FTI Consulting (FCN) sold off 7% on Tuesday, April 9th due to a Deutsche Bank note to clients indicating the bank had seen recent weakness in IPOs and M&A activity. In spite of record low interest rates and record high corporate cash balances, M&A activity, which is a very profitable business for FTI, has been depressed for a while following the recession, and this is already built into FTI's stock price. The diversified consulting company is currently trading at a very attractive free cash flow multiple and investors can use this dip to pick up (more) shares.
FTI offers consulting services in five operating segments:
- Corporate Finance/Restructuring
- Forensic and Litigation Consulting
- Economic Consulting
- Strategic Communications
These segments turn what could be a highly cyclical company into a very non-cyclical one:
Corporate finance and restructuring generates the most earnings for the company (around 1/3) and does well at the top or the bottom of the cycle due to M&A and bankruptcy work. This segment is best-in-class and has been involved with very high profile assignments, including Lehman Brothers and General Motors (GM).
FTI's other segments are positioned to take advantage of the long-term growth secular of regulation, litigation, risk mitigation, and the increase in e-discovery and digital forensics for legal casework. If you think regulation and litigation are going to continue to increase, you may be interested in FTI.
Per the below graphic from the 10-K, earnings for FTI have been muted over the last few years following the recession due to a few factors, including a stagnant Europe, some pricing pressures, and the roll-off of large engagements. While FTI can do very well during boom and bust, the company performance suffers somewhat when everybody is just muddling through, as has been the case recently, and particularly in Europe.
Gobbling up shares:
FTI has taken the cash generated during the recession and bought back $300mm of shares over the last three years, reducing diluted shares outstanding by 13% from 47.6mm in 2010 to 41.5mm in 2012. FTI completed an accelerated buyback in 2011 of $209mm at an average of $36.45/share to complete an existing $500mm authorization. Following this, the board authorized another $250mm share repurchase program in June 2012, representing approximately 20% of the company's market cap at the time. While the company had to redeem its $150mm convertible bond issue in 2012, approximately $50mm of shares were still retired at an average price of $29.76.
The 2012 refinancing was slightly dilutive to interest expense by about $5mm as the 3 3/4% converts were taken out along with $220mm of 7 3/4% notes and replaced with a $300mm 10-year issue at 6%, but this also reduced diluted shares outstanding by 836k (2%), and FTI locked in long-term financing at an attractive rate. We've all heard shareholders press companies to use cheap debt advantageously to retire shares, and that's exactly what FTI has been willing and able to do, while still maintaining a BB+ credit rating. Due to shareholder friendly policies, I would not expect the ratings agencies to give FTI an investment-grade rating in the near term.
FTI's cash from operations was a reported $120mm in 2012, but this includes the acceleration of $25mm of bonus payments due to tax considerations, so the adjusted figure of $145mm is still a decline from 2011's $174mm. But with an average of ~$25mm of capex requirements, the stock is back to a ~10% FCF multiple at $33/share. The company has spent $60-$65mm on tuck-in acquisitions during each of the last three years, and if cash flow is just flat for 2013, FTI can buy back another 6-7% of shares outstanding with FCF alone.
On the 4Q12 earnings call, FTI's CEO called out the backlog of potential mergers at "the highest levels in the history of the company." The company guided to a resumption of earnings increases, from an adjusted $2.30/share in 2012 to an adjusted $2.50-$2.60/share in 2013, a bit over 10% growth and without any adjustment for acquisitions or share repurchases. Cash from operations was guided to $175mm-$200mm, with capex of $31mm-$37mm. Backing out the $25mm from the accelerated bonus payments, the midpoint of this range gives FTI a 10% forward FCF. FTI has been growing organically through expansion in Asia/Pac and Latin America, while also completing the tuck-in acquisitions to expand both capabilities and geographic reach.
Keeping in mind that this is one of the worst environments possible for FTI, a 10% FCF yield is very attractive. Should the economy return to reasonable growth and confidence, or slide into a double dip, FTI's business will pick up, and not many companies can claim to benefit from movement in either direction. If we continue to muddle along for another year or two, you're still holding a stock with a 10% FCF yield with management that's committed to returning that to shareholders.
FTI Consulting is my largest holding and I took advantage of the dip to add to my position.
Additional disclosure: I am also short FCN puts.