SAIC, Inc. (SAI)

An investment in SAI at today's prices will likely yield above average returns under a wide variety of potential outcomes looking out 3-5 yrs. This capital light high technology research and engineering company is currently in the process of transforming itself from an ambitious but scattered "think tank", into one focused much more on profitablity and operational effectiveness. If management is able to execute, expect returns approaching 20-25% annualized over the next few years.

Taking a deeper look at this newly public company reveals exactly the type of underlying dynamics i hope to dig up when evaluating potential investment opportunities, a combination of quantitative and qualitative characteristics that on average has and should continue to result in above average results for the business in question and its shareholders. After all, SAI possesses a sustainable competitive advantage, high quality management, and a long history of consistent (.i.e. predictable) earnings growth. Additionally, due to the capital light nature of its business model it has and should continue to generate significant free cash flows, which historically has resulted in ROIC well above 20%. Did I mention its cheap? It's pre-tax TTM earnings yield is 20%. Considering normalized earnings should be meaningfully higher over the next 3-4 yrs, SAI is even cheaper than it may first appear.

Personally, I find an investment in SAI compellingly attractive due to its considerable "optionality", especially during times like today where earnings visibility is becoming increasingly scarce. Putting it a little differently, there is a wide variety of paths for SAI and its management team to traverse over the next few years, each leading to the same favorable result or outcome (i.e. significant capital appreciation for shareholders from today's levels). SAI's management has multiple levers or "options" at their disposal to drive returns and profitability meaningfully higher over the next few years. Some of these levers will impact the bottom line more than others, but taken together they provide a level of hidden earning power that I don't believe the market expects and is definitely not currently reflected in today's price.

Let's look at the ways SAI's business should improve over the next 2-3yrs:

A large and growing backlog should provide accelerating revenue growth due to considerable strength within its end markets. Secular tailwinds should also benefit SAI in this regard. One example of the type of secular trend I believe are likely to aid SAI going forward can be found in the fact that our govn't expects nearly 30% of its work force to retire over the next 10 years. In my opinion, this will essentially force the government to continue to outsource more and more of its activities - particularly within the technical fields that SAI excel's in.

More important to my investment thesis than the probable top line growth outlined above, is SAI's ability to improve it's ROIC through margin improvements. Examples include:

Improvements in operational efficiency should be realized through a combination of common sense initiatives such as the modernization of their IT infrastructure, and accounting and billing systems to name just a few. Today's elevated level of capex spending should be accretive to earnings relatively quickly upon the completion of these initiatives. The result will be reduced overhead costs relative to current levels, therefore increasing normalized free cash generation going forward.

Managements focus on increasing the benefits associated with economies of scale is another initiative that should result in meaningful margin improvement over the next few years. Mgmt's working hard to put the systems and processes in place that will allow them to grow the business without increasing overhead costs associated with that growth, therefore delivering more incremental dollars to the bottom line.

Mgmt. should be able to further enhance margins by improving their business mix by focusing on higher margin (more profitable) and faster growing areas.

Improvements within these three areas should bring SAI's currently below average margin up to, if not above the current industry margin. The benefits that will likely fall to the bottom line due to the optimization of their current bidding system and development functions, etc...the return on the internal infrastructure expenditures (expensed as incurred) made in the two years leading up to the IPO, as well as the enhanced future earning power that will likely be the result of SAI's focus on a more profitable business mix going forward should be more than enough to drive EPS estimates materially higher. For what its worth, these improvements should be more than enough to substantiate SAI's CEO's claim that he believes a best in class industry margin should be attainable within the next few years.

Finally, let us not forget to notice the significant opportunity on SAI's balance sheet. SAI went public ridiculously overcapitalized with no net financial debt, while having almost no capital requirements needed to sustain and grow the business. My hope is that mgmt will strive to allocate capital wisely...and will return any excess capital to shareholders through value accreting buybacks, and/or a growing dividend as opportunities present themselves. SAI also has valuable real estate holding's which are carried on the balance sheet at roughly $250m. My guess is that these holding's are carried at cost, and that the actual value of these properties is materially higher. There is also a possiblity for SAI to obtain a favorable tax ruling in the hundreds of millions, that should shield part of its future income, and further increase is cash on cash returns.

Putting it all together I believe that mgmt should be able to easily bring the EBIT margin up to 9% by the end of calender '08 (fiscal '09). By more effectively utilizing their scale and increasing internal revenue as well as by realizing the rewards of past research and development I have significant confidence that SAI will deliver on its goal of 15% annual EPS growth. If it does, SAI should trade north of $25 a share. Assuming that mgmt buys back up to 100 million employee owned share, as I believe they should, or the stock is rerated at a valuation comparable to its peers, IV moves closer to $30 a share. If SAI ends up as an aquisition target of one of the larger defense contractors at prices comparable to recent transactions within this space (of roughly 14x 2010 EBIT), which in my opinion is by no means out of the question, then (w/ 100m in buybacks included) SAI's IV approaches $40 a share. Mgmt could also potentially monetize $250-$500m in real estate which would add further incremental upside to the equation. Bottom line is that for investors looking out 2-3 years odds are shares will trade materially higher...

