Computer Sciences Corp: Upward Trajectory Will Continue

by: Violent Capitalist

Computer Sciences (NYSE:CSC) is basically a IT outsourcing and consulting business for organizations that rely on lots of data (i.e. government, Fortune 500 Co's). Its primary, most direct competitor is notably the formidable Accenture (NYSE:ACN) but spans out to organizations with significant IT consulting operations such as Hewlett-Packard (NYSE:HPQ), IBM (NYSE:IBM), Dell's Perot Systems (NASDAQ:DELL), and more.

Computer Sciences Corp was actually founded after Accenture's predecessor and quickly became the largest software company in the world. When the internet bubble burst and Accenture went public, Computer Sciences was somewhat dogged by a lack of consistent growth that it once enjoyed prior to the turn of the millenium. Regardless, with Accenture's IPO and competition increasing across the board, Computer Sciences has adjusted - and that with a low valuation compared to its peers.

At a current market cap of $8.5 billion and net debt of $1B, Computer Sciences has an enterprise value of $9.5B. Analysts estimates are coming in at 5.37 a share for earnings. But I conservatively estimate that the company will able to hit $800 million in net income over the next 12 months, giving a P/E ratio of 10.55x. Accenture, on the other hand, has a P/E of 16.34x.

However, I prefer looking at free cash flow as a metric: It's also one of the reasons that Computer Sciences has been lagging Accenture. Accenture is a highly efficient, low capex business compared to Computer Sciences, with a consistently +50% return on invested capital. Computer Sciences' return on invested capital is only about 10%. This is essentially a function of the large amounts of capex that Computer Sciences incurs for each of its new contracts. The company is supposed to be following Accenture's lead in reducing capex and boosting capital efficiency, but it seems like it may take another few years to work that out.

Going back to free cash flow - with $800M in net income, depreciation/amortization totaling $1.2 bil, and capex of $1 bil, free cash flow for Computer Sciences should total about $1B. Enteprise value to free cash flow equates to about 9.5x. Using the same equations, Accenture comes in at over 13x.

By being a more efficient operation, analysts expect Accenture to grow its bottom line by just over 10% a year vs. approximately 8% a year for Computer Sciences. In my opinion, I think Computer Sciences will be able to grow its free cash flow by 10% a year for the next five years given award wins and lower capex. At the end of five years, the company should have free cash flow of about $1.5B. If I apply a conservative multiple of 10x, I get an enterprise value of $15B. Back out the net debt of $1B and divide by 156 million shares, that equates to a share price target of $90 in 5 years.

  • Price Today: $54

  • Conservative Fair Value: $90

  • Projected return: 75% gains with dividends

  • Alternate Strategy: Sell February puts at strike 52.5, for 2% yield or 24% annualized

Disclosure: I am long CSC.

Additional disclosure: I also am long March 60 calls of CSC