Description

1. Executive Summary

GATC is a British firm that recruits mostly contract staff into engineering and technology roles for its clients. It is not a bad business, and it is cheap. Returns on capital are generally mid-teen or higher, it has a real reason to exist, and it is financially healthy. Under new management, and with an expanded sales force, the stock could go up 2-3x over the next few years.

At 70p per share the market cap is £24m and there is net cash on the balance sheet. FY21 EBIT was £3.5m. Normal EBIT levels should be more like £6-8m which, at 8-10x EV/EBIT, suggests an EV of £50-80m (140-240p).

The company is cheap for two main reasons. First, performance since 2015 has been weak due to poor M&A and a subsequent restructuring – those problems should now be in the past. Second, GATC is a small, illiquid, and underfollowed stock.

2. Company Overview

GATC was founded as Matchtech in 1984 and it listed in 2006. Most Net Fee Income (“NFI”, essentially revenue) is generated from “normal recruiting” transactions in the UK: a client comes to GATC with a specific role to fill, GATC fills it and gets a fee. These are ad hoc assignments that appear whenever clients have rolls to fill. Fortunately, client demand for STEM contractors tends to be regularly reoccurring, if not strictly recurring.

Matchtech (60% of NFI) is GATC’s main brand. It specialises in recruiting engineers. Networkers (20%) is the other key brand. Established in 2000 and acquired in 2015, it specialises in filling technology roles (think network engineers, IT project managers etc). Both brands focus on contractor, rather than permanent, placements. Separately, within the group there are also several smaller brands offering complementary recruitment services.

The client base is diverse, with clients spread across the Infrastructure (31%), Defence (15%), Mobility (10%), TMT (10%) or Energy (8%) sectors. The client list contains both well-known (e.g., McClaren, TFL, Safran, Leonardo…) and smaller companies. Many of these relationships have been long standing and recurring.

Most clients have three key questions when assessing GATC as a recruitment partner. First, and most importantly, can GATC quickly fill the vacancy. Second, will they be easy and enjoyable to work with. Third, are their services available at a reasonable price. GATC does well on the first and third question by virtue of both its long record and its ability to price competitively. They do reasonably on the second question, but they should be able to improve. The new CEO, Matt Wragg, wants to make client experience more of a differentiator.

The main competitive threat is from third party recruitment firms. These consist of 3-4 niche full-service players (Morson Group being the most similar), as well as the engineering/technology departments of global recruitment firms (Hays, SThree etc). While the market is both fragmented and competitive, it is also large, and it is not winner-takes-all. GATC has a proven record of successfully competing in its niches over multiple decades. 

Internal recruiters are the other main competitive threat. They tend to threaten existing rather than prospective client relationships. There is no trend in favour of or against internal solutions, it is more of an idiosyncratic issue.

In terms of the organisation, it is mostly comprised of sales staff (394 out of 540). Interestingly, total headcount has grown by 24% in the last twelve months. That’s meaningfully faster than the 5% NFI growth over the same period. Normally it takes 12-18 months for new sales staff to be at full NFI earning capacity so I would expect higher fee growth over the next year or two as new hires become fully productive.

In terms of management, Matt Wragg is the key guy. He has been with GATC for over 20 years, starting as a graduate hire. He joined the management team in 2016 and became CEO in 2022. He is young (43), energetic and seems genuinely passionate about the business. One of his priorities is restoring the firm’s culture to what it was pre-2015: “a self-built, family business that employees were excited to be a part of”. Getting this right could lead to a more engaged workforce, better outcomes for clients, and improved financial performance.

Importantly, Matt and his team witnessed the Wilkinson-era M&A debacle (more on this below), seeing how shoddy M&A can degrade culture and performance. That lesson seems to have stuck – their stated capital allocation priorities are organic growth (more sales staff, better internal systems etc.) and getting back to paying out 50% of earnings as dividends. No mention of further M&A.

3. Historical performance & Outlook

From 2006-15, GATC performed well, led by a largely unchanged management team. Growth was mostly organic, margins were robust, and the balance sheet was healthy.

From 2015-18, a new CEO – Brian Wilkinson – executed several acquisitions. While that boosted NFI levels, it also ladened the business with debt and damaged margins and staff efficiency. Wilkinson was eventually ousted.

From 2018-2021 replacement CEO Kevin Freeguard led a restructuring to repair the Wilkinson-era issues. The debt was repaid, bloated costs were reduced, and the acquisitions were integrated. By 2022 the restructuring was complete, and a new management team led by Matt Wragg stepped-in to lead the next stage.

On top of the M&A issues, Covid hit the business in FY20-21. Two hundred staff were furloughed, clients reduced their hiring needs and GATC went into survival mode. Fortunately, the business survived, emerging with a clean balance sheet and a 13% return on capital. However, EBIT fell to just £3.5m which the market punished.

Profitability remained weak in the first half of FY22. EBIT was breakeven and the second half of FY22 will probably be similar. Some of this was due to continued impact from Covid and the restructuring. However, it was also partly the result of organic growth investment (see increase in staff count mentioned above). Positively, there are hints that performance should improve in the future.