I used to work for SAIC and it's a great company. They were the largest privately traded company in the world for a $5B market cap. The are also very selective about the people and skill-sets that they hire (with me as an exception :-). There is solid, profit-driven management and a well-established brand in the eyes of it's largest customer...uncle sam.

Although this company has won many new DoD contracts and is rolling in money, their bad business methods will catch up with them. The management within SAIC has a record of gender discrimination, cronyism and delivering products/technology that does not work and they are currently mired in lawsuits (see Mar 07 Vanity Fair article). Additionally, the DoD spendathon will end at some point - probably beginning with a Democratic Administration (which should be just on the horizon).

1st everyone working for Sai has a vested interest. It's a tremendous Co. and is just beginning to be known. It will be a major play. A book value of over 15 in an $18 stock. A peg ratio of less then 1 and a growth rate of 22 % while the P/E is 18 and the chart looks good. It's just a matter of time. ThisCo. will outperform by far.

Advanced technological innovation and services to the Defense Department and other govt agencies, including the NIH. New IPO, solid company with significant potential to increase in value.

this is going to waffle around 20 for too long to beat the S&P. Plus the democrats are going to start reducing spending on militaristic ventures. Expect SAI to continue to be a profitable company, but don't expect huge gains from the stock.

This stock is going was about the largest private company in the US. It treats the employees well and is focused on supplying quality products.

With the current state of the world and everybody looking for more security, I think SAIC is going to do great. SAIC has been profitable for a very long time and I don't see that changing.

war is good for business

SAIC, Inc. is a provider of scientific, engineering, systems integration, technical services and solutions to all branches of the United States military, Department of Defense (DoD), intelligence community, Homeland Security, Government civil agencies, as well as to customers in selected commercial market. It offers a range of services and solutions, including defense transformation, intelligence, logistics and product support, systems engineering and integration, research & development and commercial services.

U.S. government spending to the global war on terrorism and in transforming its military has increased ever since September 11,2001 attacks, making a favorable impact on SAIC’s business through fiscal 2005. For the reason that, since then U.S. government has increased outsourcing of information technology (IT) and other technical services from the company.

From fiscal 2002 to 2006 company’s consolidated revenue has increased at a CAGR of 15.5% to a company record of $7.8bn, of which major portion of the revenue upto 90% is generated from the government segment. Conversely, this favorable progress has slowed down in fiscal 2006 and 2007 as a result of diversion in funding toward the ongoing military deployment in Iraq and Afghanistan by U.S. government and tightening of spending in I.T. initiatives. Supporting the same, President Bush has announced a budget of 145 billion for 2008 to finance the wars in Iraq and Afghanistan in military deployment. Besides, competition for contracts with the U.S. Government is increasingly becoming intense. Also, according to management the operating margins that are lagging behind its peers would perk up in coming few years.

Company’s cash deployment strategy announced during the recent IPO roadshow would take effect only in the long run. Furthermore, increasing political pressure to reduce overall levels of government spending is negative for the company. Looking at the above factors SAIC’s stock price would enter a bearish phase.

Small beans for a big fish.

WIth government backing it up, SAI has contracts worth billions. in addition, SAI constantly acquires other private companies and that make it bigger so that it provides wide ranges of security / defense products and contractors.

It is hard to see it fall as long as Bush is still around...
low PE, great company infrastructure and management, it won't go skyrocket overnight, but steady growing. Can easily going over $20.

Good long term buy, getting lots of contracts from Uncle Sam, buy and hold for a couple of years.

SAIC does a lot of highly classified work for various defense and secret service agencies making it difficult to evaluate their products, but judging by how much repeat work they get, how frequently company employees receive awards from customers, and how highly the company is spoken of in the industry, SAIC appears to be a top quality contractor with a heavy emphasis on ethics, R&D, employee ownership, technical competence, and customer service.

Has a unique position within Department of Defense. Has a consulting model rather than a contractor model. This keeps captial expenditures to minimum and means SAIC can respond quickly to changes in Defense budgets and prioities. SAIC also has a sizeable prescence outside of DOD. The difference will become apparent when DOD experiences the next round of budget cuts (whenever that occurs). A good way to get exposure to DOD stocks.

This company has a strong, innovative corporate culture and though it is very large it has proven agile in responding to opprotunites in various sectors. This is not a pure defense play, and will adapt to respond to other engineering, management, and IT opprotunities should the defense sector weaken.

I work for SAIC, so there's a bit of a bias - but with all these employees holding stock directly, watching it fluctuate... if we don't outperform the S&P, direct management will feel HEAT, and that'll flow uphill quickly.

As long as technology is perceived to be the answer to Government and Corporate management, environmental, security and productivity problems, this company will continue to be in demand for consulting and solution implementation. In the next year or two, employees will need to get used to the public market, as the "employee owned" culture will be tested by the fluctuating value of a now publicly traded stock price, but growth will continue, as employees continue to be able to achieve significant ownership in the company via great stock ownership purchase plans and retirement programs. Vested interest in company growth has already been inculcated via the previous structure, but the fluctuation is something employees are still getting used to.

