Right Management Consultants, RHT
November 03, 2002 - 10:51pm EST by
bibicif87
2002 2003
Price: 13.59 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 308 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Right Management Consulting is the largest company in the outplacement business, which means that companies hire RMCI to help them handle the process of laying off employees, and to help those downsized to get new jobs. A laid off employee typically is given a cubicle, desk, and phone at an RMCI outplacement center, either one already existing in hundreds of locations, or set up ad hoc for that corporate client in the case of larger scale layoffs. RMCI helps the ex-employee to write a resume, plan and execute a job search, and learn how to be effective in interviews. RMCI is paid only by the ex-employer, who typically does this, not out of benevolence to those laid off, as much as to help the morale of those still employed, by giving them the message that the company will treat them fairly even if further cuts become necessary.

RMCI dominates the outplacement business (which it refers to as “career transition” or CT) worldwide. In 2001 its customers included more than half companies in the S&P 500, and no doubt that was the case again this year. It is not an employment agency, nor does it want any individual clients not paid for by their ex-employer.

As one would expect, RMCI’s outplacement business is inversely related to the strength in the economy. Business grew rapidly in the late 1980’s and early 1990’s recession, then became weak in the late 1990’s bubble when few were laid off and jobs were easy to find, then exploded again in the last two years as the bubble burst. EPS, which was bouncing around $0.40 in 1999 and 2000, jumped to $0.81 in 2001 and should be about $1.57 this year on revenues of around $475M.

With few companies showing that kind of earnings growth in the last two years, to say the least, the stock soared from under $3 in 2000 to over $22 earlier this year, recently pulling back to the low teens.

RMCI is not just a reverse play on the economy. There are secular growth aspects to the business, discussed below, that should allow it to grow nicely in anything other than a booming economy. And about 15% of the company’s sales are in organizational consulting which does better in good times than bad. Nevertheless, in thinking about the correct value for RMCI please consider this concept:

Companies with a strong inverse correlation to the economy and the stock market are very, very, rare. At the same time, most investment money resides in portfolios that are not permitted or inclined to sell equities short, yet whose managers may occasionally take a bearish stance on the economic outlook. A stock with RMCI’s highly unusual characteristics is a way to hedge against that possibility and reduce the portfolio’s overall risk.

This rarity value should, and presumably some day will, deserve a premium price. At a P/E of 8.5, and an EV/EBITDA of just a shade over 4, RMCI certainly doesn’t have one now.

The most likely reason for the low valuation is that three of the four analysts covering it give it their lowest rating, on the grounds that “the outplacement cycle has peaked” (as if they know), and that RMCI “normally” sells at a big discount to the market P/E (including in the baseline the recent bubble years, when everyone “knew” that the “New Economy” had banished recessions.)

Sell side analysts tend to hate this stock, and regularly seem to think that any good quarter the company has is probably its last. After all, if they were genuinely enthusiastic for RMCI’s prospects, the expected economic weakness that such an opinion would imply would contradict the overly optimistic economic assumptions they need to justify all their other “strong buys.”

One doesn’t have to be bearish on the economy to think that RMCI might deserve a place in a portfolio; all one has to be is agnostic, or less than 100% certain, and there should be something attractive about a stock whose earnings take off when one’s other holdings get weak.

The best current information source about RMCI is the last S-3 material filed in connection with a stock offering proposed in June when the stock was around $19, and subsequently cancelled. I won’t clog up this report with too many details that one can read there. Here is a link:
http://www.sec.gov/Archives/edgar/data/802806/000095011602001410/0000950116-02-001410.txt

Also, check out the website for more info: http://www.right.com

Some issues:

Acquisitions: With several dozen of them in the last five years, including that of Coutts, a very large competitor, last March, RMCI might be accused of being a rollup. But the acquisitions have all been integrated quite successfully into the RMCI name, and are part of a coherent strategy.

Fortune 500 companies want vendors who can handle their business worldwide. Increasingly, companies’ international operations are integrated such that, when they need to downsize, they must do so in many countries at once. With acquisitions helping it to grow to over 300 offices in 35 countries (many times more than anyone else in the business), RMCI is usually the only outplacement company able to provide one stop shopping. Similarly, RMCI has used acquisitions to build up a organizational consulting business with strong cross selling opportunities to the same human relations departments that hire RMCI to handle outplacement.

