Following a suggestion from a reader, I had a look at PS&C Ltd (ASX: PSZ), the IT and security consulting/services firm. I can see the investment case quite simply – the market capitalisation is ~$20m, whereas the people + security divisions are worth $15m and $10m on the books respectively. There is the pending spin-off of the security + communication division to unlock value. There’s obvious upside if I knew for certain that the People and Security segments would return to previous levels of profitability.
The whole company looks to be priced at 5-ish times EBIT which is about half what is normal for ASX listed companies. Cheap, sort of, but I have decided not to buy it in the near term for a couple of reasons:
Why i’m not keen on it
- Despite forecasts of a stronger second half, management has made these forecasts in several previous years going back to 2014 and they have fallen short repeatedly (there are articles on the web covering this)
- Management looks to be using double-speak, saying ‘we are not paying a dividend in order to save cash for the spinoff‘ but I looked at statement of comprehensive income and cash flows and I don’t think there was any cash available to pay dividends in the last half
- Management reports EBIT before head office costs in their results announcement but doesn’t report EBIT after head office costs (always a warning sign)
- Debt of $15 million is quite high. I might have missed something since they say they have ‘executed’ debt which is why it’s listed as a current liability, but I am not entirely sure what is meant by that (refinancing? repaying?)
- I don’t understand the earnings drivers of the business (where growth will come from) and if a return to revenue + earnings of previous years is possible
- Finally and probably the biggest issue, the company looks to have a Enterprise Value to EBITDA (EV/EBITDA) multiple of around 9x ($20m mcap + $15m debt, divided by $4m in estimated EBITDA for full year). This is higher than or equivalent to similar businesses like DWS Ltd (ASX: DWS). So it’s not as cheap as it might appear.
I can get behind the idea of a new CEO, I believe the business badly needed it. I also think a spinoff makes sense, although it’s a pity they’re bundling the unattractive (and unprofitable) communications business in with the attractive security one. Existing shareholders will receive shares in the new business, while PSC will also receive some cash which will be used to pay down debt.
The thing is, spin-off or no, it almost looks more like a capital raising to me. Where is the capital coming from to fund the spin-off? Management says they’ll receive some cash for selling the business. Cash from who? And how much of the new Security business will this buyer take, and how many shares will be left over for distribution to existing shareholders? I could hypothetically buy PSC and end up with just 40% of the security business post spin-off. Or I could wait, and buy shares in the security business directly.
I’m also concerned about the mention of further acquisitions for both the People business and the spin-off. PSC appears to have got itself into this state through the use of acquisitions and I’m wary of management saying that more acquisitions are in the pipeline.
Of the $$ raised by the spin-off, probably most of it will go to pay down debt. It doesn’t appear likely that there’ll be a special dividend or anything like that. So management will sell an apparently attractive business (they keep telling investors how much the cybersecurity industry is growing), give shares in it to shareholders, then use their newly refreshed balance sheet to go and buy more businesses. I’m not sure I understand the logic.
Finally, I am wary of the ‘rising tide lifts all boats’ theory of earnings growth. E.g., ‘cybersecurity market is growing at x% over the next 5 years and we do cybersecurity, so we will benefit‘. In my experience, it doesn’t work that way. Earnings growth goes to the most competitive/best managed/most useful company, and PSZ has in my humble opinion not been that one.
As a standalone business with a new CEO, the security business could be well worth owning – especially if it can build a niche and or return communications to profit. However, for now, I think I’d like to see a few more cards on the table.
Disclosure: I don’t have any financial interest in either PSZ or DWS.