Perspecta from DXC
Summary
(11 Jul 2018) The government contractor, Perspecta, features management alignment incentives, discounted price to peers, high leverage, significant core business protection against competitors and remains within the six month investment window out to November of 2018. Interested parties may find that activist investor involvement, the lack of a differentiated market, a significant size difference and dividend policy difference from its parent cause this company to be less attractive than other spinoffs. This company has the added benefit of being a better play against geopolitical upheavals.
Parent Ticker: DXC
Announced Record Date: 15 Apr 2018
Announced Distribution Date: 31 May 2018
Anticipated Ticker: PRSP
Business
Perspecta is a government contractor focused on the defense and medical sectors. Their contracts include the US Navy, NASA, the US Air Force, and Medicare/Medicaid. The company maintains contracts for highly sensitive areas of intelligence and mission necessary positions. The reader should note that the product mix includes Cyber, Space, and networking products and services. This product mix is of such a sensitive nature that it would be difficult for competitors to replicate. Also, the company's past includes providing similar services to the government for about 40 years. The stability and growth opportunities that this sector provides the company will allow for consistent growing returns over time.
Parent Child comparison
The spinoff splits DXC's government contract business (USPS or US Public Services) into the new company and merges it with Vencore and Keypoint. Both will pay a dividend. The spinoff is simply removing the government contracts business from DXC.
Spin Ratio
1 share PRSP for every 2 shares of DXC
Cash Flow
The company had cash flows from operations of $530 Million ending March 31, 2018. This is about 17.8% of the annual revenues for the company. Free cash flow reduces this number to $512 Million, indicating that the costs for future revenues are minimal.
Cash Position
Perspecta will have $95 Million cash upon separation from DXC according to the pro forma balance sheet
Revenue Projections
Perspecta should maintain revenues of about $4.2-4.6 Billion over the next three years.
Dividend Policy
Perspecta plans to pay a dividend post spin.
Management Alignment
Over 50% of the compensation for the CEO and CFO are derived from options and RSUs. The management team will be well compensated for their time with compensation packages that are much larger than their previous positions with DXC. They were promoted to their positions from the predecessor companies therefore, they understand the business they are operating in.
Activist Investor Activity
Ramzi M. Musallam, through Veritas Capital Management, LLC maintains just over 14% control of Perspecta. This is a continuation of the management company's investment in Vencore. Veritas appears prepared to maintain this holding for a few more years and focuses on government contractors like Perspecta.
Peer Comparison
Some of Perspecta's competitors in this category include Leidos, Booz Allen Hamilton, CACI, CSRA, Science Applications International, Engility, Securitas and ManTech International.
Conducting a comparative valuation to these companies creates a likely price for the company between $28-36/share. The share price will likely be closer to $28/share. Note however, that Perspecta is highly leveraged compared to its competitors. Deleveraging the balance sheet would increase safety. During the investor day, the CFO did note that the priority for the first 18 months of operations was to reduce the company leverage.
Opinion
This company is in a very stable industry and one likely to weather the geopolitical risk that seems apparent in the market. If the world were to get more dangerous, Perspecta will likely increase revenues as its services become more sought after through military and government contracts. A purchase below $22/share would be appropriate.