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We currently regard FTI Consulting (FCN) as attractive for purchase by investors seeking long-term growth of capital. In addition, we believe FCN provides an opportune play on the restructuring business in times when Chapter 11 filings are soaring. Nationwide restructuring filings jumped 44% in June compared to 2019 and are only expected to rise as we head into the fall.
Strong Second Quarter Performance
On July 30, FCN reported its highest revenue quarter in its history with its fifth best quarter for adjusted EPS. FCN shares surged on the strong results led by the performance in its Corporate Finance and Restructuring segment. Record segment revenues of $246 million increased 29.5% compared to the prior year second quarter. This is despite a decline in business transformation and transaction services. Total revenues grew 0.3% to $607.9 million for the quarter. This uptick in corporate restructuring is expected to continue at this level for at least the remainder of the fiscal year, barring any extraordinary government intervention to prevent bankruptcies.
Business Strategy and Outlook
FTI Consulting engages in the provision of financial, legal, operational, political and regulatory, reputational, and transactional advisory services. Operating in 82 cities globally, FCN consists of over 5,800 employees, with over 590 in senior managing director positions. A Fortune 1000 company, they operate in nine specialized industry groups and hold as clients 8 of the 10 world’s top bank holding companies, 96 of the 100 top law firms, and 53 of the global 100 corporations. Having expensive, niche experts on the payroll cannot often be justified at most firms. FCN takes on the utilization risk by hiring these experts and providing consulting work to solve this issue.
Despite short-term weakness in parts of the business, specifically litigation and M&A dealings, FCN continues in line with its goals to increase headcount in segments with planned expansion while also keeping up with its strong client base and spread of capabilities. FCN added 715 professionals in this most recent quarter.
FCN has shown strong performance relative to the S&P 500 over the last four and a half years.
Data Source: FactSet
Breakdown by Segment:
As a preface, FCN does not breakdown specific competition in its 10-K outside of rather vague descriptions. This leads us to the conclusion that because different players compete in different spheres depending on the segment of the business, competition is highly fragmented. We have done our best to identify significant competitors on the basis of scale and reputation of a firm. These are two of the most prominent factors when it comes to retaining large clients and winning new bids. In regard to smaller boutiques, in spite of lacking the ability to offer the range of services that FCN is able, competition will be more on the basis of geographic location and pricing advantages.
Corporate Finance and Restructuring
Primary focuses of this segment include chapters 7 and 11, mergers and acquisition, and other various corporate finance services. In the past, especially in the aftermath of the global financial crisis, a majority of this segment’s business revolved around restructuring. However, much effort has gone into striking a balance between restructuring and more procyclical work. This has allowed for more predictability in revenues in both flourishing and weak economic periods.
FCN expects to see growth through penetration in industries such as Retail and Health Care. Ten years ago, when operations while still global were concentrated in the US, FCN was in the top five in this segment in the UK. Since then, it has established a dominant position in creditor rights in the US, UK, and many parts of Europe. In addition, their Hong Kong practice has since created a dominant position in creditor rights and restructuring.
Primary competition in this segment of the business involves smaller, specialty boutiques who compete with FCN’s scale and extensive client network. Other large consulting firms such as Bain and McKinsey also compete in this sphere. Though their size does give them advantages over boutique firms such as what FCN is afforded, their specialties revolve around the corporate finance and strategy side of this segment more so than in restructuring.
Forensics and Litigation
This segment revolves around forensic accounting and advisory assistance, global risk and investigations practice, and other dispute and solutions services. In addition, rather than its usual business focus on financial disputes, FCN has recently pivoted toward construction disputes as business in the former slows. Closures and disruptions to court systems nation-wide have led to not only delays in the giving of testimonies and graphics assistance during court proceedings but also the preparation that leads up to them. Fortunately for FCN, North American bankruptcy courts have remained fairly open, allowing the uptick in this part of the business to surge as need for these services continue to increase.
