CDI Corp. (CDI, Financial) is a staffing agency whose stock fell below net current asset value today. This is an opportunity where there is asymmetric risk to the upside. The downside should be limited by the company's strong balance sheet and a management team whose incentives are squarely aligned with shareholders. The stock currently trades at $8.43 per share and just barely makes it into the net-net category.
The definition of a net-net is when market capitalization exceeds NCAV (total current assets – total liabilities). The NCAV (($274.5M- $108M)/ 19.69M diluted shares outstanding) comes out to $8.44 per share.
Company
CDI operates three segments: Global Engineering and Technology Solutions (GETS), Professional Staffing Services (PSS) and Management Recruiters International (MRI).
From the company’s 10Q:
Global Engineering and Technology Solutions (GETS) - GETS provides engineering and information technology solutions that involve principally the production of deliverable work products. These solutions include analysis of a customer's engineering or information technology needs and the development of a solution that generally ranges in duration from several months to multiple years.
Professional Staffing Services (PSS) - PSS provides skilled technical and professional personnel for discrete assignments.
Management Recruiters International (MRI) - MRI is a global franchisor that engages in the recruitment of executive, technical, professional and managerial personnel for employment by their customers. The MRI franchisees provide permanent placement services and also provides training and support, implementation services and back-office services to enable franchisees to pursue contract staffing opportunities.
History
CDI was founded in 1950. The company’s revenue has been flat since 2005. My research indicates that prior management was mediocre at best and the company languished.
Net income history is also a reflection of the prior regime as profitability was inconsistent.
The company peaked in 2000 and has slid downward over the last 15 years. A prime example of the past management's poor execution includes their contract writing. CDI entered into fixed contract agreements with customers that gave it very little wiggle room in the event of cost overruns. This practice resulted in low margins. You can see how the company's gross margin percent has deteriorated over time. From FY 2000 to FY 2014, the highest gross margin was 28.56% in FY 2000 and the lowest was FY 2014 at 18.39%.
Investment Thesis
In September 2014, Scott Freidheim was brought in as CEO to turn the company’s fortunes around. Freidham’s past experience includes leading Sears’ Kenmore, Craftsman, and Diehard divisions as president up until 2011. He did an excellent job and helped lead that division into profitability. Immediately prior to joining CDI, Friedman was previously CEO for the Europe region for Investcorp International Ltd. His early career involved investment banking experience, most notably a stint at Lehman Brothers.
The new CEO has a lot of skin in the game. Most of Freidheim’s compensation package is a value creation contingent award where he would get the following:
- $15 million if CDI stock goes to $27.76 per share (~$275M market cap)
- $40 million if CDI stock goes to $41.64 per share (~$549M market cap)
His base salary is $600,000 and the value creation contingent award vests over five years. In other words, the CEO's compensation is much more weighted towards making CDI's share price appreciate to $28 or $42 per share than from his base salary.
I like this opportunity because of the company’s simple business model. There’s no inventory to deal with, nor is there any need for heavy capital spending. Staffing agencies hire salespeople and recruiters who in turn find contractors and then source to end customers. They pay contractors a set fee and charge a markup. If the recruiters don’t meet their quotas or CDI’s business in general slows down, then they downsize headcount. Given the CEO’s heavy incentive to create value, I find it unlikely that he would carry bloated headcount or make any other value destroying moves.
Risks
A short term risk is that IBM (IBM) is CDI's largest customer and has already given notice that business with CDI will slow down. The long term risk is that this is a turnaround situation where the new management team needs to inspire the rank and file employees. The company has approximately 800 full time employees. Management has introduced new compensation and commission structures, which it believes will better incentivize employees. On the other hand, it's possible that many long time employees have gotten used to a routine and aren't able to adapt to new expectations. If this is the case, then it may take longer than expected to flush out low performing employees and change the company culture. In May, the new CEO announced that 20% of the North American staffing headcount was reduced compared to April 2012. The risk is that the new management and the general employee population don't get on the same page and earnings slide.
Conclusion
As previously discussed, CDI is an extremely simple business model with low capital requirements. The CEO has already made common sense moves like revamping the commission structure, hiring new executives, shutting down unprofitable business lines and reviewing overall headcount closely. However, a staff agency's success is dependent on human relationships. That's not something that can be automated or rushed. It's important to have realistic expectations in terms of how long the investment thesis will play out. It takes time to earn the trust of employees and customers. As always, people should perform their own due diligence before investing in a stock.
Disclosure: I'm long CDI Corp.
