Cooper Creek’s Best Small-Cap

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Cooper Creek Partners, the small New York hedge fund is up nearly 9% annualized from inception in 2008 through 1Q 2016. They’ve highlighted a $900 million market cap IT company has a “heck of a buy.”

The company is Engility, which they say presents a compelling risk-reward within the government information technology services industry. The key is that the stock trades at a material discount to peers, in part because they are higher quality and safer companies. Then there’s the disappointing 2016 guidance.

But over the last two years, it’s made two meaningful acquisitions, helping properly position itself towards the more sophisticated, technical and growing government service work. Cooper Creek sees the company as finally being ready to prove its strong revenue growth and earnings power. The upside? Cooper Creek sees fair value at $35 a share — 40% upside from here.

Why Engility?

Engility, like its competitors, provides a range of services to the US government, including engineering and technology lifecycle support, IT modernization and sustainment, supply chain services and logistics management, and cyber security implementation.

Cooper Creek has a knack for finding successful investments in the under-the-radar group of government information technology companies. From 2010 to 2011, they benefitted from several take-outs as the industry underwent consolidation, as strategic players sought scale and private equity firms looked for consistent cash flow

The catalyst — a new CEO

Engility is shifting its revenue mix towards higher quality and growing end markets through two major acquisitions – Dynamics Research in 2014 and TASC in 2015. Previously, the company lacked the right leadership to foster the transition effectively. That’s changed, with Lynn Dugle becoming the CEO in March 2016.

This is a key inflection point, where Dugle has the “right technical pedigree, operational excellence, and network necessary to integrate these acquisitions and new mix of work.”

In the past, Engility has succeeded at winning and implementing low-margin contracts, but sequestration and withdrawal from Afghanistan has created significant revenue headwinds. Revenues were down in 2012 and 2013 to the tune of 15-20% per year. Since its spinoff from L-3 in 2015, shares are down 33%.

The grand plan

Engility management has embarked on an aggressive acquisition strategy since 2013 to help fend off these revenue declines. Prior to the Dynamics Research acquisition, Engility had a $1.4 billion revenue base, which was made up of ~75% low-value and declining DoD work. The acquisition of DRCO brought an estimated $275 million of sales with approximately 75% of that revenue base focused on “growth markets” such as healthcare, homeland security, and other civilian oriented programs.

Cooper Creek has done the legwork, including channel checks on new CEO Dugle, to verify that the company has precisely the right type of operational experience to enable her to make immediate contributions.

Dugle has more than 30 years of experience in intelligence, communications and defense, having spent over a decade in senior management positions at Raytheon. The Cooper Creek Our channel checks showed that Raytheon’s IIS unit’s win rates improved significantly under Dugle. At TASC, she was a board member prior to the merger, and transitioned to the EGL board with the acquisition.

The big overhang creates an opportunity

Engility’s discount to fair value reflects the market’s disappointment with its 2016 guidance, which highlighted revenue declines from the legacy defense-dependent business, and weakness in its business development organization.

The key is that the market is focusing on the past, while investors should be looking forward. You have to appreciate the positive transformation that is actually occurring at Engility. The company has gone from being heavily reliant on competitive and declining work for the Department of Defense, to having nearly two-thirds of its revenues in strong and growing markets.

And for the first time, it has the necessary leadership to oversee this new entity. With CEO Dugle’s efforts already the market should have just cause to re-assess and appreciate the Engility strategy in the interim.

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Cooper Creek Partners

Cooper Creek Partners