It’s easier to discern rivals in this segment of the business as FCN primarily competes with other large consulting and accounting firms. Deloitte, PricewaterhouseCoopers, Ernst & Young, and KPMG, though well-regarded for the accounting side of their businesses, also offer support in forensics and litigation. They do tend to specialize though, with PwC’s niche being securities litigation for example. Other consulting firms, both private and publicly traded, offer services in this sphere.
Services in this segment revolve around antitrust and competition, financial economics, and management consulting. FCN’s subsidiary, Compass Lexicon, is considered one of the world’s leading economic consulting firms.
Specialty boutiques and large consulting firms compete in this sphere, in addition to competition with individually recognized economists. Services offered by other players are similar, but like other segments of the business there exists some variance between firms. Compass Lexicon’s advantages are its immense scale and reputation, access to the best array of personnel in this field, and synergies with FCN’s other business segments.
Their technology segment is closely linked with the Forensics & Litigation and Economic divisions. Services in this segment revolve around e-discovery and data compliance management, managed document review, digital forensics, information governance, privacy and security, and contract intelligence.
In this segment, FCN faces competition from consulting and software provider firms in the realm of electronic content management. To an extent, Accenture competes in this realm. Consolidation is taking place alongside rapid innovation in this industry. In the future, we expect bigger rivals to go toe to toe with FCN on the basis of price.
Services in this segment revolve around corporate reputation, public affairs and governmental relations, capital markets communications, crisis communications, transaction communications, and digital, analytics and insights. These services pair well in assisting with other divisions of the company, providing synergies that most other competitors lack.
In addition to region-specific, specialty boutiques offering a range of services from public relations to marketing assistance, large marketing and PR firms also compete for market share in this segment. Reputable names include Edelman and W20 in the reputational area, with analytics revolving around brand and its awareness also playing a role. FCN is aided by its vast global footprint, spanning 106 countries across the globe. This has allowed them to become leaders in the fields of crisis management and antitrust.
Continued expansion across all business segments has allowed FCN to transform into more than just a restructuring consulting firm.
Data Source: Second Quarter Investor Presentation
Areas of Operation:
In North America, current operations span across the United States and Canada, with locations in 38 cities in the former and three in the latter. Latin America accounts for six offices across Argentina, Brazil, the Caribbean, Colombia, and Mexico. Europe, the Middle East, and Africa host offices in 19 cities across Belgium, Finland, France, Germany, Ireland, Israel, Qatar, South Africa, Spain, the United Arab Emirates, and the United Kingdom. In Australia, offices can be found in Brisbane, Melbourne, Perth, and Sydney. Asia plays host to 12 office locations in China, India, Indonesia, Japan, Korea, Malaysia, the Philippines, and Singapore.
As further international expansion takes place, the firm should see its dominant US position expand to other corners of the globe.
Data Source: Second Quarter 2020 Earnings Conference Call Presentation
We assign a wide moat rating to FTI Consulting, a result of the intangible assets that the firm possesses and its scale. These provide the ability to take on large enterprise contracts infeasible for smaller, boutique firms. In terms of intangible assets, FCN’s reputation and expertise stems from its strong, talented headcount in multiple fields, providing a breadth of niche expertise in both consulting and outsourcing. Though outsourcing accounts for only a small portion of overall business, solutions that are outsourced are ensured to be well-defined and measurable to provide optimal results for both new and returning clients.
Related to the firm’s reputation, switching costs present an advantage over smaller firms attempting to enter into these subsections of the consulting industry. As FCN grows and adds to its list of repeat clienteles, familiarity with the firm’s abilities increases the reluctance to take future business elsewhere. With a rough approximation of assignment lengths being six months, the time it would take to offer up a bidding contest or to search for alternative firms further increases the likelihood that satisfied clients will stay with the firm.
With any consulting firm, the value derived from seeking out their expertise can be difficult to measure. Usually a problem will arise without a defined course of action, leading to clients seeking out those with expertise in solving these varied issues. FCN has demonstrated over the course of its history that it has the ability to provide great value in developing customized solutions to fit these needs. This is emphasized by its strong base of reoccurring clientele and the value these clients are receiving from the, as of the first quarter, over 4,600 consultants at the firm. A revenue-to-salary ratio per consultant of 4.2 demonstrates the high level of value provided by FCN services. In 2019 revenue per consultants averaged approximately $500,000 compared to an average salary of $120,000 across positions ranging from entry-level consultants to senior directors.