VIC Write Up...Great base description to build of off when drilling down deeper on this wonderful company's current investment merits. Hopefully this will encourage investors to give this company a deeper look, and compel them to join me in participating in SAI's risk-adjusted above average returns for years to come...

10/26/2006 2:29:00 PM SAI ($18.00) by jordan23 Rating 5.0 (17 users)
Description:

SAIC, Inc. (“SAI”), previously known as Science Applications International Corporation, is a high technology research and engineering company. The company was formed by a group of scientists in 1969.

Generic description: SAI’s engineers and scientists work to solve complex technical problems in national and homeland security, energy, the environment, space, telecommunications, health care and logistics through systems engineering, systems integration and advanced technical services. The U.S. government accounts for over 80% of revenue, with the U.S. military being a very significant contributor. They don’t build hardware but mostly work as contract labor to advise, install, and integrate high-tech solutions.

Until its IPO a couple of weeks ago, it was 100% owned by employees (43,000 total employees), of which 23,00 have security clearances (almost a license to print money). 1/3 of the employees sit side by side with the customer. With $8 billion in trailing Revenue, this is one of the largest companies that no one on Wall Street had ever heard of.

At current price of $18 per share, SAI is valued at 90% of revenues, while its peers trade a least 1/3rd higher.

The business itself is very stable. They have 9,000 contracts and the top 10 contracts account for less than 14% of sales. They also win 70% of the contracts that they bid on. SAI has strong positions in its end markets and should grow at over 5% per year organically.

There is a lot of opportunity for the SAI business to improve. SAI is on the verge of acceleration in its revenue growth. SAI’s current total backlog of $16 bn is twice its annual revenue. In the last two and a half years, SAI experienced very significant growth of 59% in its unfunded backlog ($12 bn currently) but only modest growth of 19% in its funded backlog ($4 bn), which was constrained by diversion of government funds to military deployment in Iraq and Afghanistan. Recent legislation has authorized substantially better funding of SAI’s backlog. This should allow for a large portion of the unfunded backlog to convert to the funded status and revenue in the near term. Moreover, since SAI’s latest published financials and metrics dated July 2006, the company has experienced a surge in bidding activity and awards that should add to it its total backlog further.

The bigger story is margins. EBIT is 7% of revenues. Peers have margins 9% or better. It is understandable why. SAI brought in a new CEO three years ago and a new CFO last year. They see a lot of opportunity:

1) On the vast majority of Materials & Sub-contract revenue (37% of total revenue), SAI gets no margin. Standard industry practice is to charge 4%. If they do that, SAI would add 150 bp to its margins.

2) Another opportunity is from the mix shift towards higher margin time & materials and fixed price contracts and away from sub-contracting. Surely, it’s a shift to higher-risk, higher-margin offering vs. lower-risk, cost-plus, but management contends that they’ve been in business for so long and are so ingrained into government organizations (often co-located, and co-develop the project) that the added risk is small compared to added margin. They maintain that margins on Fixed Price are in double digits while cost-reimbursement contracts are bad. If they manage to substitute 10% of Revenue that relates to Cost Plus with Fixed Price, it should lift the overall EBIT margin by up to 100 bp.

3) Another lever to increase margins is improvement in operational efficiency. When the new CEO came in, there were 70 operating units. He described the culture as Byzantine. 300 managers have been cut over the last two years. He promises to cut more than that in the next 2 years. At $100K per person (very conservative), that’s $40 mm per year in cost saves, which should add 50 bps (on $8 bn in revenues) to its margins.

The three points above should give their EBIT margin a boost of 300 bp and get them to above average industry margin. I could have also mentioned… that they are optimizing bidding & business development functions at SAI… that they should earn some return on internal infrastructure expenditures (expensed as incurred) made in the two years leading up to the IPO… that given so much forward looking project opportunity for them, profitability of new projects added to the backlog now should be better than recent past, etc…. but why get greedy?

For what’s it worth, the CEO thinks he can achieve a “best in class” margin.

Finally, there is a significant opportunity on the balance sheet. SAI went public significantly overcapitalized with no net financial debt, while having almost no capital requirements to sustain and grow the business, 70%+ win rates on its contracts, multi-year backlog and the majority of expenses being reimbursable by the government They also have valuable real estate holdings (in La Jolla, CA and Tyson’s Corner, VA). They carry those at about $250 mm on the balance sheet, which are likely worth at least twice as much. There is also a possibility to obtain a favorable tax ruling (in the hundreds of millions) that should shield part of its future income.

Putting this all together, the upside case is over $11 bn in revenues at a 9% EBIT margin is fiscal 2009, which is basically calendar 2008, and it earns about $1.50 per share.

If SAI returns $350 mm of free cash flow, monetizes $500 mm of real estate and takes 3 turns of EBIT leverage, it can buy back half the company. At that point earnings would be around $2.50 per share and the stock dramatically higher.