Recovery audit specialist PRG-Schultz has traditionally helped retailers find and reclaim overpayments resulting from complex purchasing processes and human error.
While this offers high ROI to customers, PRG’s problem is a declining core business with a concentrated client base, whose need for the company’s services diminishes over time due to better payment processes and greater in-house capabilities.
As management tries to expand into other industries with high transaction volume such as healthcare, as well as adjacent services including broader analytics and consulting, execution becomes a greater risk.
That said, the shares appear undervalued at a trailing EBIT-to-enterprise value yield of 18%. JANA Partners owns 9%.
Investors appears to be overly negative on PRGX due to consensus analyst estimates for EPS to decline from $0.59 in 2009 to $0.48. Despite the negative near-term operating environment for PRGX, the company's business remains one that achieves high returns on invested capital and provides customers strong return on investment.
The company also has a clean balance sheet, with no net debt-- investors may not be giving the company any credit for this, as they are overly focused on near-term operating dynamics.
PRG-Schultz provides recovery audit services to companies and government agencies with large transaction volumes.
- “Pay-for-performance” business model. Under its recovery audit contracts, the company receives a percentage of overpayments and other savings it identifies and clients recover as a result.
- Target clients include retailers, wholesalers and other commercial clients. PRG-Schultz also serves government agencies and is a subcontractor in the national recovery audit contractor program of the Centers for Medicare and Medicaid Services.
- Advantages include scale and proprietary processes. Barriers to entry are higher in contract compliance auditing versus simpler disbursement audits for duplicate payments and statement errors.
- Average recovery per customer was $2.8 million in 2008, up from 2.0 million in 2005. Over the last four years, PRG-Schultz recovered an average of over $1 billion annually for its customers. The company earned average revenue per customer of $625k in 2008, up from $379k in 2005.
- JANA Partners filed a 13D in 2009 “to reserve its right to take steps to bring about changes to increase shareholder value, which may include changes in the board composition, strategy and future plans” of PRG. JANA initially reported a PRGX stake in ‘06.
- Strong balance sheet, with $27 million of cash and $16 million of debt. The company also has $34 million of federal NOLs, of which $25 million have a usage limitation of $1.4 million per year.
- Shares trade at 18% trailing EBIT-to-EV yield.
INVESTMENT RISKS & CONCERNS
- Risk of becoming a victim of its own success. As client relationships mature, the dollar volume of overpayments recovered typically begins to decline, decreasing revenue to PRG-Schultz.
- Competes against clients’ internal recovery audit departments. PRG-Schultz’s revenue is at risk as clients’ internal recovery teams, especially at large businesses, increase recoveries via process improvements and more advanced software.
- Ambitious growth strategy raises execution risk. Management aims to double EBITDA over next five years driven in part by acquisitions, including $15-20 million of investment over next 18 months.
- Weak retail industry represents headwind. 3Q09 revenue was down 4% on constant currency basis.
- Romil Bahl is the fourth CEO since 2005. Former controller Robert Lee was appointed CFO after Peter Limeri’s resignation in 2009.
- Top five clients accounted for 30% of revenue in 2008, with Wal-Mart contributing 11% of the total.
CEO 2% | Other insiders * 4% | Blum 15% | Jana 9% | Weintraub 9% | RenTech 6% | Acadian 3% | Whitebox 3%
* Excludes shares attributable to director Lind who represents Blum Capital.
Disclosure: No positions