2023-03-22 13:05:17 ET
Summary
- Growth in recurring revenue and expansion of the client base has driven steady earnings growth for ISG.
- ISG’s focus on profitability and returning cash to shareholders makes the company especially attractive.
- We initiate with a buy rating and a $9.90 price target.
Investment Thesis
Information Services Group ( III ) offers advisory and strategic consulting services to a blue-chip client base of large corporations, financial institutions, medical care providers, and government agencies in the U.S. and globally.
The company’s custom consulting engagements serve specific client needs. Many custom engagements have focused on cost reduction and business transformation, creating deep expertise in this area. Cost optimization is crucial to large-scale users of technology who often face technology spending above $100 million per year. ISG’s revenue from cost optimization engagements grew by double digits in 2022. Additional subject areas where the Company has developed expertise include cloud services, cybersecurity, and networking.
According to the company, ISG has a dominant market share position in advising on technology procurement, providing advice, market information, and oversight for over $18 billion in technology contracts in FY:22.
In addition to custom engagements, ISG also offers subscription platforms for monitoring vendor performance, pricing, and compliance. The company’s GovernX platform provides contract management and monitoring of vendor performance against contract terms, Service Level Agreements (SLAs), and compliance requirements. ISG’s ProBenchmark and Inform platforms provide metrics such as pricing and performance data across a broad universe of technology products and vendors.
With its specialized suite of advisory and strategic services, we forecast ISG to grow its revenues by a cumulative 25% over the next three years. ISG’s management has demonstrated a focus on profitable growth, turning an operating profit in each of the last five years ? despite the COVID pandemic and despite currency headwinds. With profitable growth, we forecast 25% cumulative revenue growth will drive a 50% increase in earnings over the same three-year period.
ISG also has shown a track record of returning cash to shareholders. At the current share price, the company’s stock offers a 3.2% yield. Between dividends and share buybacks, ISG returned $23.6 million to shareholders in FY:22 for a total cash yield of 9.8% on the company’s current share price of $5.00. The company has expressed an intention to continue buying back shares, in addition to maintaining its dividend and paying down debt.
In summary, ISG is a highly shareholder-focused company with a leading position in the market for strategic and advisory technology consulting services. In our view, continued revenue and earnings growth could drive significant share price appreciation for ISG.
We initiate with a BUY rating and a $9.90 price target
Information Services Group ? A Specialist in Advisory and Strategic Technology Consulting
Information Services Group, Inc. provides specialized, high-value services within the market for technology consulting. Figures for the overall size of the technology services market vary, with different estimates based on different universes of service offerings. Statista’s estimate is $65.36 billion in 2023 for worldwide IT consulting and implementation services 1 (see Exhibit 1).
At $286 million in annual revenue, ISG holds a tiny share of the overall market but dominates the niches in which it operates. ISG’s service specialties include technology strategy and advice on technology contracts, where the company has a greater than 50% market share. Other specialties in high demand include end-to-end cost optimization, cybersecurity, networking, and cloud services.
Through continued client engagements in specific industries, ISG has developed deep, industry-specific expertise in more than half a dozen vertical markets. In each, ISG has won engagements from some of the largest and most well-known companies. To cite a few examples:
- ISG counts 12 of the top 15 global banking and financial services companies as clients, including Bank of America and BNP Paribas.
- Nine of the top 15 global packaged goods companies, including Nestle and Procter & Gamble.
- Fourteen of the top 15 global pharmaceutical and healthcare companies, including Cigna and Pfizer.
Other vertical markets where the company has developed substantial in-house expertise include insurance, auto manufacturing, telecommunications, and media.
The company’s cost optimization consulting services are a particular strength, growing by double digits in FY:22. A second significant source of revenue and revenue growth is advising on technology procurement, where ISG advised on more than $18 billion in technology contracts in FY:22.
Latest Quarterly Results
Revenue. Q4:22 revenues were $74.2 million, up 6.6% YOY. Full-year revenues were $286.3 million, up 3.0% YOY. Both Q4 and full-year revenues hit record highs, but both were held back by the currency impact of a strong U.S. dollar. In constant currency terms, Q4 revenue would have been $3.2 million higher, with an impact of 447 basis points on revenue growth. Full-year revenue would have been $12.7 million higher in constant currency terms, or 440 basis points. Recurring revenue reached $30 million in Q4:22, up 26% and now 40% of total revenue. Recurring revenue was $108 million for the full year or 40% of the total.
Gross Margin. Gross margin was 39.9% in Q4:22, up modestly from 39.8% in the prior year. Gross margin for the full year was 40.7%, up 130 basis points versus the prior year.
SG&A. SG&A expenses were $21.0 million in Q4:22 and $81.8 million for the full year, up 3.8% from $78.8 million for the full year of 2021.
Operating Income. Operating income was $7.2 million in Q4:22 and $29.5 million for the year, up 17% from the prior year.
GAAP Net Income. Q4:22 GAAP net income was $4.3 million, up 20% from the prior year. Full-year net income was $19.7 million, up 27% from the prior year.
Adjusted EBITDA. Q4:22 Adjusted EBITDA was $11.1 million, up 9% from the prior year. Full-year EBITDA was $43.3 million, up 11% from the prior year.
Investment Risks
- With its share price of $5.00, investors in ISG could experience reduced liquidity, and high bid-offer spreads when buying or selling shares.
- A major recession could lead to reduced spending on technology consulting services, potentially reducing ISG’s revenue.
- Large competitors could develop competing service offerings, putting pressure on ISG’s pricing and margins.
Valuation
We value ISG using a blend of peer multiples and a discounted cash flow model. The multiples we use to value the company are EV/EBITDA, Forward Price/Earnings, and Forward Price/Revenue. In our relative valuation, we value six publicly-traded technology consulting companies based on their 2023 P/E, EV/EBITDA, and Price/Sales ratios. We then average those values to come to an overall industry average metric per ratio. We apply these industry average multiples to our 2023 forecast for ISG’s EPS, EBITDA, and sales which leads us to three relative valuations for ISG in 2023. We average those three valuation targets and discount that value back at ISG’s cost of equity to arrive at a price target of $9.63. Exhibit 4 summarizes our peer group multiples.
Our DCF model uses forecast income statement values for years one through three, and we assume EBIT grows at a CAGR of 1.5% per year for years four through eight. This DCF model produces a value of $10.22. We then average the two price targets of $9.63 produced by the relative valuation and $10.16 produced by our DCF model to come to a final target price of $9.92, which we round down to $9.90.
For further details see:
Information Services Group: Strong Earnings Growth, Initiate With A Buy Rating