Technology and defense company Parsons (NYSE:PSN) has been trading stagnant for quite a while, which is interesting enough given the moves seen in the market itself.
In the final days of 2020, I concluded that Parsons was delivering on its promises, and delivering on bolt-on M&A after going public in spring of 2019. With shares trading at a fair valuation multiple, I considered shares to be fairly valued, yet with defense markets attracting greater interest for obvious reasons, it is certainly interesting to update the investment thesis here.
Parsons is a provider of technology-driven solutions for defense, intelligence, and critical infrastructure markets. The company has been around for some 75 years, helping clients with its technical design, engineering, service, and software in order to keep the world safe, smart, and connected.
Shares went public at $27 per share early in 2019, but rallied to the $36 mark by the time I looked at the investment case late in 2020. This valuation was based on a business which posted $3.95 billion in sales in 2019 on which the company posted GAAP earnings of $120 million, or $1.30 per share. Adjusted EBIT came in around $200 million, with EBITDA reported at $325 million. The multiples looked fair with shares trading at $36.
The company guided for modest growth in 2020, despite the pandemic, as it kept on pursuing bolt-on deals. Parsons reported adjusted earnings at $1.39 per share in the first nine months of the year already, with the number being quite "clean". With growth and bolt-on dealmaking upping the adjusted earnings number to a $2 per share run rate, the resulting 18 times multiple looked quite fair, while net debt came in below 1 times EBITDA, all quite comforting.
Since urging a fair opinion on Parsons by year-end 2020, shares rallied to the $45 mark in spring of 2021, but then fell back to the $30 mark at the start of 2022. Shares rallied back to the $40 mark, aided by the political tensions unfortunately seen nowadays.
Early in 2021, the company posted a 1% decrease in full year sales to $3.9 billion. GAAP operating profits were posted at $178 million, with net earnings of $98 million, or GAAP earnings at $0.97 per share. Adjusted earnings per share fell from $2.04 per share to $1.90 per share, as the reconciliation looked quite fair with most of the reconciliation being the result of asset amortization expenses, the result of past dealmaking.
Net debt was down to just around $100 million which is comforting since the company employed a large cash and debt position, triggering some higher interest expenses than perhaps needed. With EBITDA posted at 343 million, there was plenty of room for dealmaking.
The company guided for flattish sales at $3.95 billion in 2021, despite the backlog increasing to $8.0 billion. EBITDA was set to rise further to $350-$375 million, implying modest earnings growth, but nothing too spectacular.
During 2021, the company kept on reporting large contract awards, adding to the backlog. But despite large contract awards, the company was forced to cut the full year guidance alongside the release of the second quarter results. Sales were seen at a midpoint of $3.65 billion, with EBITDA seen down to $305 million, quite discomforting. To provide some impetus to the business, the company announced a $203 million purchase of BlackHorse Solutions in order to expand its cybersecurity capabilities. The deal was set to add about $100 million in annual sales and roughly $17 million in EBITDA, indicating a real margin accretive deal.
Forwarding to February, the company posted 2021 results as full year sales came in at $3.66 billion, down quite a bit from 2020. And while it was ahead of the latest guidance, note that this was cut meaningfully alongside the second quarter earnings release. Adjusted earnings fell from $1.90 to $1.65 per share. This year excluded about $20 million in stock-based compensation, which means that realistic earnings likely come in just below $1.50 per share.
Amidst this backdrop, it was understandable why shares fell to the $30 mark, implying 20 times earnings multiple, on the back of earnings power being pressured. Net debt of a quarter of a billion coming in just below the EBITDA contribution of $310 million.
The company guided for modest growth in 2022 with sales seen at a midpoint of $3.8 billion and EBITDA at a midpoint of $330 million. This marks modest growth, but given the deal announced this past summer, it really implies stagnation of the core operations.
While the recent operating performance has been lackluster, Parsons has come to life again, in part in anticipation of increased global defense spending and thus a better outlook for the business. In May, the company posted resilient first quarter results, as the company maintained the full year guidance, yet net debt inched up a bit towards the $300 million mark.
To provide the next impetus to the business, the company announced another deal in May. Parsons reached a deal to acquire Xator in a $400 million deal, adding mission-focused solutions to address critical infrastructure protection, national security and mission training, among others. Accounting for $57 million in tax benefits, the $343 million deal is valued at 10.7 times EBITDA, implying a $32 million EBITDA contribution. With pro forma EBITDA now seen around $350 million, leverage is seen around 2 times with the pro forma net debt load increasing to $700 million.
The deal adds about 10% in EBITDA to the pro forma operations, as the multiple look fair. All of this means that realistic earnings likely trend around $1.75 per share now, as valuation have inched up to 22-23 times earnings, all while leverage has increased to 2 times. The reason for that is obviously anticipation of greater defense spending benefiting the business, but that still has to be delivered upon.
Given the discussion above, that of mediocre operating performance, I find myself not being able to commit to the shares here after they rallied 30% from the 2022 lows, while the market has taken a beating, all in anticipation of better days. Amidst all these moving parts, the valuation is more than fair, certainly if we account for pockets of softer share price performance in the remainder of the markets.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.