Description
RCMT is severely undervalued with solid downside protection and significant appreciation potential.
RCMT:
- Is close to a net/net situation with 93% of its market value in cash + net receivables
- Is profitable and cash generative (21% trailing FCF yield, will generate adjusted enterprise value in free cash twice this year alone)
- Has generated positive operating income every year since 1992
- Has meaningful growth opportunities ahead
- Rejected a strategic buyout offer last year for a premium to today's price
- Has grown EBITDA and adjusted EPS by 60% and 80% in the last twelve months, respectively
- Has a substantial share repurchase program in place (>10% of market value)
- CEO is closing in on 70 years old and is incentivized to sell (mgmt indicated to us a sale / breakup is inevitable)
We think the stock is cheap because it's off the radar (small-cap, $5 stock price), a large litigation gain in 2009 veils substantial improvement in operating earnings, and a turnaround in its largest segment clouds the strength and profitability of the two others (which alone we estimate are worth well more than the RCMT's entire market value).
We anticipate this stock has 60-75% upside in the next 6-9 months through operational performance alone. In an eventual breakup, the upside is nearly a 170% (which they've indicated is likely in the future). Neither of these scenarios contemplates significant near-term traction in a turnaround of their IT business which would significantly inflate both target prices.
| Scenario Summary |
|
|
| Upside |
Price |
?% |
| Sum-of-the-Parts |
8.12 |
60.8% |
| CDI Bid Multiples |
8.90 |
76.2% |
| Breakup |
13.47 |
166.6% |
| |
|
|
| Backstop |
|
|
| Cash+Net A/R |
4.68 |
-7.3% |
| Net/Net |
4.24 |
-16.0% |
| |
|
|
| Reward / Risk |
Price |
?$ |
| Sum-of-the-Parts |
8.12 |
3.07 |
| Backstop |
4.46 |
(0.59) |
| Ratio |
|
5.2x |
Additionally, RCMT's downside appears limited given the strength of its balance sheet, operational flexibility, and a sizeable share repurchase program. Except for a one-time write-down of bad debt in 2008, RCMT has generated positive operating income every year since the early '90s. In fact, in the last 40 quarters of operation, The Company generated an operating loss only once during the first quarter of 2009 (a <$500k operating loss). We believe that RCMT will continue to generate and improve operating income going forward. In addition to stable operating cash flows, cash and net receivables represents 93% of RCMT's market value and a pure net/net analysis reveals a value equal to 84% of the current market cap.
| Capitalization |
31-Mar |
| Diluted Shares |
13.2 |
| x Current Price |
5.05 |
| = Market Value |
66.8 |
| - Cash |
25.9 |
| + Debt |
0.0 |
| = Enterprise Value |
40.9 |
| Downside Protection |
31-Mar |
| Cash |
25.9 |
| + Accounts Receivable |
42.0 |
| - Accounts Payable |
6.0 |
| = Cash+Net A/R |
62.0 |
| % of Market Value |
92.7% |
| Net/Net Analysis |
31-Mar |
| Current Assets |
71.0 |
| Total Liabilities |
14.8 |
| Net Value |
56.2 |
| % of Market Value |
84.0% |
The above framework is a good starting point for a discussion on the business.
SEGMENT DISCUSSION
Headquartered in New Jersey, RCMT provides IT and engineering consulting services to some of the largest companies in North America. RCMT is also a provider of specialty healthcare services to healthcare and educational organizations. The company has offices across North America and roughly 2,200 employees.
