I first mentioned Mastech Holdings (NYSEMKT:MHH) when I updated the results of the negative enterprise value screen. Mastech is not a net net value stock but after briefly analyzing the financial statements, I believe it to be within my circle of competence and margin of safety. There is also a limit to the downside. In other words, this is a cheap value stock idea.
Nevertheless, all fundamental analysis requires more reading and analysis to come up with a conclusion and fair value estimate. Like previous stock analyzes, it will be broken into two parts. This one looks at the business, industry, risks and advantages and the second post will go over the various numbers.
I’ll start with a quick overview.
Spider Graph Business Valuation
Mastech Holdings, Inc is a provider of IT and brokerage operations staffing and consulting services to Fortune 1000 companies.
Mastech delivers a broad range of services within business intelligence/data warehousing, service oriented architecture, web services, enterprise resource planning & customer resource management and eBusiness solutions segments.
The company managed to survive the dot com bust and retooled its recruiting model to focus on the recruitment of U.S. based IT talent, which has allowed the company to access a larger and differentiated recruiting pool compared to many of their competitors.
Growth Strategy and Competitive Advantage
The staffing industry as a whole is very fragmented with low barriers of entry and high competition. This means that there is no clear leader dominating the industry like Cola (COK) and Pepsi (NYSE:PEP). The pie is big enough for everyone, i.e. everyone has the potential to profit and stay in business, although a moat does not exist.
In this type of industry, regardless of size, a company can steal or lose market share.
As for growth, I see it being dependent on a couple of things.
- Stealing market share and contracts - Staffing is a service. It isn’t a product that can be sold internationally. An H1-B visa is useless outside the United States and a US staffing company isn’t likely to send their contractors to other countries.
- Growth is entirely dependent on the economy - This is an investment that should be monitored along with the economy. When the economy is good, companies increase their business which will require additional employees, whether they be permanent or temporary. With the nationwide unemployment rate being 10% at the moment, it is safe to say that the probability of economic growth is higher than a depression.
- Acquisition of companies - MHH has a healthy balance sheet and has the ability to acquire other companies.
One competitive advantage that MHH states in their 10-K is the following:
“Unlike most staffing firms that have a high concentration of either H1-B workers or W-2 hourly U.S. citizens, we have approximately a 50/50 composition of H1-B and W-2 hourly employees. As such, this balanced mix allows us to tap a broad candidate pool.”
I’m not quite sure how much of an advantage this is, since it should be easily replicated.
However, if you look at the numbers that I will go through later, MHH compares to a company 4-5 times its size. Their margins and profitability are higher than a number of their competitors which does prove they have an advantage. I just can’t see or pinpoint it.
Sales and Marketing
Mastech focuses their marketing primarily on large businesses with spending power and recurring staffing and software development needs.
MHH declares, “much of our marketing efforts are focused on increasing business with our existing accounts.” As you can see already, MHH is not a growth company.
The company does business through two business channels - wholesale and retail with most of the strategic relationships in this channel being established vice presidents and sales directors.
“Wholesale channel consists of system integrators and other IT staffing firm customers … Revenues from this channel represented 48% of total revenues in 2008.
IT retail channel focuses on customers that are end-users of IT staffing services.
Within the retail channel, many end-users of IT staffing services have retained a third party to provide vendor management services to centralize the consultant hiring process. Under this arrangement, the third-party managed service provider (“MSP”) retains control of the vendor selection and vendor evaluation process, which acts to weaken the relationship built with client contacts.”
1. Concentrated customers
IBM, Tek Systems and Wachovia Securities are the top three clients representing 14.9%, 12.7% and 10.7% of total 2008 revenues, respectively. If they lose even one of these clients, MHH will suffer huge setbacks.
However, with their history, expertise, broad talent pool and client relationship, this possibility seems to be small.
2. No Pricing Power
Because the industry is highly fragmented, MHH does not have the luxury of increasing prices without jeopardizing their business.
3. Immigration law
Immigration law is also another issue. There is a quota to how many H1-B visas can be issued each year and it fills up very rapidly. The good thing is that Mastech focuses on employing people in the US already with a H1-B visa.
4. Dependent on Economy
Mastech’s business is directly correlated to the economy. i.e. buy the stock when the economy is bad and sell when things are doing well.
5. Margins and profits will suffer if the trend towards Managed Service Providers (MSP) continues. Managed Service Providers are employed by bigger companies and act as the middle man to handle the negotiation and hiring of contractors. More companies have been using this business model which means that a direct and close relationship will be hard to maintain.
6. MHH also operates internationally to recruit talent which introduces currency risk.
7. Mastech hold several “preferred vendor” contracts which provides business volume although the margins are smaller. If they were to lose their preferred status, they would see a drop in revenue.
8. Co-founders of iGate, Sunil Wadhwani and Ashok Trivedi, hold 57% of MHH common stock. If they are shareholder orientated, great, if not, even an wolf activist like Bill Ackman won’t be able to do anything.
To be continued
The next post will focus on the financial statements, fair value calculations and other number discussions. Stay tuned.
Disclosure: I hold MHH at the time of writing.