Cegeka to Acquire CTG for $10.50 Per Share; Q2 ’23 Results Fall Short of Expectations
CTG has agreed to be acquired by Cegeka, a leading European IT solutions company, for $10.50 per share in cash. The transaction price represents a 31% premium over yesterday’s close, and on a TTM basis, reflects EV/Sales, EV/EBITDA and P/E multiples of approximately 0.5x, 10.0x and 22.9x, respectively. Considering that the implied EV/EBITDA multiple sits above the top end of CTG’s historical trading range over the trailing three and five-year periods, aligns with the median multiple of 9.8x afforded to peers in the IT services space and exceeds the 6.8x median multiple garnered by comps in the staffing industry, we believe the acquisition price is fair and a positive outcome for shareholders. The transaction is expected to close later this year and is subject to customary closing conditions, including regulatory approval and the successful tender of at least two-thirds of CTG’s outstanding shares. Certain directors and executive officers of CTG representing 8.8% of CTG’s outstanding shares have already agreed to tender their shares.
Further underscoring the benefits of a sale amid uncertain economic conditions, CTG reported Q2 ’23 results below our estimates and consensus. Revenue fell short of our forecast, primarily due to a higher rate of dis-engagement from customers in the Non-Strategic Technology Services segment and slightly lower revenue in the Europe IT Solutions and Services segment. Revenue from the North America IT Solutions and Services segment exceeded our estimate, and more importantly, enabled CTG to increase the mix of higher margin revenue to over 85% of total revenue. This in turn translated into significant expansion in gross margin, which reached the highest level in the company’s history. However, operating expenses were above our estimate even after adjusting for the one-time items in Q2, resulting in both adjusted EBITDA and EPS coming in short of our projections.
Due to the pending sale and ongoing macroeconomic uncertainty, CTG did not host an earnings call and management withdrew its prior FY ’23 guidance. We lower our estimates for this year and next to reflect a higher rate of dis-engagement in the Non-Strategic Technology Services segment, a slower recovery in the Europe IT Solutions and Services segment, and an uptick in our operating expense assumptions. Our price target, which was previously based on a FY ’23 EV/EBITDA multiple of 6x, increases from $8.25 to $10.50 to match the deal price.
Exhibit I: Reported Results and Guidance Versus Expectations
Sources: CTG, K. Liu & Company LLC; FactSet Estimates
Q2 revenue of $74.6 million (-9.9% Y/Y) was below our estimate of $78.4 million and consensus of $78.7 million. The shortfall relative to our model was primarily related to a higher rate of dis-engagement from Non-Strategic Technology Services and to a lesser extent, lower than anticipated growth in the Europe IT Solutions and Services segment. Revenue in the North America IT Solutions and Services segment outpaced our expectations due in part to strong growth in the healthcare vertical. By segment, North America IT Solutions and Services revenue was $26.0 million (+27.8% Y/Y) versus our estimate of $24.6 million; Europe IT Solutions and Services revenue was $38.4 million (+3.3% Y/Y) versus our estimate of $40.3 million; and Non-Strategic Technology Services revenue was $10.2 million (-59.6% Y/Y) versus our estimate of $13.4 million. Worth noting, CTG’s mix of higher margin IT Solutions and Services revenue reached 86% of total revenue.
Reflecting the higher mix of solutions revenue, gross margin reached 28.1%, representing a record high for the company and easily exceeding our 26.8% assumption. By segment, gross margin was 40.4% in the North America IT Solutions and Services segment versus our 39.5% assumption; 24.1% in the Europe IT Solutions and Services segment compared to our 24.0% assumption; and 12.2% in the Non-Strategic Technology Services segment versus our 12.0% assumption. Operating expenses of $20.7 million were above our $19.0 million forecast mostly due to non-recurring costs for strategic initiatives. Reflecting the combined impact of lower revenue and higher expenses, adjusted EBITDA of $3.7 million fell short of our $4.3 million projection and consensus of $4.1 million. Non-GAAP EPS of $0.13 were also short of our $0.15 estimate and the Street’s $0.14.
In Q2, CTG used $2.0 million in operating cash flow and had $0.8 million in capital expenditures. The company exited the quarter with $19.1 million in cash and no debt. Due to the pending sale of the company to Cegeka, management withdrew its prior FY ’23 guidance, which included revenue of $310.0-$340.0 million and non-GAAP EPS of $0.56-$0.64.
Exhibit II: Estimate Revisions
Source: K. Liu & Company LLC
We reduced our revenue estimates for this year and next to reflect lower revenues from non-strategic staffing customers and a slower recovery in Europe. Although we raised our gross margin assumptions to reflect the higher mix of IT solutions and services revenue, we also increased our estimate of operating expenses slightly. As a result, our adjusted EBITDA and non-GAAP EPS estimates also decline for FY ’23 and FY ’24.
Our report with model and disclosures is available here.
Disclosure(s):
K. Liu & Company LLC (“the firm”) receives or intends to seek compensation from the companies covered in its research reports. The firm has received compensation from CTG, Inc. (CTG) in the past 12 months for “Sponsored Research.”
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