Description

The Hackett Group (HCKT) is a IT consulting firm that’s been public since 1998. Ted Fernandez, the CEO, has been there since the beginning, and owns 6.6% of the outstanding. As far as small-cap CEOs go, he’s a straight shooter, and on the last earnings conference call was ebullient at the response to their newly released AI XPLR (pronounced “AI Explorer”) product, commenting that “booking and responding to the demo meetings is like nothing we've ever done before.” The stock, though, has been weak in recent months coincident with a temporary slowdown in enterprise IT spend as, ironically, companies have somewhat delayed large consulting engagements as they scramble to figure out how AI can make their business more efficient. Now feels like a good time to get into an underfollowed great business with exposure to corporate IT spend as I expect forward estimates to start ticking back up.

If you’re like me, it’s hard to separate the wheat from the chaff reading through all of the corporate jargon to understand what areas or processes are affected by new AI technologies. The cynical small/microcap investor part of me instinctually wants to run away from any company that suddenly rebrands new AI-enabled business lines. But the trend of executives at-large trying to figure out how AI can and will impact business is just starting, and I think there’s an opportunity for proactive consultants to guide the process. Taking advantage of corporate FOMO is squarely in Hackett’s wheelhouse, and as new AI tools actually start getting implemented in enterprise processes, HCKT will be at the forefront of telling C-suite execs which AI tools they could be using to increase productivity in specific business functions.

Segments

Global SB&T (56% of ttm revenues)

The company’s biggest segment by revenue aligns with the biggest asset at the firm, their database of performance metrics for various corporate processes. It’s also the segment that’s grown the most since 2021–up about 20% in total over two years (before 2021 they lumped non-US SB&T revenues into an “International” segment). As opposed to a firm like Gartner putting out estimates for market size and spending, Hackett focuses on surveying, evaluating, and benchmarking common practices around various business processes, and they’ve engaged or benchmarked a ton of companies. From their most recent 10-K, they have benchmarked “97% of the Dow Jones Industrials, 89% of the Fortune 100, 70% of DAX 40, and 55% of the FTSE 100.” The benchmarking business has a natural synergy feeding into executive advisory and enterprise software implementation solutions (the company calls this the “halo effect”), which has been around 40% historically.

AI XPLR fits seamlessly within the company’s traditional framework of helping businesses to understand best practices on a function-by-function or process-by-process level. There are myriad software companies pitching various “AI-enabled” “solutions” to corporations, but figuring out what sort of specific use cases companies actually have, and what personnel decisions and vendors best match those needs, is especially challenging at the present moment. Hackett is already a trusted partner for its clients, so basically the need/opportunity for realignment and spend around AI is a very significant opportunity for Hackett, and although it’s too early to know if the company will execute well, I believe that they have a bit of a head start here, and that the interest around this sort of consultancy work is somewhere between massive and unprecedented, something akin to the “Y2K problem” boom in 1998-1999, but with a much more durable and longer tail. Thus, it makes perfect sense when Fernandez speaks of reorienting the entire firm around AI. Although it’s too early days for AI XPLR to have generated significant incremental revenue for Hackett, as of the May 7 quarterly earnings call, Fernandez noted that the product has already led to “over 170 client demo meetings with many more scheduled,” with “a number of new enterprise or functional domain-specific AI engagements.” 

Oracle Solutions (27% of ttm revenues)

Hackett has consulted on Oracle ERP implementations since at least 2004 and is currently a Platinum level partner in the Oracle Partner Network (one tier below Diamond, the top level, which requires $100 million of Oracle-related annual revenue). Prior to 2017, the work was all on-premise, but in 2017 they acquired the capabilities to implement Cloud-based ERP. While certainly not early to Cloud/Saas, they picked a good time to acquire the capabilities right at an inflection in the industry. It’s a little difficult to tease out the trends in this segment historically because they’ve only broken it out separately for the reporting period ending FY 2021, from where it’s grown 2% in each of the subsequent two years.  

SAP Solutions (16% of ttm revenues)

Similar to the Oracle Business, they also deploy and consult on SAP implementations. Most of the rest of their business lines are spread out amongst various end-markets but their SAP is more concentrated in healthcare and consumer goods, primarily. This has been a steady, slow grower (about 3% CAGR since 2016), and I’d expect similar going forward. 

Capital Allocation

As a matter of course, consulting firms are capital efficient businesses, but sort of any way you slice it Hackett’s ROIC in recent years is at least in the 30% range, consistently in the upper half when compared to peers. They have also done right by shareholders, paying a dividend, and buying back 15% of their outstanding shares via tender after evaluating M&A opportunities and concluding they didn’t like anything. They’ve done a big tender before in 2012, and the last time the stock was up over 300% in the subsequent 3 years. HCKT is probably one of a very few tech industry stocks that IPO’d in 1998 and have decreased share count by about a third since. All that is to say, I generally trust the company’s ability to deploy capital efficiently, so I think pouring resources into their AI offerings is likely to bear fruit.

Valuation

HCKT has historically pretty constantly traded between 8-11x forward EBITDA (currently trading around 9.1x next 12 months). The company has historically achieved roughly 5% revenue growth which has led to an earnings growth rate of about 10%, but management is confident that investments in new AI initiatives and salesforce could result in revenue growth north of 10% which would lead to 20% earnings growth. I assume 2024 is still a mixed-bag in terms of execution on new offerings, but that 2025 they can reach the high end of that number, and I get close to $55 million in earnings in 2025, which puts today’s price at just above 11x earnings, and if they actually achieve that stated growth goal, I think the market will reward that with a multiple at or above the high end of its historical range, or about 40% upside from current prices. 

Risks

AI productivity-enhancing use-cases are overstated or years away from coming to fruition.

General slowdown in IT spend is structural and not temporary.

Buying a small-cap name that is rebranding with AI doesn’t actually work out.

Catalyst

AI investments converting to revenue

uptick in corporate IT spend