Table of Contents
After initiating coverage last quarter on FTI Consulting (FCN), much has taken place in terms of the pandemic and its effect on small businesses and large corporations alike. This presents a favorable opportunity for one of the leading restructuring consulting firms in the country as insolvencies are projected to rise and many companies struggle to keep up with decreased demand due to the COVID-19-driven economic downturn.
Since the previous quarter, despite the surge in defaults failing to come to fruition as quickly as anticipated due to the massive monetary stimulus the Fed has put into markets, revenues have grown by 3.9% compared to Q3 of the prior year. Their restructuring business continues to perform above historical levels. An increase in their ability to conduct business in litigation dealings with a boom in M&A and burgeoning antitrust dealings are spurring growth. Segments other than Corporate Finance will continue to ramp up business as online court proceedings and the like are utilized.
What’s changed Since Last Quarter
Source: Twitter via @lisaabramowicz1
The expected strong pickup in bankruptcies has yet to see the light as unprecedented monetary stimulus has artificially propped up markets. Current credit spreads have tightened since last March and are now close to long-run levels generally seen during the healthy part of the economic cycle. Asset prices are suggesting that investors expect insolvency to remain very low. After all, the Fed has implied that they will do everything in their power, including buying speculative debt, in an attempt to keep liquidity high and the economy steadfast.
Due to this artificial environment, we have seen a fundamental disconnect as the Fed has strayed from capitalistic principles that have allowed for drastic increases in the number of “zombie” companies barely remaining financially viable. I highly doubt this trend will continue indefinitely due to the serious consequences associated with controlling the yield curve in this manner. As time goes on, poorly positioned, over-levered companies will fail – and with it, bankruptcies will rise.
Source: Wall Street Journal
Overall trends across the country for both small and large companies confirm the instability that exists across markets. With fears that further needed stimulus/support is still some time away, small business owners are further thrust into a realm of danger. According to Census Bureau data, “around 30% of small business owners reported having one month or less of cash on hand (Jefferies – Greed and Fear).”
Small Business Pulse Survey
Source: Census Bureau
We are most likely witnessing a significant disconnect between economic indicators based upon real GDP growth projections and market prices. Normally, equity and debt market prices and real GDP growth work in unison to provide indication that risk for defaults, insolvencies, and bankruptcies in light of contraction is building. As economic activity slows, firms’ revenues prospects drop, and their ability to generate sufficient capital becomes constrained to service existing debt.
According to September Consensus Economics’ real GDP annual growth forecasts for the remainder of the year in conjunction with their projections for expected default frequencies, the Bank for International Settlements expects bankruptcies to rise on average by 20% by 2021 (BIS Bulletin No 30). FCN has readjusted its own estimates, and now expects a pickup in bankruptcies closer to the end of 2021 as well. Originally citing a “hockey stick” pickup in Chapter 11’s in 2Q, they have acknowledged this quarter that “loose money” will play a role in pushing off looming defaults and filings (FCN Q3 Earnings).
Source: The Daily Shot via Variant Perception
Other research on this issue points to even higher rates of chapter 11 filings.
Source: Euler Hermes via Quill Intelligence
Buy Case Recap
Though looming turmoil that would equate to large increases in restructuring and bankruptcy may still be a way out, it is important to keep in mind that FTI in the interim has much more to offer than just a cyclical opportunity in bankruptcy. For decades, the United States has strayed further away from the idealized capitalism that has made our economic system one of the most revered in the world. Now I won’t spend time delving into our current economic system’s misgivings. But it is important to understand that this country has increasingly allowed for monopolization, duopolies, etcetera to give rise to major corporate powers. With this in mind, regulatory opinions are shifting. As the tech sector begins to receive an increasing bombardment of antitrust outcries from different constituents, it’s my best guess that antitrust proceedings will escalate. FTI Consulting is primed to take advantage of this. I expect to see strong growth in antitrust and litigation consulting for the foreseeable future.
In addition to antitrust pickup, M&A has seen an enormous rise in response to the abundance of cheap money and market animal spirits facilitating activity. The combination of antitrust and M&A engagements has spurred on over 9% growth in the Economic Consulting segment of the business compared to the prior year quarter (FCN Q3 Earnings). The combination works well for bringing in large deals as the company is able to assess antitrust possibilities on the M&A work they are providing.
Pulling from my coverage initiation last quarter: unlike many other consulting firms, FTI has a strong reoccurring revenue base due to its trusted reputation and past performance. The firm has demonstrated its ability to keep up with strong growth projections through organic and generally synergistic M&A. By constantly adding new, highly qualified employees and subject matter experts, FTI gives itself the ability to jump into adjacent services, as necessary. As defaults, insolvencies, and eventually Chapter 11’s pick up pace, already elevated levels of restructuring business will obtain new growth levels, yielding large profits for the company’s Corporate Finance segment in what is among its highest margin businesses.
And as the company’s ability to conduct business in the face of Covid-19 is impacted near-term, it is continually focused on value creation for the medium- to long-term. CEO, Steve Gunby has placed emphasis on increased headcounts and retention rates as of late. Attracting quality talent from competitors, the firm is in a strong position to continue to add to its growth.
The company’s stock has had a volatile year as has been common for many companies. However, my long-term thesis stands unchanged. If anything, with valuation and share price sitting considerably below both the forward market P/E and its own one-year highs, the company is an attractive prospect on a longer time horizon at current price levels.
Despite a new age of digital technology being used to proceed with virtual court proceedings, other aspects of the legal system, and other consulting work, circumstances still impair the ability of the company to fully conduct business. As progress is made on the front of fighting the pandemic, I expect the utilization rates within the Litigation and Economic Consulting sides of the business to continue to grow. However, uncertainty still exists. As cross-border travel is restored, these businesses that were hurt will see faster returns to normal. Until then, the hope is that online client meetings and testimonials will continue to allow for better operations of business.
Uncertainty surrounding the US dollar may also play a small role in hampering profits over the long run. With fears of inflation on the horizon as a result of the monetary policy we have witnessed; it may be a difficult decade for the world’s reserve currency. Even in the short-term, as investors move out of the dollar and into traditional hedges such as gold, the company has had to contend with FX remeasurement losses. Though it only makes a small dent in the company’s profits, over the long run, it may become more significant.
Though this isn’t a pure play on restructuring, the uptick in business throughout this pandemic should be an added benefit. With a strong balance sheet and a continual strive to increase headcounts and retention rates, the company is setting itself up for a strong future. Despite extraordinary tailwinds propelling the company to new heights, particularly in restructuring, M&A, and antitrust, at current valuation levels, I believe FTI Consulting has the ability to continue along its growth trajectory, barring any exceptional circumstances.
Disclosure: I am/we are long FCN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.