Sept 26 -
Summary analysis -- FTI Consulting Inc. --------------------------- 26-Sep-2012
CREDIT RATING: BB+/Stable/-- Country: United States
Primary SIC: Legal services
Mult. CUSIP6: 302941
Credit Rating History:
Local currency Foreign currency
04-Sep-2009 BB+/-- BB+/--
21-Mar-2008 BB/-- BB/--
Our corporate credit rating on FTI Consulting Inc. is based on our expectation that debt leverage will decrease to under 3x over the intermediate term through debt reduction, and covenant compliance will remain adequate over the next 18 to 24 months. Pro forma for debt repayment in July, FTI had about $175 million of availability under its $250 million revolving credit facility and about $90 million of cash and cash equivalents on June 30, 2012.
We view FTI's business risk profile as "fair" because of the company's dependence on highly mobile and sought-after senior staff, and some earnings variability associated with its restructuring practice. The restructuring practice is a significant contributor to the company's overall revenues and profitability, but its performance can exhibit volatility with business cycles. Positive factors including FTI's segment diversity, businesses not strictly tied to the economic cycle, and discretionary cash flow generation support our assessment. We view the company as having "significant" financial risk because of its aggressive acquisition growth strategy and equity-focused financial policy.
FTI has five main practice areas: forensics and litigation, corporate finance/restructuring, technology, economic consulting, and strategic communications.
FTI's performance is highly dependent on its senior managing directors, whose expertise is sought by clients. Retaining these leaders is critical to the company's success. Although the company has been successful in retaining its most senior professionals, this will remain a key factor that we will continue to monitor. Maintained high utilization of consultants and the ability to increase the hourly rate charged to clients are factors essential to profitability growth. FTI has kept utilization rates steady in recent years--in the 70% to 80% area, depending on segment--by reassigning some employees to new projects in different business segments and reducing headcount to better match demand. The company has expanded its service offerings over the past few years through acquisitions, with increasing focus on expertise for certain specialized industries, such as the energy, healthcare, and telecommunications industries. This strategy has further strengthened they company's competitive position.
We expect the trend of improving demand in the restructuring business in the first half of 2012 to continue for the remainder of 2012. Under our base-case scenario, we expect revenue to increase 0.3% in 2012 and 2.5% in 2013. We forecast 2012 EBITDA to decline by a low-single-digit percentage rate due to the staff reduction charges taken in the second quarter of 2012. We believe that the restructuring, forensic litigation, and economic consulting practices will each experience modest growth in 2013, which will offset further decline in the technology segment.
We also expect the EBITDA margin will slowly recover over the intermediate term to the high-teen percent level. Recovery to the low-20% level of 2009 is unlikely because of the current business mix and competitive pressures that are contracting the technology segment's margins.
The restructuring business performed better than expected through the first half of 2012 as a result of opportunities in Europe and North America. This, combined with the growth of the economic consulting practice, has offset softness at other business segments, particularly the technology segment. During the second quarter of 2012, revenues decreased 1% while EBITDA (excluding noncash special charges) fell 6.8%, reflecting a cash charge for staff reduction and a decline in the technology segment, offset by modest growth in the corporate finance/restructuring and economic consulting segments. The technology practice's EBITDA margin has declined over the past two years. The technology segment contributed about 18.5% of EBITDA for the 12 months ended June 30, 2012, down from about 23% for 2011. FTI continues to see increased competition in the technology sector, which has led to lower prices and volume.
The EBITDA margin remains fairly healthy at 16% for the 12 months ended June 30, 2012, despite steadily declining from 22.6% in 2009. The margin decline was a result of increased spending, higher compensation expenses, lower margins at acquired businesses, and one-time staff reduction expenses.
Pro forma for the July debt reduction, for the 12 months ended June 30, 2012, total debt to EBITDA (including cash expenses to reduce workforce) declined to 3.1x, above our threshold of 3x for the company at the current rating. We expect leverage to improve to the high-2x area by the end of 2012 through the anticipated repayment of the company's revolving credit facility. As of June 30, 2012, EBITDA coverage of interest expense was healthy, at 4.3x. Conversion of EBITDA to discretionary cash flow was satisfactory, at 34% for the 12 months ended June 30, 2012, although down from 49% for the same period last year because working capital was a use of cash, mainly because of increased days sales outstanding (a measure of the average collection period). Based on our forecast, we expect the conversion of EBITDA into discretionary cash flow for 2012 to remain healthy, at around 50%. We expect FTI will continue to use its discretionary cash flow to fund acquisitions and stock buybacks.
