Computer Task Group (CTG) – Tender Offer + Shorting Opportunity – 10%-30% Upside

Current Price – $8.10

Tender Price – $8.05 – $9.00

Upside from Tender – 11% or $90 (if tender is priced at the upper limit)

Upside from Shorting – 30% (if share price reverts to unaffected levels)

Expiration Date – 16th of April 2018

No proration for odd lot holders

SEC Filling

 

Tender Offer with Odd Lot Provision

This is standard odd-lot dutch tender by micro-cap company. Shares currently trade close to the lower limit. Pay-off depends on how many shareholders tender and at what price points they do it. My expectation is that this tender will end up being priced close to or at the lower limit due to reasons outlined in the shorting section. Couple arguments in favour of higher tender prices:

  • Tender is for c. 10% of all outstanding shares (tender size $12.7m -$14.2m);
  • Insiders own another 10% of shares and have agreed not to participate in the tender.

 

Case for Shorting CTG

CTG share price has increased from $5.29 to current $8+ (50% jump) after tender intentions have been announced. I believe this was driven by pure technical buying in expectations of the tender being priced at premium to the newly established market price. Therefore significant share price correction is likely after the tender expires.

The only material announcements that might have caused the share price run-up are: (1) intention to launch the tender offer, (2) acquisition of Soft Company, (3) Q4 results and (4) guidance for 2018.

Soft Company Acquisition

Acquisition of Soft Company is unlikely to have had such an effect on the share price as acquisition amounts to less than 10% of the parent in terms of revenues and employee count. Profitability levels were not disclosed. Soft Company revenues are growing at 5% annually, but workforce has increased by 15% annually. There might be cross selling possibilities for a combined company, but judging by the provided guidance management, these are not expected to be material.

Q4 Results

Q4 results showed continuation revenue decline observed over the last few years, albeit the decline has somewhat slowed down and margins have improved (see slide 19). Results were in the mid-point of the guidance, so no positive surprises that would warrant 50% share price jump.

2018 Guidance

Based on management’s figures organic revenue growth is expected to be 3%-10% and non-GAAP EPS is expected to improve by 50% (heavily weighted towards the second half of the year). However, CTG management has tendency to miss the guidance – e.g. the very first 2017 guidance indicated flat revenues, however the eventual result was revenue drop of 7%. Therefore, I doubt market is giving much credibility to the new guidance.

Also, quite similar revenue guidance was issued for 2016 (which was also missed), but stock traded at $4.81 after the announcement. The only difference today is that CTG is finally forecasting growth (most of which acquisition driven), but even that was already partially baked in their 3-year plan announced in the beginning of 2017 (see Slide 4), so no positive surprises here either.

Tender Offer

This leaves us with the tender offer as the only likely explanation for the sharp share price increase. Worth noting that this increase has been gradual over couple of weeks rather than instant jump as would happen if there was a positive surprise from earnings, guidance or acquisition.

So my theory here is that some smart guys (sadly I was not one of them) with plenty of cash saw tender announcement and realized that if they push the share price upwards management will be forced to select tender pricing within the newly established price range. At which point the same smart guys will have a whole month to unload the acquired shares at significant premium to cost. Weekly trading volume increase up to 5x-10x since the tender announcement seems to be supportive of such view.

 

Is CTG Overvalued?

I am trying to base this trade mostly on technical aspects related to unjustified share price run-up after the tender offer announcement. For more detailed overview of the company from fundamental perspective (as well as bullish view) I suggest to read this VIC article. The main thesis is that CTG is a misunderstood turnaround situation where growth in higher margin Solutions segment will surpass the decline in lower margin Staffing segment. And also that downside is somewhat protected by $5 BV/share mostly comprised of cash, accounts receivables and cash value of life insurance policies.

After two years this turnaround story has not worked out so far – CEO was replaced after only 15 months in the office and revenues continue to decline across both segments. Dividend was cancelled and despite material share buybacks, the share count has decreased only slightly due to dilutive stock based compensation. Revenues are still heavily concentrated with two largest clients (IBM and Lenovo accounting for 37%), which continue to reduce their needs for CTG services every year.

I have no idea if we are on the edge of turnaround right now, but at least Q1 2018 guidance does not look very promising.

Assuming CTG achieves the targets set out in the 3 year plan and reaches EPS of $0.45-$0.55 by the end of 2019, then currently the company would be trading at PE of 14x-18x. Not overly expensive especially in the current market, but that is based on questionable earnings at least two years out. So I do not think I am risking too much by shorting CTG for a short term trade at current prices.

 

When to short?