An indication of this strong value-to-consumer drive and an ability to differentiate themselves from other consulting firms can be seen in the growth of the firm’s return on equity. Profitability is a good sign of a company’s moat since high margins allude to a sphere that’s difficult in which to compete. Updated in January 2020, NYU’s Stern hosts a database of over 7,000 companies, giving figures on different margins by sector. Looking at the economy as a whole, the average net margin across all sectors is 7.7%. Since December 2014, FCN has grown their net margins from a below average 3.3% to a strong 9.2%. As a comparison, Accenture, one of the largest publicly traded consulting firms in the US, has net margins of 11.1%. Accenture has noted in the past that the commodification of application services has not hurt their bottom-line, indicating that there is no replacement for quality expertise in this industry.
Valuation and Profit Drivers
Prior to its earnings report, consensus estimates were for EPS of $5.49 for 2020. With the $0.28 earnings beat and FCN management reaffirming its guidance for the second half of 2020, we expect consensus EPS to move closer to $6.00.
Current analyst estimates for FCN result in a forward P/E of 19.2 compared to a 5-year historic average of 18.7. This is in line with the overall market average, despite considerably higher historical and forecasted growth rates. The consensus 5-year EPS growth rate is 14.0%, which gives FCN a very reasonable 1.4 forward PEG ratio.
Multiple factors contribute to driving strong profit margins. Namely, a wide moat, synergies from acquisitions, timely divestures of underperforming businesses, and a strong management team that promotes necessary expansion and increasing returns to shareholders. As the company continues to expand headcounts and grow business overseas, we expect leading positions to grow in underutilized markets. Over the last ten years, the firm has transformed from being primarily domestic facing to establishing leading positions in the UK, Hong Kong, and Latin America.
Risks and Uncertainties
Risks of a Serial Acquirer
Since 1996, the company has initiated 67 M&A deal transactions. Though not all of these ended up making it to completion, this kind of volume can easily lend itself to a few bad deals. The large impairment charges racked up on goodwill midway through the last decade demonstrates the risk associated with a growth strategy that relies on acquisitions.
Organic growth has taken priority over expansion by acquisition in recent years. Although, synergistic purchases such as the acquisition of Anderson AG in 2019 have resulted in significant value for the firm.
Data Source: FactSet
Debt currently is not a huge concern for FCN. Current Net Debt/EBITDA at the end of the second quarter was 0.9x, and that figure has decreased in the last three months. FCN is helped by the fact that it runs a capital light business model.
As a quick note, since FCN made use of convertible debt in its credit issuance, the notes may have a dilutive impact going forward on EPS. Current share price sits considerably above the conversion threshold for these notes. To combat this, FCN has undergone an aggressive share repurchase program with 1.27 million shares bought by the company on a trailing twelve-month basis.
Similar to fields like investment banking, the consulting field experiences relatively high turnover, with 30% as a rough industry standard. For the average consultant, average tenure might not eclipse three years. Though exact figures for FCN aren’t released, looking at similar firms can yield comparable statistics. Boston Consulting Group released figures in 2019 stating 77% of employees had worked for the firm for less than five years. Despite FCN’s past results in attracting world-class talent, with high turnover rates, this attrition is a constant factor to be accounted for as management continues expansion globally.
In consideration of its reasonable valuation, track record of strong revenue and EPS growth, current performance in a difficult environment, and our outlook for continued future growth as it expands its services and geographic footprint, we regard FCN as attractive for purchase at its current price level.
Disclosure: I am/we are long FCN. 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.
Additional disclosure: The author is an intern at Vista Investment Management, an investment adviser registered with the Securities and Exchange Commission. Vista Investment Management has a long position in FTI Consulting (FCN) in some client accounts.