III started life as a SPAC and in late 2007 bought Technology Partners, Inc.(TPI) - the world's leading sourcing advisory firm. TPI helps companies lower their cost structure in IT and other business processes by evaluating, implementing and monitoring programs in business process improvement, shared services outsourcing and off-shoring. TPI does a cost/benefit assessment, helps construct an RFP, guides vendor selection and program implementation and then monitors compliance by selected vendors with the implemented programs. The company largely invented the business 19 years ago and publishes the definitive quarterly outsourcing industry index, naturally called the TPI Index, which covers about 85% of the total industry contract value.  The III mgmt team is a group of operators, not just typical SPAC deal guys, and they have already begun to improve margins at TPI since the Nov '07 deal closed.  In 2007, pro forma for the deal and public company costs, III earned about $20M of ebitda on revenue of $173M. In short, mgmt thinks that BEFORE acquisitions they can increase revenue 50% and more than double ebitda over the next 3 years. On '08 revs/ebitda III is cheap, but valuation becomes compelling if mgmt can begin to deliver on the revenue/margin enhancement plan.  The valuation in the out years is obviously also dependent on how mgmt deploys the nearly $300M of cash that would be generated if all the SPAC warrants were to be exercised. There is the typical SPAC warrant dilution risk but only at substantially higher prices.

 

I believe III is cheap because it started life as a SPAC, has minimal coverage/sponsorship (DB, the underwriter, finally put out a report last week), and operates a truly niche business.  As management delivers solid revenue growth and improving margins with substantial free cash flow, the business should be revalued upwards.  Given the current <2X leverage and the substantial cash inflow from potential warrant exercises (at substantially higher prices), astute capital allocation decisions MAY enhance shareholder value over the long term. Given management’s acquisition history and stated appetite, this can cut both ways.  Currently a modest $15M buyback program is underway.

 

31.5M shares outstanding (incl. 7.5M owned by mgmt), with another 38M $6 SPAC warrants (inc 6.5M purchased by mgmt @ $1/warrant) and 5M $9.18 seller warrants. There are also 1.4M $9.60 underwriter unit warrants (the 1.4M warrants in the underwriter units have a $7.60 strike). Given the strike prices, we view it as unlikely that the seller warrants and the underwriter warrants will be exercised, but (from $4.60 and $0.35) we’d love to have to eat those words.

 

$95M debt, $45M cash, thus $50M net debt.

 

Current stock price is below the warrant strike so current valuation on common only is 6.5X '08E ebitda of about $28M (on revs of $185-190M). 2010 revs and ebitda could be $235M and $40-45M, respectively. I’m using $42.5 assuming an 18% margin versus 15% in ’08. Ultimately, mgmt expects to hit 20% ebitda margins, although this appears to include acquisitions and may require some success in monetizing/syndicating TPI’s substantial data resources.

 

Capex is very low, probably $2M/year, so free cash flow is VERY strong.  III appears to be generating about a 13% FCF yield on current EV.   ($28M-$2M)/($146+$50M).

 

I believe III is worth at least $6 - $7 (8-10X ’08 ebitda) today and $8-$10 in 2-3 years, BEFORE the benefit of acquisitions, which are definitely part of the plan.

 

Note: due to acquired intangibles amortization and a relatively high tax rate in ‘08, III may report GAAP eps of only $0.20 while cash eps should be $0.45-$0.50/share.  For my cash eps, I do NOT add back $2.5M or about $0.08 for non-cash comp expense.  After tax free cash flow should exceed $20M in ’08 ($0.65/share), while the yearend balance sheet should show cash above $60M assuming no acquisitions or accelerated buybacks.  Reminder, there is $90M of term debt.  

 

Senior management previously helped run, build up and sell ACNielsen and takes NO CASH COMPENSATION, but has 7.5M common shares and bought 6.5M $6 warrants at $1 per warrant as part of the original SPAC IPO.  Note these warrants currently trade at $0.35, expire 1/31/11 and also seem quite interesting to us. The warrants are callable when then common trades above $11.50 (I should be so lucky).

 

Note: 128 TPI equity holders reinvested $21M of the deal proceeds into 2.9M shares of III common stock (@ $7.20/share).

 

Management is what I’ll call semi-active on the second buyback ($15M). The first buyback was 20% of common, but really serve to clean out potential/actual no votes on the deal. We confirmed with management that they have been buying both common and warrants, although the pace has been somewhat disappointing to us given management’s commentary about the business prospects and their own long-term revenue and ebitda aspirations.

