Description
I usually don’t pay much attention to $4mm market cap companies, but in this case it’s a recent spin-off with $100mm in revenues selling at a seemingly absurd price. The stock is trading at 1x average EPS of the past 5 years. The company has no debt, low fixed costs, has been around for 20 years and has never lost money – even in the technology meltdown of 2000-2002.
Two additional facts to consider: the board turned down an offer to sell the company over the summer and management has been buying stock in the open market.
Price $1.19
Shares 3.6mm
Market cap $4.3mm
Cash $2.5mm
Book value $9.0mm (cash + A/R from likes of IBM)
Mastech is a niche IT staffing company. The company was founded in 1986 by two Indian IT engineers who came to study in the US who remain co-chairmen and together own 56% of the company. As Mastech grew, excess cashflow was used to create an offshore outsourcing/services business and the parent company name was changed to iGate. Now that iGate has reached critical mass (mkt cap $300mm), the founders decided to spin off the legacy business (Mastech) to focus on the sexier, higher growth offshore offering. The spin off occurred on Sep 30th, jut in time for the October market carnage.
The investment case is straightforward here, so I’ll keep it short:
o Revenues over the last few years have been around $100m. EBIT has been in the $6-8mm range. Capex is de minimis.
o In the three years from 2005 to 2007, Mastech transferred to its former parent $33mm.
o Given the economy, 2008 has been a tough year. Still in the first 9 months, MHH generated $73.6mm of sales and EBIT of $3.6mm.
o The company was founded 20 years ago. The current management has been in place for most of the last decade. Mastech has always remained profitable and cashflow positive. 2001 and 2002 were very tough, as IT industry hit the wall after going 100mph in the late 90s. The business survived that depression and the management is confident they will be able to weather the current economic uncertainty.
o The business has very low fixed costs, essentially only a small corporate office. The rest of the employees get hired to work on specific projects. The cost of keeping consultants on the bench is low and can be further reduced if necessary.
o No additional overhead costs are expected as a standalone entity, above what was previously allocated by iGate.
o During the summer, the iGate board received an offer for the business. They decided it was inadequate and proceeded with a spin. In conversations with the management, it’s clear that insiders expected the stock to trade around $10 when they decided to set the spin ratio at 15:1. They knew that iGate shareholders would likely sell and expected some weakness initially, but they didn’t think MHH would trade at $1. Since releasing Q3 earnings, management has been buying stock in the open market.
Catalyst
Founders take the company private. They “steal” the company at $4 per share. You still make 3x your money.
The business earns $1 a share in 2011, somebody notices and stock trades at PE of 5.
Perhaps the company makes significantly less money over the next two years, but when the economy recovers they make $8mm of EBIT and get bought for 5x or $40m, which is $12/share.