Wednesday, June 23, 2010

A Quick Look at Booz Allen Hamilton's S-1 Filing

 It was also featured on The Reformed Broker's Hot Links.

The market's rebound over the last year+ has brought some "interesting" potential IPOs. Back in February, we had FriendFinder Networks, a company in default, trying to raise cash. These folks own a number of adult-themed social networking sites, including adultfriendfinder, which they claim was among the top traffic-ed sites worldwide. The market events in February shelved this masterpiece. Then in April, a small movie production company called The Film Department filed for an IPO. This company focuses on movie productions (as if the Hollywood Exchange was not enough to skim money off the naive), and outright warned that they face substantial liquidity constraints and that even with the IPO, they would still have to raise additional funds for each production. Also one of the underwriters was getting warrants for the deal: generally, not a good sign. So that IPO also got delayed as the market got rocky in May. One can even track how the offering price was dropped over the months through the S-1s.

On to a substantially better business that filed yesterday: Booz Allen Hamilton, a brand-name consulting company that derives 98% of its revenues from the taxpayers (the US government). The company is owned by Carlyle, a top PE shop, and has hired Credit Suisse (left underwriter) to do the deal. I browsed through their financials and I really do not see myself as an owner of this business. Here is why:

A feature of attractive businesses is earnings growth outpacing sales growth. This is called scale, and is an essential factor with any enterprise. Some kinds of growth are more capital-intensive (i.e. build more stores/get more inventory), some less so (app downloads). But the scale exists in both cases as the fixed costs are spread over more profit-generating units. Building additional stores does not mean hiring more accountants in corporate or upping the national advertising budget.

Since BAH was LBO'ed, I will look at EBIT margin instead of NI to eliminate the effect of the increased interest expense.
2007: Revs: $3,209,211 EBIT: $130,695 (Margin: 4.07%)
2008: Revs: $3,625,055 EBIT: $153,481 (Margin: 4.23%)
2009: Revs: $4,351,218 EBIT: $66,401 (skip, LBO year)
2010: Revs: $5,122,633 EBIT: $199,554 (Margin: 3.90%)

What is going on here? Revenues are up 60% and yet, the margins are going the other way. This is not desirable. Where is the money going? Here's a clue:
2007: Revs: $3,209,211 G&A: $421,921 (13.15% of revenues)
2008: Revs: $3,625,055 G&A: $474,188 (13.08% of revenues)
2009: Revs: $4,351,218 G&A: $723,827 (16.64% of revenues)
2010: Revs: $5,122,633 G&A: $811,944 (15.85% of revenues)

If the G&A in 2010 were at the 2007-2008 levels (13%), then EBIT would have been $146k higher, and the EBIT margin would have been 6.75%, or exactly in the way an owner would like to see it go.

On the positive side, comp expense seems to be coming down, with last year's being "only" 51% of revenues. This is not unusual for "professional" firms, such as investment banks (see JEF or GHL), but as the crisis showed, labor expenses tend to be fixed when things are going downhill and variable on the upside. There is no shareholder control over these which is something that even Buffett was unhappy about when he owned Salomon Brothers.

Then there is the whole "use of proceeds" aspect. A potential shareholder would like to see that he is funding future growth or paying down debt. At the other end of the spectrum would be a shareholder selling out directly. BAH is paying down debt, but how did this debt come about? There is the LBO debt, and then there is a subsequent recapitalization which resulted in the sponsor's receiving a special dividend last December (on top of receiving a special dividend last June). So, in effect, the IPO investors are funding the dividend that Carlyle pulled out. This clearly is not growth capital.

Finally, BAH's services are expensive. The company has 23,300 employees and generated over $5 bn in revenues from the US government. This means that the taxpayers are paying $220,000 per employee per year to Booz (all employees, not just front office). This is approaching investment bank levels but the money is coming from the pockets of the tax payers. With 98% of the revenues coming from the government, I would be worried that BAH's gold-plated services might be an easy target.

One has to keep in mind that there are two components to a purchase: price and value. If the price is low enough, then the purchase is de-risked and may present a good value. But somehow I doubt that the IPO will happen if the price is low enough for me to buy.

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