The Information Technology (IT) segment provides solutions in selected markets including life sciences, medical devices and financial services. RCMT's services allow companies to keep pace with technological developments while minimizing internal IT workforces to operate within budgetary and expertise constraints. Sales here have been challenged due to a confluence of events in 2Q10. Two major life sciences engagements ended and two pharma mergers require RCMT to rebuild business with the acquiring companies. In all, four major engagements went the wrong way. Additionally, one of the key sales persons left the company for a competitor and proactively diverted customers. Despite these headwinds, management brought this segment to profitability through significant expense rationalization and a focus on higher margin business (away from low-margin IT staffing arrangements). As a result, this business has generated $2.3m EBITDA in the trailing twelve months though you'll see in our base-case we value this entire business only for the receivables on the books ($10m or roughly 4.3x trailing EBITDA and we expect EBITDA to grow!) To grow IT's top-line, management replaced account execs, reformulated their sales message and are micro-managing the deals. Management has commented that the sales pipeline is improving but we've yet to see the impact on revenue. Following discussions with the CFO we believe the company could sell the IT business today but that they'd wait for a string of good quarters before putting it on the block.
The Engineering segment bids on longer-term, large contracts to provide design, analysis and tech-support to verticals such as energy and aerospace. This segment has a strong bench of vertical specific engineers. RCMT gets about 1/5 of their sales In North American nuclear. Our assessment is that no matter what happens with nuclear post Fukushima, RCMT will benefit as they specialize in safety related systems. Post Three-Mile-Island there was a windfall of work in order to reevaluate safety systems. In fact, most of what RCMT does on the nuclear side is a result of regulations following the Three-Mile-Island disaster which happened over 30 years ago. Post Fukushima, there will be a laundry list of fixes that RCMT will be involved with. In the worst case scenario for nuclear and all plants shut down, RCMT would be inundated with work for years helping shut down and decommission nuclear plants. In our view it's a win/win. RCMT also does a significant amount of business in aerospace - one of their largest customers is United Technologies (UTX). Additionally, RCMT is entering the Facilities Design space which has explosive potential. The Company recently won a wastewater contract, a deal related to the Long Island railroad and New York Power. They're also bidding on several other public projects that we believe will contribute to growth in this segment. We estimate that the engineering group is the most valuable of RCMT's three segments coming in at $52.2m, or 8.1x 2011 EBITDA.
The Specialty Healthcare segment provides temporary and permanent placement of nurses and therapists. The New York City Board of Education is the largest customer for this segment. While state budgets have been constrained, RCMT's services are mandatory requirements and have not been subject to budget cuts. This segment's EBITDA margins are among the highest in the industry. While it's been relatively stable for 10 years, we believe there is growth potential here as they've recently been added to the providers list in Tennessee and The Company is pursuing business with the public school systems in Chicago and Los Angeles. We value this segment at $20m based on comparable healthcare EBITDA multiples.
WHY DOES THIS OPPORTUNITY EXIST, WHAT WILL DRIVE APPRECIATION, AND WHAT'S IT WORTH?
Aside from the challenges faced by the IT segment discussed above, we speculate that this stock doesn't hit most radar screens because it's small and earnings appear to be declining precipitously. This is because of a non-recurring tax benefit in 1Q10 and a non-recurring legal settlement during 2009. On a GAAP basis, EPS has declined 46% in the trailing twelve. On an adjusted basis however, earnings have actually grown 79% excluding the prior tax and litigation benefits.
Since CDI's takeout offer for $5.20 per share management has been under an investor microscope. CDI announced the unsolicited offer which the board rejected and put in place corporate defenses. Nonetheless, we believe that if RCMT's business meaningfully deteriorated that downside risk is limited and large holders would put pressure on the board to monetize some or all of the underlying value. Through discussions with management we're comfortable that they're proactively looking for ways to unlock value (share repurchase, return of capital, asset sale, etc.) In the meantime, this business is going to generate cash thereby shrinking RCMT's enterprise value. Concurrently there are meaningful growth opportunities in the Engineering segment, incremental growth opportunities in the Healthcare segment, and the opportunity to gain traction in the IT business.
