.
· There are a variety of real business benefits to outsourcing business functions; a study conducted by Bersin & Associates (a research and consulting firm focused on training) demonstrates the most important driver is cost reduction. Bersin’s analysis shows nearly 48% of outsourcing decisions have the goal of reducing operational costs. The key argument supporting the trend among Fortune 1000 companies to outsource training is that the outsourcing firm performs the same function on a larger scale and consequently has more efficiencies and experience in a particular function; the notion of “experience curve” yields net benefits to the customer on a cost basis in addition to the outsource provider (e.g., General Physics) generating training administration, curricula design, and access to best-of-breed training that is much more effective.
o Firms that outsource spend 31% less in total annual training expenditures per learner than firms that run training internally. In terms of personnel involved in training activities, outsourcing firms have 26% fewer staff per 1000 learners than companies that manage all training internally.
Ø Approximately $1200 is spent per learner when training operations are all in-house; this decreases to $825 when outsourced
Ø Approximately 10.5 in staff per 1000 learners when training operations are all in-house; this decreases to 7.8 when outsourced
o Staff allocation by function and by project is one of the most strategic decisions a Chief Learning Officer can make. If outsourcing can make these allocations more effective, the impact is much higher than simply saving operational costs.
· Other key reasons (per Bersin study) that corporations outsource training operations is to focus on core of their business, to create variable cost structure, and to access needed skills
· In most organizations (per Bersin study), over 50% of training expenditures occur outside of the centralized training group, so this necessitates a thorough investigation of other groups in terms of the money they are spending and the people who may be partially or fully involved in training-related activities (outsource providers like General Physics help client organizations assess potential inefficiencies and fortify a training process/program that is more effective in substance and cost)
· The Lifelong Learning Market Report, published by Simba Information, estimates that spending on training outsourcing will grow at a high-teen rate in the next couple of years based on about two dozen major outsourcing deals in the pipeline
· In a 2004 survey conducted by TrainingOutsourcing.com, over 60% of the buyers surveyed believed it was likely or very likely that their organization would increase the percentage of training outsourced over the next three years
· The areas that “Outsourcers” have least outsourced are the areas with the highest growth prospects and notably where GPX is most focused; based on data gathered from over 10% of the Fortune 1000, only 22% have outsourced training administration and only 13% have outsourced vendor management (learning management system outsourcing and hosting of other learning technologies are the most outsourced at 47% and 70%, respectively; LMS outsourcers reduced operational costs by nearly 60% on a per-learner basis)
o Least outsourced with significant growth prospects: Training Administration and Vendor Management (key players are Accenture, Convergys, General Physics, IBM, Intrepid Learning Solutions, KnowledgePlanet and Raytheon)
o Most outsourced: Content-driven Learning Technologies and Learning Management Systems (key players are Edcor, ElementK, General Physics, GeoLearning, Intellinex, KnowledgePlanet, NETg, Skillsoft, TEDS)
- Two surveys of HR outsourcing (Conference Board and Society for Human Resource Management) in 2004 estimated that only 1-2 percent of organizations were outsourcing the entire training function; however, ~10% of respondents indicated at that time an intent to consider outsourcing the entire learning function in the future
- Though we haven’t seen an updated survey in this regard, our hypothesis is that the 10% from two years ago has and will continue to increase (VC firm Madrona asserted such to me in a call based on their research which led to them investing additional capital in private competitor Intrepid)
- With an emphasis on training operation management and logistics, GPX is well-positioned to respond to the increased interest in outsourcing
- Leveraging its existing training operations infrastructure, GPX can handle all or part of customer training operations
- Consistent with the past 15 years, the US government is expected to continue outsourcing technical services as it downsizes and replaces government employees with more cost-effective commercial vendors
- As a result of downsizing and expected retirement, government agencies need to rely more significantly on outsourcing to provide skilled workers
