Highlights from Virtual Non-Deal Roadshow with CTG
We hosted virtual investor meetings yesterday with CTG, Inc.’s (CTG) CEO, Filip Gydé, and CFO, John Laubacker. In our view, management appeared upbeat with respect to the company’s progress since the outset of the COVID-19 pandemic, its strategic shift towards solutions and the prospects for further margin expansion over time. With no end in sight to the current public health crisis, CTG has seen its customers and prospects focus their attention on managing, optimizing and securing technology solutions that enable remote work, telehealth and other digital experiences. This tacit acknowledgement that a return to prior norms is unlikely bodes well for CTG’s prospects in 2H ’20 and FY ’21, in our opinion, as the need to adapt business processes and systems to the new reality should provide incremental opportunities to grow the higher margin solutions business. We continue to believe shares are undervalued and maintain our price target of $6.25, which reflects a FY ’21 EV/EBITDA multiple of 5x.
In the early days of the pandemic, both CTG and its clients were intensely focused on transitioning their employees from working on-site to working from home. Although the rapid shift to remote work weighed on parts of the business, primarily lower margin staffing engagements, CTG benefited from incremental demand for higher margin solutions opportunities ranging from IT systems procurement to help desk support. At the same time, solutions projects already underway continued to move forward, resulting in a favorable revenue mix and the company’s strongest six-month non-GAAP EPS performance in the past six years.
While working virtually was largely expected to be a temporary measure, the ongoing pandemic and corresponding impact on in-person engagement has brought about the realization that work-from-anywhere and digital interactions will remain the norm for the foreseeable future. In this regard, organizations are now moving from simply adopting video conferencing and collaboration solutions to considering how best to manage, optimize and secure these environments. In fact, the rapid adoption of Microsoft Teams by its customers and a subsequent uptick in demand for related services has spawned CTG’s launch of a formal Microsoft 365 services offering that leverages the company’s experience in migrating legacy on-premise collaboration applications to the cloud. In the healthcare vertical, increased demand for telehealth and patient access to online health records has created additional workloads for CTG’s help desk operations. The energy sector has also produced new opportunities, particularly around CTG’s Enterprise Information Management Advantage services. Worth noting, CTG remains engaged with a large energy customer that was acquired at the end of Q2, an event which created some uncertainty pertaining to the scope of work available going forward. Lastly, CTG’s pipeline has also increased following the introduction of its testing services in North America.
Given the uncertainty surrounding COVID-19, sales cycles remain somewhat elongated. Our sense, however, was that stalled discussions pertained more so to the staffing segment, particularly with respect to CTG’s efforts to elevate certain relationships to more strategic managed services arrangements. Within staffing, the company also continues to focus on mid-market expansion with an emphasis on IT and other professional staffing assignments. Between the staffing segment being more impacted by the pandemic and business development efforts continuing to skew towards solutions, CTG’s transformation into a solutions-centric company should accelerate further in the coming quarters.
CTG exited Q2 ’20 with 38% of revenue from solutions, up from 33% in the prior quarter and 36% a year ago. As a result, the company’s non-GAAP operating margin increased approximately 100 basis points Y/Y to 3.3% and yielded non-GAAP earnings consistent with the year ago period despite a low double-digit decline in revenue. Although no long-term operating margin targets have been put forth, management is far from satisfied with the progress thus far and does not consider the high-water mark of 6% achieved during the heyday of CTG’s healthcare solutions business as a ceiling. With this in mind, we surmise our current estimates for this year and next leave room for upside.
Subsequent to our meetings with management, Assurance Global Services (AGS) and Wax Asset Management, which together own 6.4% of outstanding shares, filed an amended 13-D containing a letter to CTG’s Board of Directors. The letter expresses the shareholders’ dismay with the Board’s compensation levels and the payment of that compensation via undervalued stock. As such, the shareholders plan to vote against the two directors up for election at this year’s annual meeting and against a proposal to approve and ratify CTG’s 2020 Equity Award Plan. Finally, the shareholders presented several recommendations to the Board of Directors, including improving shareholder relations by committing to attend next year’s annual meeting in person; reducing its directors’ annual compensation to $90,000, payable in cash; individually purchasing shares of CTG on the open market; adopting performance targets based on metrics such as EVA or ROIC in lieu of non-GAAP EPS; using excess cash to reinvest in the business or to repurchase shares at prices below intrinsic value; and replacing the two directors up for election this year as well as Chairman Daniel Sullivan if those up for election fail to receive “For” votes from at least 2/3 of shares outstanding in the upcoming annual meeting. Recall that AGS presented a non-binding proposal to acquire CTG for $7.00 per share in January. Neither AGS nor CTG have provided an update on the status of that proposal since that time.
Earlier this morning, CTG responded with a press release outlining its strategic initiatives and commitment to further enhancing shareholder value. The company’s strategic shift from staffing to solutions has been covered above, but CTG also highlighted the addition of two new directors to the Board in the past three years and significant share repurchases conducted with the support of numerous shareholders in recent years. As for the criticism of its Board compensation, the company cited its consultation with an independent consulting firm and a concerted focus to ensure compensation for both the Board and management was fully aligned with shareholders. Finally, CTG stated that “[w]e are confident that our expanded solutions offerings during the second half of the year will advance our future growth opportunities and accelerate the achievement of our objectives, including generating substantial long-term value for CTG shareholders.”
Our report with model and disclosures is available here.
Disclosure(s):
K. Liu & Company LLC has received compensation from CTG, Inc. (CTG) in the past 12 months for “Sponsored Research.”
Sponsored Research produced by the firm is paid for by the subject company in the form of an initial retainer and a recurring monthly fee. The analysis and recommendations in our Sponsored Research reports are derived from the same process and methodologies utilized in all of our research reports whether sponsored or not. The subject company does not review any aspect of our Sponsored Research reports prior to publication.