First, NFI to EBIT conversion since FY20 has been unusually low. In FY20 less than 12% of NFI converted. In FY21, less than 10% converted. By comparison, pre-FY20, more than 20% converted for most of the last decade. Management sees 20% as an achievable benchmark. That will depend on increasing productivity of recently hired staff, while staying disciplined on costs. Not a straightforward task, but also not beyond the wit of man. The table below shows how a higher conversion rate would have changed FY21 EBIT (actual was £3.5m) and the current EV/EBIT multiple.

Second, the NFI earned per staff member has also been unusually low. Typically, this would be ~£95-100k per member of staff. But it was just £79k in FY20, £87k in FY21 and £80k in 1H22. Part of that is due to the Covid impact mentioned above. But part of it is also due to having increased headcount by 24% in the LTM with a lag in reaching full productivity. As productivity improves, NFI per staff member should improve towards historical levels. If productivity doesn’t improve, unproductive staff can be cut which should also improve the NFI per staff member. The table below shows how total NFI would respond to different levels per staff member. The table also shows implied EBIT and EV/EBIT assuming a 15% conversion rate. Note, FY21 NFI was £42m.

4. Why GATC is not a bad business

Return on capital

GATC has historically earned a decent return on capital. The table below shows EBIT as a percentage of opening invested capital since 2012. Remember, 2018-21 were restructuring years, while 2015-2018 was the period of misguided M&A.

This record is partly the result of a capital-light business model – while there is some need for working capital as the business grows (DSO 50-60 vs. DPO of 30), there is little need for fixed or intangible capex. It is also helped by a variable cost base, lowering the risk of unprofitability.

Customer value proposition

GATC has a real reason to exist. Clients value them and candidates recognise them. Clients prefer firms that know their niches and are easy to work with. GATC can offer both. They are amongst the larger UK-focussed STEM specialists and have recognisable brands within their markets. The two core businesses, Matchtech and Networkers, have been successfully operating for decades.

Management

In “people” businesses like recruiting, culture can be a critical factor in attracting the right staff and offering great customer experience. While ex-CEO Kevin Freeguard (FY18-21) executed a much needed financial and operational restructure while successfully navigating the Covid crisis, the business lost its focus on culture. New CEO Matt Wragg seems well-equipped to build on the last few years while steering the culture back to where it was pre-Wilkinson. He is an energetic personality, highly competitive and seems sensible.

5. Valuation

At 70p per share the market capitalisation is £24m. The balance sheet has a net cash position.

Over the next few years, I think that NFI per staff member can return to around £90-100k per head while NFI-to-EBIT conversion could be more like 15-20%. If that happens, EBIT would be at least £6-8m. GATC and the broader sector typically sell for 8-10x EV/EBIT. All of that implies 2-3x upside to current prices. That ignores any further upside from today’s cash balances and any future cash generation.

In terms of downside risk, I think the chances of losing money from this level are low. For the current price we get: £35m of working capital and £10m of tangible non-current assets offset by £15m of total liabilities. We also get a business with a variable cost base, strong liquidity, and no financial covenant. There is very little debt in the business – just a (mostly undrawn) working capital facility and some leases. GATC should be able to survive any unexpected medium-term suffering.

The share price is at this depressed level largely because of the performance issues of the last few years. On top of that, this is a small UK-based stock that is under-followed and tightly held. Only 35% of the shares are in public hands, with the rest held by three major shareholder groups.

6. Risks & Mitigants

The main risk I want to discuss is from an open US DOJ investigation into Huawei. Unfortunately, GATC subsidiary Networkers provided contractors to Huawei in Iran from 2010-16, receiving $7.6m in return. A 2016-17 HSBC probe into Huawei made the DOJ aware of that. Fortunately, after acquiring Networkers GATC quickly terminated the contracts and reported the transactions to HSBC. But, since 2019 GATC has been voluntarily cooperating with DOJ requests for information as part of the investigation into Huawei. More details on the HSBC probe are available here. Some key points:

• The Iran contracts took place mostly prior to GATC ownership.
• GATC terminated the Iran contracts within 12 months of acquiring Networkers.
• GATC has cooperated voluntarily with requests for information from the DOJ.
• The DOJ has had responses from GATC to all info requests for two years now.
• GATC legal spend relating to the investigation has been falling. In FY19, they spent £3.4m. In FY20 that was £1.4m and in FY21 it was £29k. FY22 looks like it will be similar to FY21.
• The “Middle East and Africa” region contributes less than 0.5% of total GATC revenues.
• HSBC and Huawei each do $50-100 billion of revenue vs. GATC’s FY21 NFI of £42 million. They are orders of magnitude apart.

I am not a legal expert. But the worst-case scenario here seems survivable (single digit millions fine maybe?) and in the best-case scenario this is a non-event.

7. Appendix

Chart 1: Historical financial Performance

Chart 2: Historical staff efficiency

Chart 3: Historical Enterprise Value

Catalyst

• Reporting improved profitability. If NFI per head and EBIT conversion can get back to historical levels, this should be at least a £6-8m EBIT business. In that case, a £24m market cap backed by net cash would be too low.
• Positive resolution of the DOJ noise.