FTI is very acquisitive, having made numerous acquisitions since 2005. The company's goal is to increase its international revenue contribution to about 30% of consolidated revenue in two years. International operations are profitable, but their margins are typically lower than those in the U.S. because of scale. As of June 30, 2012, FTI operated in 24 countries, accounting for 26% of total revenues, compared with 10 countries in 2006. Despite FTI's success incorporating acquisitions into the business, the company's aggressive acquisition strategy and integration risks remain potentially negative factors.
In June 2012, the company announced a $250 million share repurchase program to be executed over the next two years. The company generates good discretionary cash flow and has excess cash to finance both the buyback program and ongoing operating needs, without increasing debt leverage. We will continue to closely monitor the company's financial policy with regard to its share buybacks and sizable acquisitions.
FTI has adequate liquidity to cover its needs over the near to intermediate term, in our view, even in the event of moderate unforeseen EBITDA declines. Our assessment of FTI's liquidity profile incorporates the following expectations, assumptions, and factors:
-- We expect sources to cover uses for the upcoming 12 to 24 months by 1.2x or more.
-- We also expect cash sources will continue to exceed cash uses, even with a 20% drop in EBITDA over the next 12 months.
-- The company has adequate covenant headroom for EBITDA to decline by 15% without breaching coverage tests.
-- Because of the company's high conversion of EBITDA to discretionary cash flow, we believe it could absorb low-probability, high-impact shocks.
-- In our opinion, the company has a generally high standing in the credit markets.
Pro forma for debt repayment in July, liquidity sources include a cash balance of about $90 million and availability of roughly $175 million on the company's $250 million revolving credit facility. We expect $135 million of discretionary cash flow in 2012 and $150 million in 2013. FTI's next debt maturity is the $250 million revolving credit facility, which matures on Sept. 25, 2015. The $215 million issue of 7.75% senior notes is due on Oct. 1, 2016.
The credit agreement contains financial covenants, including a maximum total and senior leverage ratio, a fixed-charge coverage ratio, and a minimum liquidity requirement of at least 115% of the aggregate outstanding principal amount of the convertible notes. The company's tightest covenant is the total debt leverage ratio. The margin of compliance with that covenant was almost 30% as of June 30, 2012. The 4x total debt leverage steps down to 3.75x on March 31, 2013, and the 3x senior debt leverage covenant steps down to 2.75x on March 31, 2013. Based on our assumptions for 2012 and 2013, we expect the company to maintain an adequate margin of compliance over the near-to-intermediate term. While working capital usage can fluctuate with revenue growth, capital expenditures as a percentage of EBITDA are typically low, at between 9% and 12%, and should not impede cash flow generation.
We rate FTI Consulting Inc.'s senior notes 'BB' (one notch lower than our 'BB+' corporate credit rating), with a recovery rating of '5', indicating our expectation for a modest (10% to 30%) recovery for lenders in the event of a payment default. (For the complete recovery analysis, see Standard & Poor's recovery report on FTI Consulting Inc, to be published as soon as possible on RatingsDirect.)
The rating outlook is stable. We expect FTI will have moderate revenue and EBITDA growth over the intermediate term. We could lower the rating if debt leverage rises above 3x on a prolonged basis. We believe this would most likely occur as a result of debt-financed acquisitions, combined with major share repurchases and accelerated declines in the technology segment, along with negative operating trends in the company's other businesses. We could also lower the rating if the EBITDA margin falls below 14%. We believe this could happen if the technology segment declines further as a result of increased competition and if the corporate finance/restructuring business faces a steep decline in business.
Although unlikely, we could raise the rating on the company if FTI were able to adopt a more conservative debt-usage policy and return to more balanced growth across its various practices, while expanding its geographic diversity and maintaining adequate liquidity. Moreover, an upgrade scenario hinges on robust growth across all segments over the next two to three years, supported by a continuing economic recovery. Upgrade potential also would be linked to FTI's pursuing its $2.5 billion revenue objective while at the same time preserving an EBITDA margin above 20%, and maintaining leverage below 2.5x.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008