Currently I have no position as there are still another three weeks until tender expiration and I doubt pricing will move below the lower limit till then. The possibilities are to short now and risk portion of position being bought in the tender or wait till after tender expiration, however opening prices the next day after expiration are likely to be lower.

Interested in hearing other views on this setup and opportunity.

9 COMMENTS

  1. Brian Sturgeon

    Thank you for posting this idea. I am under the impression that it is illegal to go short during the tender period more shares shares than you are tendering. This allows shareholders to fully hedge the tender offer but doesn’t permit outside shareholders to purely profit on the price drop that often occur post-tender. I should probably consult a securities lawyer but would appreciate any knowledge anyone has on only having a short position during the tender period, instead of waiting until post-tender period to go short. Thanks.

      1. dt

        By going long before the tender one is risking that a portion (or all) of the position will be bought in.
        I can not comment on legal aspects of tendering and shorting at the same time, but do not imagine anyone would really care if retail investors do that. Your brokers might have some insight regarding that as well.
        I am interested in CTG from short perspective in post-tender timeframe only.

  2. Michael Lax

    CTG authorized open market purchases of $10 million worth of shares, which may mean they can put a floor on the stock

    .BUFFALO, N.Y., April 02, 2018 (GLOBE NEWSWIRE) — CTG (CTG), a leading provider of information technology (IT) solutions and services in North America and Western Europe, today announced the Board of Directors authorized the Company’s repurchase of an additional $10 million of CTG’s outstanding shares. The expanded repurchase authorization complements the Company’s recently commenced modified “Dutch Auction” tender offer to repurchase up to 1,530,990 shares of its common stock by providing additional capacity for open market purchases following completion of the tender offer.

    CTG’s Board of Directors Chairman, Daniel J. Sullivan, commented, “The additional $10 million share repurchase authorization increases the Company’s future capacity to opportunistically repurchase CTG shares in the open market after completion of the modified “Dutch Auction” tender offer. Together with our previously announced actions, this authorization clearly demonstrates both the Board’s and management’s continued commitment to maximizing shareholder value and achieving our strategic growth plans.”

    CTG’s share repurchase program authorizes the Company to repurchase its common stock from time to time in compliance with applicable securities laws. Neither the program nor the authorization requires the Company to repurchase any shares, and the timing of any such transactions as well as the number of shares will be decided at management’s discretion based on market conditions and other factors. The Company’s share repurchase program does not have an expiration date, and it will remain in place until terminated by CTG’s Board of Directors.

    The provisions of the “Offer to Purchase” and the “Letter of Transmittal” relating to the tender offer are described in the Company’s recent filings with the U.S. Securities and Exchange Commission. Additional copies of these materials may be obtained for free by contacting Computer Task Group, Incorporated at 800 Delaware Avenue, Buffalo, New York 14209, Attn: Investor Relations, or Georgeson LLC, the information agent for the tender offer, at (800) 676-0194. The tender offer and withdrawal rights will expire at midnight, at the end of the day on April 16, 2018, unless extended or terminated by Computer Task Group, Incorporated.

    1. dt

      Definitely a negative from the shorting perspective. Management’s eagerness to keep share price elevated might be related to this:
      “Under the new plan, all equity-based compensation awarded to senior executives will consist of performance-based restricted stock unit awards that will vest only if the Company’s stock price increases during a performance period beginning on the date of grant to a specified target. To earn the full award, the Company’s share price must increase by 100% in the three-year period from the date of grant.”
      http://investors.ctg.com/news-releases/news-release-details/ctg-reports-2016-fourth-quarter-and-full-year-results

      I did not manage to find any more details on how this equity based compensation plan works and whether it might influence management to push up the share price during specific time periods.

  3. Ben

    Hey dt, Your short thesis actually proved out very well post tender expiration with the exception of 3-4 days of stock price increases immediately following the tender close. Why do you think the price climbed immediately after but than tanked to levels not far above pre-announcement prices afterwards? Put another away, why didn’t the rapid decrease start the day after preliminary results were known. There was an positive earnings announcement made 4/19 which might have be the cause but I would love to hear your thoughts.

    1. dt

      I would not say my short thesis proved well. Actually quite a few things worked out against it:
      - tender happened close to the upper limit;
      - share buyback expansion was announced;
      - revenue growth excluding three large staffing clients continued to accelerate (15% this quarter). So maybe the turnaround is finally happening.

      All of these together might have had an upward pressure on the share price and also are the reasons why I have not pressed the button on the short.

      Nevertheless, company still hardly generates any cash and organic revenue growth is flat (excluding currency, accounting and acquisition impacts).

Comments are closed.