 

 Outsourcing industry growth – given the current economic climate, demand for outsourcing advice and services is quite strong and should at least continue the recent growth rate in the 7-9% range.  Several of the providers we monitor have reported some weakening of workstation demand from existing clients, however the pipeline of new business continues to build. Teletech even reported that contract implementation cycles were accelerating as clients pushed to accelerate expected savings from outsourcing.  Of course, TTEC also reduced guidance at the same time so that could just reflect Kenny (CEO) being Kenny.  Various industry sources (not just the TPI Index!) do confirm that demand for outsourcing continues to grow and that new industry segments and new service areas are coming into play for both client corporations and service providers. In addition, the recent volatility of both currencies and wage rates of the traditional Asian outsourcing labor providers have increased the complexity of the outsourcing decision and should support future demand for TPI’s advisory services and market data. The recent trend towards shorter contract durations should benefit TPI as clients assess options and negotiate contracts more frequently. Incidentally, there were 120 outsourcing service providers at TPI’s annual conference.

 

About 50% of the sizeable outsourcing contracts awarded in 2007 used an advisor and TPI captured about 50% of these advisory assignments. Competitors include independent outsourcing advisors EquaTerra and Everest, as well as strategy consultants Booz/Allen, Bain and McKinsey as well as research firms Gartner and Forrester on specialized assignments.

 

TPI has about 475 employees (about 360 senior advisors) and served about 270 clients in 2007.  Most senior advisors are hired from industry. TPI’s services cost a small fraction of the overall outsourcing contract value and can more than pay for themselves in better RFP structure, contract negotiations and compliance with targeted savings.  Stage 1 – Assessments - take about 6 weeks to complete and generate revenue in the $50k-$150k range. Step 2 – RFP structuring/negotiation/selection/implementation – 4-6 weeks to complete, revs typically $350 - $750k, although TPI has recently landed several $1M+ deals.  About 70% of assessments turn into RFP negotiations.  Step 3 – Governance – ongoing compliance monitoring. This is a relatively new business for TPI, but is growing rapidly and obviously quite appealing given the recurring revenue and continued relationship with the client company.  Governance deals appear to be in $50k to $250K range.  Currently about 25% of implementations are also signing on for governance services, although that “take rate” has been rising each year.  Management is focused on accelerating growth in assessments (which feed the core negotiation/implementation engine) and on driving the governance conversion rate.

 

Management is in the process of implementing a cost reduction program expected to trim $8-10M of annual expenses when fully effective in 2010.  In addition, mgmt is focused on migrating the organization structure at TPI from its current “box” to the “pyramid” shape more typical of higher margin consultancy firms. This multi-year process will result in more (higher % mark-up) mid-level consultants leveraging the senior rainmakers and should drive higher ebitda margins as higher utilization rates take hold.  TPI has about 35 employees in Bangalore and expects to move to 100 over time.  In certain areas, TPI will pull back from client locations to better utilize multi-client hubs.

 

Geographic expansion – International now 40% of revs and growing faster than domestic. Europe now $50M, goal $100M in 3 years, Asia-Pacific now $10M, goal $25M in 3 years.  In Europe, TPI’s assessment services give corporate management additional ammunition to prove bloated cost structures, and allow objective review of off-shoring, outsourcing and shared services options.

 

Product extension -TPI was historically strong in the outsourcing early adopter sectors, particularly financial services, manufacturing and healthcare and is now adding energy, private equity and public sector specialists, among others. TPI recently added to its contact center and governance services capabilities.

 

GM was TPI’s biggest customer in ’05 and ’06 (over 20% of revs) due to unusually large re-contracting of prior EDS work. 42 different outsourcing contracts (could THAT be part of GM’s problem?) and clearly a risk if GM goes bust but clearly need to keep cutting costs. Average contract is 3 - 6 years and GM has been with TPI for 11 years. GM should be less than 10% of revs in ’08.  TPI’s client list includes Royal Dutch Shell, Chevron Texaco, Lockheed Martin, Volvo, Singapore Airlines among many others.  TPI’s top 20 clients accounted for 52% of revenue in 2007.

 

Vast amount of data on contracts, providers, best practices, cost structure benchmarking etc. Some 2700 assignments over 19 years. Management hopes to syndicate this data, although specifics and timing on this plan are somewhat vague.  Management appears to be looking at Corporate Executive Board and Advisory Board models as pure syndicators, as well as Gartner and Forrester models as advisory/syndication hybrids.

 

 ACNielsen experience - mgmt did over 20 acquisitions while at ACNielsen and ironically the enterprise valuation expanded from 6.5X (where III is now) at the start of mgmt’s tenure/program to 10X, realized upon the sale of the company to VNU.  Net debt is only 2X ebitda, strong FCF generator, $300M cash proceeds if all warrants exercised (unlikely, but over $200M could certainly happen).  Given the potential capital at management’s disposal, the acquisition strategy is a source of both risk and opportunity. Management’s prior track record offers some comfort but we are watching closely to see both what they buy and what they pay.  At each of our meetings over the past 6 months management has promised to create value and to be patient. So I guess we have that going for us, which is nice.

 

Execution on revenue and margin enhancement strategy.  Visible benefits from cost reduction program.  Value added capital allocation (buybacks, acquisitions, maybe a dividend?)  I believe III reports Monday 8/11 post close, should be solid with some of each of the above.