The Art of Streetplay

Thursday, July 14, 2005

CAI analysis (Snapshot trade on May 29th 2004)

Well guys I'm putting on my value investor hat, so watch out... today I'm looking at CACI (ticker: CAI). First I go through who they are and the general industry they are in. Then I look at trends and bring them into perspective in light of recent events.
To put it simply, CAI is a contractor for the government. The company is among the largest government information technology contractors, providing a wide range of services including systems integration, network management, software development, and engineering and simulation services. CACI also develops marketing software and databases for sales tracking, demographics reporting, and other market analysis applications, and it provides debt management and litigation support services. Contracts with the US Defense Department account for about 64% of its annual revenues.
While on the topic of revenues, lets take a look at the numbers. Sales is growing.
The story is pretty clear: topline growth because of the war in Iraq-- new contracts.
Growth is expected to continue going forward. CACI has plans to reach $1 billion in revenue in 2004 so it can better serve large clients such as the Department of Defense, which is increasingly trying to do business with a smaller number of large contractors. The company plans on joining that select group by growing through acquisitions and by making technology services a high priority.
Two of CACI's main clients are already part of the Department of Defense: the Defense Information Systems Agency (DISA) and the US Army's Communications-Electronics Command (CECOM). CACI also holds a significant GENESIS II contract with the United States Army Intelligence and Security Command (INSCOM). In addition, civilian agencies such as the Department of Justice (CACI staffs its litigation support services and maintains an automated debt management system), the Department of Veterans Affairs, the Securities and Exchange Commission, the Space and Naval Warfare Systems Command's Naval Tactical Command Support System, and the US Customs Services drive a large portion of CACI's revenues.
CACI acquired intelligence contractor Premier Technology Group, Inc., or PTG, for an undisclosed amount in mid-2003. PTG had revenues of $43.4 million in 2002. Most of its 360 employees hold high-level security clearances and are experts in intelligence analysis, information technology and security services, and logistics. CACI picked up some of the juicier government contracts through this acquisition.
Growth catalyst: Military aptitude (or lack thereof). I like CACI's industry, because frankly I don't see war going away anytime soon. However this fact by itself wouldn't mean much for government contractors. What makes contractors promising is the fact that government needs their help. Since the gulf war the government has been steadily increasing the amount of non-military related outsourcing it performs to: (1) cut costs, and (2) make up for the general diminution in military strength. (1) is highly debatable, especially in light of wasters like Halliburton and KPR . However trend (2) is real. So in come companies like CACI, responding to the increased demand for their services.
Present situation:
So now we zoom to the present. The company came under fire in early 2004, when CACI employee Steven Stefanowicz, who worked as an interrogator at the Abu Ghraib prison in Iraq, was accused of participating in the abuse of prisoners held there. CACI manages various facilities for the US Army under a blanket purchase agreement inherited when it acquired Premier Technology Group in 2003. When the scandal broke out in May 2004, various government agencies, which together oversee the contract, launched an investigation to determine whether CACI should continue to assist the US Army in placing new interrogators in Iraq. The results of the investigation will determine if CACI will be able to fulfill and collect the approved $66 million funding for the blanket purchase agreement. The company had collected $16.3 million when investigations started.
Now from what I've read, the stir over Stefanowicz isn't the issue, CACI isn't vulnerable over this. It is vulnerable because it had an IT contract with the Interior Department, and yet ended up in Iraq doing interrogations for the Army. Does IT have anything at all to do with interrogations? Frankly, no. Technically, what CACI did was illegal.
So what is going to happen?
-- First, hypothetically lets say that CACI loses its government business-- is there anyone who could replace them?
Were CACI to be fired, from what I’ve read it would be unlikely for other companies to enter into the interrogation line of business too easily. Titan, another of the big interrogators-for-hire, was also implicated in the Abu Ghraib snafu, so I doubt that they would be eligible as a substitute. Other companies could substitute CACI’s other legal contracts though, if the government decided to take away all of CACI’s contracts.

This is the other thing that was passing through my head as a read some of these articles—people were surprised as hell at the sensitivity of the tasks that private contractors like CACI were doing. Contractors for the gov’t routinely provide little information on the nature of the contracts it has with the gov’t, and sometimes can’t even acknowledge that certain contracts exist. This means two things: (1) There is good potential hidden upside for the private contractor industry, in the form of classified contracts, and (2) the companies which are now working with the gov’t on sensitive activities (ie. Interrogation) will naturally obtain classified information. The obtained classified information should create some good lock-in with the gov’t for future deals, and general leniency should the companies go on trial. You don’t want a large number of private companies to be walking around freely with classified information.
--Could the military take over what CACI employees were doing?
While the gov’t could possibly try to replace private contractors with army guys, it’s unlikely. The army is coming to the private companies and not the other way around b/c of (1) big need to keep costs down and be more efficient and (2) lack of manpower, general weakness of the military. (1) is debatable and might not leave CACI in a defensible position. The company is making a shitload from those guys. However trend (2) is here to stay. The government needs help badly, that’s why it’s outsourcing so much. I also think this may push the trial towards the lenient side, especially in light of the above point concerning CACI’s current stockpile of classified information.

-- An extra little tidbit:
One of the articles I read mentioned something interesting—“due to a loophole in prosecuting law, it may be difficult to pursue the contractors in court. The 2000 Military Extraterritorial Jurisdiction Act applies only to Pentagon contractors.” CACI is an Interior contractor, so some of the more snappy laws don’t apply to it… could come in handy.

I see Martha Stewart-like politics being the biggest potential downside risk for the company.

Short term: In general I see a 5% up movement as pretty darn reasonable, even assuming some shit does happen. There’s a general consensus among analysts that the recent situation shouldn’t affect the company’s long-term prospects, which gently implies to me that this downtrend might not carry its own weight for an extended period of time (the stock has dropped around 14% in teh past two days alone).

Long term: I see growth here as long as they don't lose business in Iraq.

Oh, and the chief executive bought $380k of the stock the day the stock initially went tumbling down, at 38.306. He increased his holding by 33%. It's now at 37.14.

My two cents.


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