Description

Before starting, let me forewarn you that this company is involved in a scary sector: Internet consulting and development. These last four words are enough to make any rational investor run in today’s market, but Proxicom offers some compelling characteristics:
· A price/sales ratio of 0.72x (0.21x TEV/revenues) and price/book value of 0.76x.
· Positive operating cash flow on its cash flow statement, with a price/ trailing operating cash flow ratio of 8.8x. Even excluding interest income and the benefit of option-related tax benefits, the company generated slightly positive operating cash flow last year.
· “Cash earnings” of $0.10 in 2000 and projections of $0.19 for 2001 (although this is likely to be reduced – probably significantly -- due to the current industry slowdown.)
· Nearly 70% of its market capitalization in cash. Based on today’s $2.50 closing price, the company’s market capitalization was $150MM. As of 12/31/00, the company had cash and investments of $105MM with no debt. (Investments are in commercial paper – not securities on the verge of worthlessness.)
· A blue chip client roster with minimal dot.com exposure. Proxicom’s focus is Global 1000 companies that are not going out of business and will continue to utilize the efficiencies of the Internet. Dot.coms have historically accounted for less than 5% of business and that level has currently dropped to virtually zero.
· Stable leadership and a relatively long history of strong revenue growth. Current Chairman and CEO Raul Fernandez founded the company in 1991. The company has had annual revenue growth in excess of 55% every year since 1996. Excluding 1998, annual revenue growth during that period was between 85%-115%.
· High insider ownership of 32.6%

Review
I’m not a Pollyanna suggesting that Proxicom is will maintain its amazing revenue growth levels. This year will be quite challenging, with the company unlikely to maintain even flat revenue. (Recently reduced estimates from First Union and CS First Boston call for revenue to be flat to up 9% -- both of which are probably too optimistic). In addition, CS First Boston reports that the company laid off 10%-12% of its work force over the past few months.

Everyone is slowing Internet related spending and virtually noone will emerge unscathed. Competitors Sapient, Cambridge Technology Partners, and eLoyalty have all recently announced estimate reductions for the current quarter. More such announcements are likely – including one from Proxicom.

Nonetheless, I find it hard to believe that major companies will not continue investing in Internet initiatives that streamline processes, improve efficiency, and provide higher returns. Jack Welch’s enthusiasm for the way the Internet has improved GE’s processes and profitability will not be lost on other companies.

Proxicom’s sales force has penetrated into the depths of large corporations (a major task in itself) and the company has also proven its ability to implement the global solutions these competitors need. Proxicom’s client list includes powerhouses like Enron, General Electric, General Motors, JP Morgan Chase, Marriott International, and USA Today. This customer base, combined with the company’s technical expertise, should allow the company to come weather the consulting storm better than competitors. Meanwhile, the current stock price seems to incorporate an assumption that the company will perform worse than others (see valuation below).

Assuming a resumption of normalized economic conditions, Proxicom should be able to resume at least 15%-25% revenue growth. This growth is much slower than what was achieved over the past five years, but substantially better than the pummeling the current market price incorporates. My gut instinct says that this growth estimate will turn out to be conservative.

Insider Ownership
According to the 2001 proxy (as of Dec 31, 2000), insiders own 32.6% of the company’s shares, including a 22.8% stake held by company founder Raul Fernandez. Putnam Investments has a 12% stake, General Atlantic Partners has a 6.1% stake (included in insider ownership because of a board position of a partner), and RS Investment Management owns 5.1%.

Relative Valuation
Below are some valuation stats on Proxicom and its competitors. Using price/operating cash flow, Proxicom stands out as the most attractive company in the universe, with a lower number than everyone else with positive operating cash flow. It stands out even more when its lower TEV/Rev, lower price/book, and higher Cash/Mkt Cap vis-à-vis Sapient and Answerlink are considered.

Price/ TEV/ Price/ Price/ Market Cash/
Company OCF* Rev 2001 CEPS* Book Cap MktCap
Proxicom (PXCM) 9x 0.21x 13.2x 0.76x 150M 70%
Sapient (SAPE) 16x 2.13x >100x 2.58x 1.3B 21%
Answerthink(ANSR)66x 0.61x 11.5x 1.41x 243M 21%
Eloyalty (ELOY) -19x 0.86x NM (loss) 1.62x 232M 22%
Scient (SCNT) -6x NEG NM (loss) 0.72x 164M 109%
Cambridge (CATP) -8x 0.20x NM (loss) 0.96x 215M 45%

*OCF = Trailing 12 month operating cash flow from cash flow statements for most recently filed SEC documents; CEPS= Cash EPS; Data based on 3/15/01 closing prices.

Catalyst

The current extraordinarily low valuation for Proxicom is caused by the lack of a catalyst. With other major industry companies recently warning, investors are assuming the worst for Proxicom. If the company were to report its current status, the stock could rebound assuming its world is not coming to an immediate end.

The stock will not likely see a sustained price recovery until it is clear that business trends have stabilized and are on a rebound. Until this happens, the stock will bounce up as the technology market does well (as it did in January), but plunge when confidence wanes (as it did in February & March to date). For someone with a time horizon longer than the current economic cycle, however, the company could provide substantial appreciation. The company’s relatively long and extremely strong track record, superb employee loyalty, stable management, strong customer base, and attractive valuation indicate to me that Proxicom will be one of the best stocks in this down-and-out industry. (Warning: I would have said the same thing a week ago, in fact did say the same thing, a week ago when the price was 50% higher -- this stock isn’t for the faint of heart and could be a good choice for dollar cost averaging if you believe in that strategy).

One wildcard, which is completely unknown and unpredictable, is the chance for an acquisition. This possibility would not be my primary reason for investing in Proxicom, but it isn’t unusual for leading companies with a blue chip client list to be sought out when they are trading at surprisingly low valuations. Any company trying to improve its presence in the Internet consulting business could find this attractive (Hewlett Packard, IBM, or any of the “big Five” consulting firms).

Side Note: If your assumptions differ from mine and you don’t believe this industry has much future – or you like to do an intra-industry long/short valuation differential plays -- I would encourage you to consider shorting Sapient. While it’s the industry’s premier company (included in the S&P 500), its fundamentals don’t justify the tremendous valuation premium to Proxicom.