- According to the Office of Personnel Management, the non-postal federal civilian workforce (including the Department of State) has decreased from approximately 2.2m in FY 1988 to 1.9m in FY 2004
- In addition, the Department of Defense estimates that over 40% of civilian personnel in military depots and industrial facilities will be eligible to retire by FY 2009
- According to Secretary of Defense, Donald Rumsfeld, approximately 300,000 military personnel are performing work that can be outsourced to commercial contractors
- The Commercial Activities Panel of the Government Accountability Office reported in FY 2002 that outsourcing to commercial providers of non-combat related functions has resulted in savings of 20% or more to the military
Opportunity to expand services within existing accounts
· Within any given account, the opportunity for expansion is an order of magnitude larger than the current service, thereby providing GPX significant growth opportunities to leverage its substantial current base of clients
· At an investment conference this past summer, management said it believed its “wallet” penetration of existing clients was less than 10% and the company would intensify its focus on incremental services to existing clients (to achieve higher margin selling incremental services to current clients and to further improve switching costs as GPX becomes a “sticker partner” to such clients)
· Aside from the government clients, the business that General Physics conducts among the Fortune 1000 is primarily with the Fortune 100 but GPX has few current accounts amounting to $5m or more in revenue (i.e., substantial “wallet share” to gain)
· One example of GPX gradually expanding its services within an account and having the opportunity to still penetrate much more is with Cisco Systems (a company that presumably would only outsource services to a best-in-class provider)
o In early 2004, General Physics won an outsourcing arrangement with Cisco to manage two curriculums for what is now called their corporate university (the two curriculums are Worldwide Talent Management and Management Development)
o The curriculum Management Services included content selection, scheduling, delivery, logistics, materials management, data systems administration, financial and other reporting, and benchmarking the results of this leadership and development training with the results of other companies providing training to their leadership as well
o Given GPX’s historic strength has been in the technical area, it’s quite significant that the Company’s initial business with Cisco was a provision of non-technical training services; without owning the content, GPX was able to build a BPO service line for Cisco in the learning and development area
o Two years after penetrating Cisco as a new client with Worldwide Talent Management and Management Development curriculum, General Physics manages nine curriculum sets, including Change Management, Communications, Diversity, Service Technical Leadership
o GPX’s business with Cisco extends beyond the US to the UK, France, the Netherlands, and Singapore
o For the first six months of 2006, GPX’s revenue with Cisco was up 19.5% to $6.3m; management said during its Q2’06 call that “this customer” is expected to be in excess of $10m in 2006
o Management also said that the $10m represents only ~5% of [Cisco’s] current training spend
· Another example is with Agilent where GPX expanded from vendor management to learning consulting to design/development
o GPX was retained to manage vendors that provide leadership and development; based on work done for Agilent, the client has served as a reference for GPX and also recently contracted for GPX to analyze organizational and development needs of the Agilent unit responsible for customer satisfaction (specifically, General Physics is providing structured OJT certification process for Agilent’s technical employees)
· Another example is with United Technologies where GPX’s initial business was managing and administering UTX’s tuition assistance program; based on the relationships made and success of executing the tuition reimbursement program, GPX’s business with UTX expanded to include administrative support for their corporate leadership and development curriculum at the corporate and the business unit level; the company is also now in discussion with Sikorsky regarding technical training and performance improvement consulting
New client wins continue at a rapid pace
- The focus in 2006 and beyond is on cross-selling initiatives to leverage relationships already established with Fortune 1000 clients; nevertheless, GPX continues to penetrate new clients (e.g., recently added Corning, Spansion, Clorox, Alcoa, Textron, Lexmark, AMD, Russell and Motorola as described below)
Motorola business could be a significant inflection point