From a valuation standpoint, assigning no more than the value of working capital to their largest and profitable segment (IT) and assigning comparable multiples to the other two businesses, we arrive at a value of $8.12 (60.8% upside). [Engineering comps used: CDI, JEC, KFRC, SFN; Healthcare comps used: ASGN, CCRN]
| SoP Analysis |
$mm |
Comment |
| Info Tech. |
9.9 |
Value of working capital |
| Engineering |
52.2 |
8.1x 2011 EBITDA |
| Healthcare |
19.4 |
9.6x 2011 EBITDA |
| Enterprise Value |
81.5 |
|
| Net Cash |
25.9 |
|
| Market Value |
107.5 |
|
| Per Share |
8.12 |
|
| Appreciation % |
60.8% |
|
Much like a REIT's properties would be worth more in the absence of holdco overhead, so too would RCMT be worth more in pieces. This is due to the roughly $9m of corporate SG&A that would go away if the businesses were to be broken up and sold off. In that case, the valuation balloons to $13.47 (166.6% upside) even assuming over 50% of the cash is burned winding down the operation.
| Breakup Analysis (2011E) |
|
|
|
|
|
| Segment |
Sales |
EBITDA |
SG&A |
Contribution |
Multiple |
Value |
| Info Tech. |
61.0 |
3.2 |
3.6 |
6.7 |
4.0x |
26.9 |
| Engineering |
66.4 |
6.4 |
3.9 |
10.3 |
8.1x |
83.7 |
| Healthcare |
27.0 |
2.0 |
1.6 |
3.6 |
6.0x |
21.5 |
| Total |
154.4 |
11.6 |
9.0 |
20.6 |
6.4 |
132.2 |
| Cash |
|
|
|
|
|
25.9 |
| Net A/R |
|
|
|
|
|
36.0 |
| Wind Down |
|
|
|
|
|
(15.9) |
| Total |
|
|
|
|
|
178.2 |
| Per Share |
|
|
|
|
|
13.47 |
| Appreciation % |
|
|
|
|
|
166.6% |
Finally, if we look at the value of RCMT today given their earnings growth vs. the implied value of CDI's unsolicited bid last year, the target would be $8.90 (76.2% upside).
| Implied Value Given CDI's Takeout Bid |
| |
3-Jun-10 |
14-Jul-11 |
| Shares |
12.8 |
13.3 |
| Price |
5.20 |
5.05 |
| Market Value |
66.6 |
67.3 |
| |
|
|
| Enterprise Value |
54.4 |
41.3 |
| |
|
|
| Cash+Net AR |
53.8 |
62.0 |
| Adjusted EV |
12.8 |
5.3 |
| |
|
|
| TTM Earnings |
|
|
| EBITDA |
6.5 |
10.3 |
| EPS |
0.23 |
0.42 |
| |
|
|
| TTM Multiple |
|
|
| EBITDA |
8.4x |
4.0x |
| EPS |
22.4x |
12.1x |
| |
|
|
| Growth Since CDI's Bid |
|
| EBITDA |
|
58.9% |
| EPS |
|
79.1% |
| |
|
|
| Implied Mkt. Val. (Original Multiples) |
| EV/EBITDA |
|
8.49 |
| P/E |
|
9.31 |
| Average |
|
8.90 |
| Premium |
|
76.2% |
WHAT ARE THE RISKS?
- One of the key risks to the story is Leon Kopyt's (CEO) compensation package which entitles him to a large payout (>$6m) if the company is sold. The incentive structure is funky in that he's got an incentive to sell at any price (though he's proven that he's unwilling to) and his relatively low ownership of the business could be construed as misalignment with investors. Other risks include:
- Further weakness in the IT segment
- Stalled US economic growth
- Healthcare segment contract with New York's Board of Education is through 2012. Though RCMT has been here for 10 years with periodic renewals, there is a risk that a new provider could pressure margins.
- Corporate defenses such as the newly instituted poison pill would act as a deterrent for a strategic acquirer
- Wihle not a risk to the business, I've heard anecdotally (we haven't really looked for or seen conclusive evidence) that the CEO has mis-stated his education background
Catalyst
- Potential for large contract win in the engineering segment
- Incremental growth in healthcare
- Turnaround in IT segment
- Continued cash generation reducing enterprise value
- Monetization of segments / company