Because of the large Coutts acquisition, as well as unusually high capital spending to integrate the two companies, debt net of cash jumped considerably to $92.6M as of Q3 vs. $6.6M in net cash last December. But that can be paid down rapidly from cash flow from operations, which should be in the $50M range next year.

Secular trends: Outplacement assistance is increasingly considered a standard company benefit, at least for middle managers and above, and is nearly always outsourced. In addition to helping morale of those still employed, it reduces the risk of litigation and workplace violence. With over half its business now coming from outside the US, RMCI will benefit over time as European and Asian countries gradually move toward US/UK style labor flexibility.

RMCI’s cost structure: The spectacular growth in RMCI’s earnings in the last eight quarters might lead one to believe that its earnings would plummet if business was soft. In fact, RMCI has focused on making its cost structure more variable. A big portion of its employees’ pay comes from bonuses, which require corporate earnings growth of at least 15% to kick in. Any slowdown would result in an automatic reduction in labor expenses. In addition, many of the consultants working for RMCI are contract employees used only as needed.

One cyclical trend that hasn’t kicked in yet this cycle, but might if the economy takes another leg down, is a possible expansion in the average length of contracts. When jobs are easy to find, companies aren’t expected to treat those laid off to a long stay at the local RMCI job placement center. As jobs become harder to find, if companies don’t want their outplacement program to be considered a sham, they must give RMCI longer contracts. When this happens, it has a big positive impact on RMCI’s margins, because most of RMCI’s high cost expenses (personal resume assistance, job campaign strategy advice, practice interviews, etc.) occur in the first several weeks that a laid off employee shows up. As time goes on, the person is presumably chugging away on the job search on his own, and other than as occasional back slapping “Atta boy! Go get ‘em”, RMCI doesn’t have to provide as much personal service. With revenues recognized in a straight line over the life of the contract, that makes longer contracts very profitable towards the end.

Obviously, with outplacement operating margins running at 29% of sales, there is a limit as to how much they can expand from here, but they haven’t necessarily topped out. The organizational consulting operation, which needs stronger economic conditions to flourish, is just slightly profitable in today’s conditions, and has plenty of room to expand margins if things get stronger.

One other piece of evidence that there is secular growth at RMCI over and above the inverse cyclical correlation with the economy: The peak of unemployment in the last recession occurred in early 1991. If today’s analysts had been following the stock then, they all would have said “hold” (i.e., sell) because the “outplacement cycle has peaked”, etc. Nevertheless, RMCI’s sales and earnings continued to rise every quarter for six more years until Q1 1997, when, finally, the economy got universally strong enough for outplacement demand to shrink. The point is that the measurements of the economy are averages; good times and bad times roll around the economy affecting different industries at different times. Even in a strong environment there are always industries under pressure, or divisions of companies that are under performing and must be dealt with. And good times and good stock markets bring with them mergers and acquisitions, always a cause of layoffs and outplacement.

Outlook: I would love to sound authoritative and make projections for the next few years, but I can’t because my guess for the economy is no better than yours. Nevertheless, my hunch is that the it will be many years for the economy to digest the aftereffects of the overcapacity caused by the stock market bubble. Few companies anywhere in the economy anywhere in the world are in a position to stockpile employees who don’t justify their pay. Outplacement demand should continue to be strong even if, like the early 1990’s, the statistics claim that things are on the way up. And RMCI is likely to continue to gain market share from the mom and pops who can’t really service the big customers.

Another scenario, with an unknown probability, is that the economy could take a major move down, due to a reduction in consumer spending, a housing price bust, international turmoil, or any of a number of other possible reasons of which I am sure you have read. In that event, RMCI’s new business will be strong, the average length of contract will expand, and its EPS will easily vault over the $2 level.

I don’t want to push any particular economic scenario. My point is that RMCI is relatively unique in the way its numbers respond, inversely, to economic conditions, as well as having some positive secular influences. Equity portfolios that won’t go short and must be fully invested are almost defenseless against bad times; owning RMCI provides a valuable hedge. Yet the stock price doesn’t reflect that. It is total guess work as to how much of a premium multiple RMCI deserves, or will eventually get, for its unique characteristics, but it deserves something, and hasn’t gotten it yet.

One last note: RMCI will start trading on the NYSE on 11/18/02, with the symbol RHT.

Catalyst

Short term, worries about the economy creates confidence in the stock. Long term, the realization that there is a very strong inverse correlation between RMCI's earnings and the economy will, I believe, eventually give the stock a rarity value, since that characteristic makes it an ideal stock to add to all long, all equity portfolios, to reduce risk.
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