· In November 2005, GPX announced an agreement with Motorola to provide outsourcing services; given Motorola is well-known as a leading innovator in corporate training, the fact that Motorola has chosen to outsource part of its training administration and workforce development needs (a meaningful decision by Motorola that presumably involved its CEO since ~65% of decisions to outsource a significant part of training involve the CEO, COO or CFO at the customer, according to Learning Outsourcing Research Report published in 2005 by the American Society for Training & Development and IBM Learning Solutions) coupled with GP Strategies as the outsourced provider makes the announcement a significant inflection point (for the training industry as it relates to the outsourcing trend in the training industry and for GPX in winning the business in a competitive process)
o The company has said that business with Motorola might represent $5-25m (this is from $200m that Motorola reportedly spends) but no revenue has been earned from this announcement as of yet since the arrangement is still in “pilot mode”
o Another important takeaway from the arrangement is that a portion of GPX’s payment is based on incentive compensation (we don’t know the specifics of the arrangement but since Bersin & Associates reports that firms that outsource spend 31% less in total annual training expenditures per learner than firms that run training internally, the incentive arrangement could be attractive to GPX and moreover lead to greater penetration of the $200m that Motorola reportedly spends on workforce development)
o Incentive compensation will be all incremental profit, thereby further expanding GPX’s operating margin
Heightened terrorist alert since 9/11 continues to be growth catalyst for GPX
- GPX has extensive experience helping government and commercial customers prepare for biological, chemical, radiological, and explosive threats
- Experience includes: 20 years of operations and training support to the Army’s Chemical Weapons Stockpile Disposal Program, 12 years training Hazmat First Responders nationwide, 3 years of support to Department of Justice domestic preparedness training, and responsibility for operating the American Red Cross’ Clara Barton Center for Domestic Preparedness
- GPX also has significant experience helping hospitals prepare for terrorist attacks; work in this area includes preparedness assessments, emergency planning, and personnel training
- Management doesn’t report utilization metrics but told me that it’s effectively over 100% in the government segment; when funding is curtailed for certain programs, management says it can easily assign headcount to other initiatives and, if not, then the Company rationalizes its capacity relatively quickly to eliminate the fixed cost drag
International growth opportunities
- Revenue from outside the US represented ~10% in 2005 and is expected to grow significantly based on GPX intensifying its plan to open up new offices and acquire existing operations abroad; it is important to note that GPX isn’t simply speculating on international expansion opportunities but pursuing the objective that the Company’s customers have requested (i.e., GPX doesn’t open new offices abroad unless a client has contracted for business from GPX already in that international market)
- In the last two years, GPX developed a presence in Europe at the request of customers Agilent Technologies and Texas Instruments
- In January, the Company met its objective for having resources in China with the hiring of a Chinese citizen out of Thunderbird University to open up operations for General Physics in China
- With many of GPX’s customers in China or plans to open in China, management estimates that the training market in Asia-Pacific will exceed the size of the North American training market in a few years
- During Q2’06, GPX entered into a letter of intent with a major university in China that would help expand the Company’s presence into the Asia-Pacific market; management said they were bidding on a “significant contract” with the university
- During the call in November 2005 that profiled the awarded outsourced training business from Motorola, management said they were also in discussions with Motorola’s European/Middle Eastern/African operations for a similar but expanded set of services
- During Q2’06, GPX opened operations in India with ten employees; as is typical for GPX in managing risk, the Company opened its presence in India on a contract basis (i.e., went to India with a major US account)
Growth expectation for 2007 is significant at 44% EBIT growth but reasonable given secular trends and company’s likely success focusing on increased “wallet” penetration
· For 2006, revenue is forecasted by Barrington to be $186m (representing 6% growth versus 2005); based on reported YTD revenue, growth is up a reported 2% versus the first six months of 2005 but in Q3 and Q4 GPX will anniversary some of the headwind changes noted below that impacted first half results
o Change in contract scope with a BPO customer last year (Q3’05) which reduced Q1’06 revenue and Q2’06 revenue by $2.7m in total; the contract change has now been cycled and will have no further impact on yoy comps
o Unexpected during Q2’06 was a scheduling delay on a government environmental engineering contract amounting to $1.3m; management believes it will earn these revenues in 2H’06
o GPX needs to generate $97m in Q3 and Q4 to achieve current Barrington estimate (for all intensive purposes, the Company’s “expectations”); adjusted for the above, GPX grew first half revenue at ~6% and we think secular trends and company-specific pipeline enables the Company to achieve at least $97m in the second half (i.e., sequential growth of 9%); two specific revenue generators are the Motorola business that has been in pilot stage and the expected TRADOC business (when adjusted for expected revenue from each, we think GPX needs to generate just 4% sequential growth and this is very achievable given recent trends and expected industry outlook/growth coupled with Company’s strong industry position)
Ø Motorola business is expected to begin Q4 at $5-25m (annualized); assume $10m annualized
Ø TRADOC was initially announced as $400m a year to be divided among six vendors but assume $100m (i.e., 75% cut in funding), this would yield ~$16m per annum assuming the business is split evenly across vendors
Ø Based on Motorola and TRADOC as described above, assume there is $26m of incremental revenue on annualized basis and assume that both go live in November, thereby generating ~$4.3m of revenue in 2006; this leaves ~$93m to be generated from current business and other incremental business that yields ~4% sequential growth (i.e., $97m less the $4.3m divided by $89.3 generated in first half) required (based on recent trends, a very achievable target)
o For 2006, operating income is estimated to be $13.7m; this is a 25% increase to 2005 and primarily based on improved mix and SG&A expense control; based on results achieved in the first six months of 2006 and the revenue explanation above, the $8.0m of additional EBIT to be earned in 2H’06 represents an incremental margin of just 8% on incremental revenue (this appears very achievable as it is well-below the 25-plus percent incremental margin performance earned during 1H’06 and below the Company’s targeted 18-20%)
· For 2007, revenue is forecasted by Barrington to be $215m (representing 15% growth to 2006) and EBIT to be ~$20m (44% growth to 2006); this seems aggressive at first blush but can be explained as being reasonable by the following:
o As described, Motorola and TRADOC revenue is expected to begin 2H’06 and we assume in November 2006 for evaluation purposes; the annualized revenue we estimate is conservatively $26m and on that basis, almost all of the $29m of incremental revenue from 2006 to 2007 is generated from these two announced (but yet to start) arrangements (hence, one can argue that revenue is likely to grow well beyond 15% in 2007 unless GPX loses lots of existing customer contracts and/or Motorola and TRADOC don’t actually materialize despite being announced (of course a risk but we ascribe a low probability to it)
o The growth of EBIT to $19.7m from $13.7m in 2006E is based on margin expanding by 200bps as the Company benefits from ~21% incremental margin (i.e., 100bps above the top end of management’s targeted range of 18-20%; in 1H’06, incremental margin was 26%)
o The fact that the Motorola and TRADOC arrangements could yield the targeted growth without additional new business won by GPX is what makes the 15% revenue and ~44% EBIT growth seems achievable despite what appears to be overly ambitious if one just focuses on the headlines
o Another perspective that reinforces our confidence in 2007E revenue at $215m is the Company’s intensified focus on greater “wallet penetration”; the example of Cisco Systems being up almost 20% yoy in the first six months is demonstrative of additional opportunities available to penetrate incremental business with existing customers
Ø Management believes its business with commercial customers represents less than 10% of potential; if we assume that existing business is really 20% of “wallet” potential and that GPX is able to penetrate just 10% of the remaining 80% that its customers spend on workforce development/performance improvement/training, then another $65m of additional growth is likely to be generated from existing customers (this number is derived from 70% of 2006E revenue, at $186m, being commercial; note that this estimate doesn’t include a significant amount of additional penetration of MOT since the 2006E figure has very little of MOT revenue assumed)
· For 2008, we assume top-line growth of 10% and another 100bps of margin expansion (or incremental margin of ~17%); based on the above, the assumption seems appropriately conservative
Attractive valuation; FCF is very strong and growing
· GPX is trading at low multiples, and especially if growth materializes as I assume
o 9.7x ‘06E EBIT, 6.8x ‘07E EBIT, 5.6x ‘08E EBIT
o 8.2x ‘06E EBITDA, 6.0x ‘07E EBITDA, 5.1x ‘08E EBITDA
o 16.9x ’06E EPS, 11.4x ‘07E EPS, 8.5x ‘08E EPS
o Selected comps on EBIT basis: ACN at 10.5x ‘06E and 9.5x ‘07E, ACS at 11x ‘06E and 10.5x ‘07E, CVG at 11x ‘06E and 9.5x ‘07E, FC at 13.2x (LTM), HURN at 15.2 ‘06E and 12.3x ‘07E, MMS at 8.3x ‘07E, TGIS at 11.3x (LTM)
o Selected comps on EPS basis: ACN at 17x ‘06E and 15x ‘07E, ACS at 15x ‘06E and 13x ‘07E, and CVG at 17x ‘06E and 15x ‘07E, FC at 20x (LTM), HURN at 26x ‘06E and 21x ‘07E, MMS at 17x ‘07E, TGIS at 14x (LTM)
· FCF yield is ~11% and, based on aforementioned growth expectations, FCF yield is ~15% based on 2007E
· Business model is not capital intensive; capital expenditures are expected to be less than $1m this year
· As of June 2006, there were NOLs amounting to $25m
Return on capital improving, at 18% in 2005 compared to 3% in 2004
Attractive as MBO or for strategic consolidation
· Based on the current/expected FCF yield, an undercapitalized balance sheet, and a stock price that might not converge to its “intrinsic value” because of the illiquidity of the stock’s float, GPX makes for an attractive MBO and strategic interest would be highly likely at a significant premium if GPX were to consider (view this as both downside protection and upside potential)
Management continuity coupled with alignment and pursuit of prudent share repurchases given current valuation and business performance/outlook
· Almost all of the top twenty executives have been with the Company for over ten years (this includes CEO Scott Greenberg who joined GPX over 25 years ago, recently promoted COO Doug Sharp who also joined GPX over 25 years ago, and recently promoted CFO Sharon Esposito-Mayer who joined the GPX over 10 years ago)
· Including options, management owns 10-15% of the company
· During Q2, GPX repurchased 228,000 shares at prices ranging from $6.70-7.60, for ~$1.7m ($3.3m remains authorized for repurchase)
Management is prudent in allocating capital
· Based on discussions with management regarding recently intended acquisitions, I am confident that management is prudent in allocating capital
o The management team isn’t trying to roll up an industry to hype a story to the stock market (i.e., Provant) but is thoughtful about bolt-on transactions that are complementary to existing services, enable geographic expansion, and meet client needs/interests.
o Furthermore, management is careful to not over-pay (i.e., submit to the “winner’s curse) and understands the importance of alignment and retention of key personnel among the targets it pursues.
o This is a management team that has exercised prudent risk management to walk away from numerous deals despite spending months on a couple of them.
Recent Quarterly Results Highlight Good Execution, Significant Growth in Operating Income, Bullish Outlook
Q2 2006
· Q2’06 revenue increased by 5% (which was above consensus) and EPS increased by 38% (which was in-line with consensus)
· Operating income increased 12% as margin expanded by 50bps to 7.3%
o A shift to higher-margin manufacturing and BPO work helped to expand the gross margin by 60bps yoy; the higher revenue and gross profit, coupled with stable SG&A spending led to 50bp increase to operating margin
Q1 2006
· Operating income was up 19% at $2.4m on yoy basis even after recording $300,000 of severance and $150,000 of noncash stock compensation expense in the quarter
o Key drivers for the $400,000 increase in operating income was $200,000 increase in gross profit driven by an increase in higher margin labor consulting revenue and a decrease in lower margin subcontractor revenue coupled with a $200,000 reduction in SG&A expense driven by a reduction in allowance for doubtful accounts and legal expense which was partially offset by an increase in severance expense and labor costs
· Despite the fact that some commercial and government clients are funding quarterly versus the historical annual approach, the funded backlog increased by approximately $14m to $93m compared to $79m at year-end
Q4 2005
· Gross profit increased 20% on a yoy basis and operating income grew by $4.3m to $3.4m versus a loss of ~$1m in the prior year Q4; all of this growth materialized despite flat top-line
· Overall operating income for FY2005 was up 29% to $11m compared to $1.8m in 2004; the key drivers for the $9.2m increase to operating income on an increase of $11.1m to revenue was gross profit increasing $5.7m coupled with SG&A reductions of $3.5m ($2m attributed to reduction to incentive compensation plus $1m attributed to expenses for National Patent that could not be allocated in 2004 as part of the spinoff)
· Excluding nonrecurring arbitration litigation gains, pretax income from continuing operations was $9.7m for FY2005 compared to $0.4m for a net increase of $9.3m in 2005
Q3 2005
· Q3’05 operating income grew 27% yoy (operating margin increased from 6.6% to 8.5%) on flat revenue ($44.3m); explanation was better mix coupled with cost reductions
Numerous catalysts/headlines should develop to drive increased visibility of strong performance and continued growth
· “Value is its own catalyst”: FCF generation is strong and is expected to grow; current FCF yield that grows should improve stock price (if not, then company will certainly be an attractive going-private candidate)
· Secular growth trend of training being outsourced
· Continued organic growth from cross-selling initiatives
· More consulting work done internally and less sub-contracting (i.e., improves margins) coupled with continued shift to higher-margin revenue mix in Manufacturing & BPO segment
· Motorola pilot moves into paying client (with incentive compensation) in Q4’06 and leads to additional penetration with Motorola and more opportunities to compete (and win) other training outsourcing (i.e., via halo effect that comes with serving Motorola)
· Potential for new Training and Doctrine Command (TRADOC) contract with the US Army, a $2B (if fully funded) five-year contract with six small businesses (GPX is subcontractor to one of the six, Hal-Tech), which is expected to impact the company in 2H’06
o TRADOC contract should kick off in Q4’06 (contract that was previously announced where GPX is one of six groups conducting training for the Army); TRADOC initiative is a web-based training custom content development and GPX is a subcontractor to a small business called Haltech
· International growth
· Accretive bolt-on transactions (most acquisitions being considered have revenue of $5-20m)
Bearish Arguments / Risks to LONG Thesis
Liquidity of the stock is very low
Low barriers to entry
- Thousands of training companies is evidence of the low barriers to entry
- However, this is the reason that outsourcing of administration, vendor management/selection is growing quickly so best-in-class can be chosen and cost incurred for such can be appropriately managed
- Barriers are higher in the performance improvement areas in which GPX focuses its training
- Though provision of training services has numerous players, the relationship with the paying client is not always easy to penetrate and GPX’s 35-year plus history provides it the reputation and relationships to more easily penetrate the Fortune 500
Training-related spending is correlated to employment and is inherently discretionary
Government-related spending is subject to “moral hazard” and other perceived government spending priorities
- Domestic programs have recently been curtailed, thereby impacting GPX, because of funds diverted to address the Iraqi effort
- Government has moved much of historical annual backlog to quarterly, thereby reducing visibility
- During the first six months of 2006 versus the prior year period, the Army reduced $10m of annual funding for the DPETAP contract; overall, the Army decreased by ~32% over the six-month period and went from being a 21% client in 2005 to being a 14% client in 2006 (percentages based on revenue composition for the first six months)
- DPETAP impacted GPX’s revenue by $5.4m in the first half of 2006; the balance ($4.6m) will be a revenue headwind in Q3 and Q4
Insider selling activity
- Though part of the appeal of GPX is the recapitalization that occurred in January, it is notable that the seller of shares was Sam Zell
- Founder Jerome Feldman has been a recent seller of shares; we’re told that until this year, he had never sold shares and now at over 80 years old he is trying to manage his estate and deal with recent tax leakage from the recap
Catalyst
Numerous catalysts/headlines should develop to drive increased visibility of strong performance and continued growth
· “Value is its own catalyst”: FCF generation is strong and is expected to grow; current FCF yield that grows should improve stock price (if not, then company will certainly be an attractive going-private candidate)
· Secular growth trend of training being outsourced
· Continued organic growth from cross-selling initiatives
· More consulting work done internally and less sub-contracting (i.e., improves margins) coupled with continued shift to higher-margin revenue mix in Manufacturing & BPO segment
· Motorola pilot moves into paying client (with incentive compensation) in Q4’06 and leads to additional penetration with Motorola and more opportunities to compete (and win) other training outsourcing (i.e., via halo effect that comes with serving Motorola)
· Potential for new Training and Doctrine Command (TRADOC) contract with the US Army, a $2B (if fully funded) five-year contract with six small businesses (GPX is subcontractor to one of the six, Hal-Tech), which is expected to impact the company in 2H’06
· International growth
· Accretive bolt-on transactions (most acquisitions being considered have revenue of $5-20m)