Please read our disclosure at the end of this entry. All
figures in CAD unless noted otherwise.
This is our third in a series of entries on CGI Group, Inc. (
). We remain short CGI stock.
In this entry, we examine CGI's organic revenue growth and
reported book-to-bill. We also examine CGI's cash flows in recent
We recommend that readers begin with our
articles on CGI. In those articles, we discuss "cookie jar"
accounting and CGI's acquisition of Logica PLC.
What is organic revenue growth? Why is it
Large acquisitions can make it difficult to measure how fast a
business is growing. When one company acquires another, the
revenues in the acquirer's public financials can go up even if the
businesses underlying both the acquirer and the target are
deteriorating on a stand-alone basis.
"Organic" revenue growth is a measure used by investors that
adjusts for acquisitions to calculate the revenue growth of a
company's underlying businesses.
Organic revenue growth is a key input for any standard financial
model. All else equal, a company that is able to grow organically
deserves a much higher cash flow multiple than a company that is
only growing through acquisitions.
Can we measure CGI's organic revenue growth?
CGI has made two major acquisitions in the past five years:
Stanley, Inc. in 2010, and Logica PLC in 2012.
Sell-side analysts disagree on CGI's organic growth trends in
this period. For example, Deutsche Bank's research analysts state
that CGI's organic growth has been negative, where Raymond James'
analysts state that it has been positive in all but one quarter
since CGI acquired Stanley.
We do not know why some analysts are confused about CGI's
organic revenue trends:
CGI's public filings unambiguously show that organic
revenue growth of CGI's businesses has been negative
since the Stanley acquisition:
Fiscal 2013 - 2014:
CGI has reported only one quarter of financials in fiscal 2014.
Page 15 of CGI's Q1 2014 MD&A shows that CGI's revenues
declined organically -1.9% year-over-year if we exclude the effect
of currency fluctuations.
Fiscal 2012 - 2013:
The Logica acquisition took place in fiscal Q4 of 2012. CGI does
not provide data to calculate organic revenue growth in each
quarter of fiscal 2013. However, CGI discloses data to calculate
revenue growth in fiscal 2013.
Note 24(a) of CGI's fiscal 2012 financials states that revenues
for CGI would have been $10,232 million had CGI acquired Logica at
the beginning of fiscal 2012. This figure suggests a -1.4% organic
revenue decline to reported consolidated revenues in fiscal 2013.
The Canadian dollar weakened relative to the Euro over fiscal 2013,
meaning that constant currency organic revenue decline over the
period would have been even steeper.
Fiscal 2011 - 2012:
Schedule C of a Business Acquisition Report filed by CGI on
November 5, 2012, shows that CGI and Logica combined generated pro
forma revenues of $10,412 million in the fiscal year ended
September 30, 2011. This implies organic revenue decline of -1.7%
in fiscal 2012. Exchange rates between the Canadian dollar and the
Euro supported CGI's reported revenue growth in fiscal 2012 as they
did in 2013.
Fiscal 2010 - TTM ended 6/30/2012:
CGI acquired Stanley in August of 2010, and CGI's last quarterly
report before the Logica acquisition was for the period ended
CGI's fiscal 2010 financials state that CGI would have had
revenues of $4,556 million had the Company acquired Stanley at the
beginning of the fiscal year. We compare this $4,556 million figure
to CGI's reported revenues for the trailing twelve months ended
6/30/2012 and find that annualized revenues declined organically
-8.5% over the corresponding period.
Currency moves in this 21-month period were volatile but likely
had a minimal overall impact on organic growth, as did CGI's switch
from reporting under Canadian GAAP to reporting under IFRS in
The calculations above show that the
organic revenue growth of CGI's businesses has been
consistently negative for the past several years.
We do not know of any basis for claims by sell-side analysts that
CGI's organic revenue growth has been positive.
What is the book-to-bill? Why does it matter to
Each quarter, CGI reports a "bookings" figure. Bookings
represent future revenues of new contract wins, extensions, and
renewals signed by CGI during the period. As CGI generates
bookings, they are added to CGI's backlog of revenues. CGI's
backlog is reduced as contracts are completed and the backlog is
converted into revenues.
CGI's bookings correspond to CGI's "book-to-bill" ratio, which
is also reported each quarter. The book-to-bill is the ratio
between CGI's bookings in a given quarter and the revenue
recognized by CGI in that same quarter.
Sell-side analysts closely track CGI's book-to-bill because they
believe it is a predictor of CGI's future growth prospects.
Analysts believe that if a company consistently generates a
book-to-bill above 100%, a company will grow revenues organically.
Following CGI's earnings announcement last week, several sell-side
analysts cited CGI's book-to-bill as a bullish signal for future
CGI's management also explicitly targets a book to bill ratio
above 100%. The MD&A states that management is "committed to
maintaining a target [book-to-bill] ratio greater than 100% over a
Can investors trust CGI's book-to-bill?
CGI's reported book-to-bill ratio has been above 100% in every
fiscal year since 2008.
We do not know what could plausibly account for the discrepancy
between CGI's reported book-to-bill (which reached 124% in 2010)
and the substantial organic revenue decline we have seen since the
Stanley acquisition in 2010.
Currency movements do not explain this inconsistency. The
Canadian dollar has devalued relative both to the Euro and the US
dollar by approximately 7% and 4%, respectively, from 9/30/2010
through 12/31/2013. The delta between the expected growth implied
by CGI's book-to-bill and the actual rates of organic decline is
much larger than could be accounted for by these currency
If we assume that CGI's book-to-bill is not overstated, it may
be the case that recent bookings relate to extremely long-dated
business that may be prone to cancellation.
Has CGI shifted the definitions of bookings and
CGI does not explicitly define "bookings," but the Company does
We noticed a small change in the definition of "backlog" in
CGI's MD&A in the third fiscal quarter of 2012. The change is
- Quarter ended March 31, 2012: "Backlog - represents
management's best estimate of revenue to be realized in the
future based on the terms of respective client agreements
at a point in time."
- Quarter ended June 30, 2012: "Backlog - represents
management's best estimate of revenue to be realized in the
future based on the terms of respective client agreements
at a point in time."
We do not know if, in CGI's usage, it is possible for a client
agreement to be in effect but not active. For example, we do not
know whether a contract that is booked three years in advance, but
is not being worked on today, is in effect but not active. If so,
current bookings numbers would be elevated relative to prior
Will cash flows improve in future quarters?
In the fiscal Q1 2014 financials, CGI reported negative free
cash flow to equity holders (CFO - capex - contract costs -
purchase of intangibles). Cash flow was affected by an increase in
working capital accounts of more than $200 million in Q1 2014,
which was due in part to an increase in accounts receivable. The
increase in accounts receivable may partly reverse in future
In the Q1 2014 conference call, CGI's management drew investors'
attention to CGI's operating cash flow, excluding integration
payments, for the trailing twelve months ended 12/31/2013. This
figure amounts to $819 million and is shown on slide 12 of the
We would make two points:
- Short-term accrued compensation has risen over $200 million
in the trailing twelve months. Had accrued compensation due
within twelve months remained flat over this period, operating
cash flow plus integration payments would have been less than
$620 million. (We assume that CGI will eventually pay employees
- CGI regularly spends cash on purchasing PP&E, contract
costs, and intangible assets. Over the trailing twelve months,
total expenditures on these three items was over $260
Operating cash flow before integration payments, less the cash
benefit from growth of accrued compensation, less the disbursements
on PP&E, contracts costs, and intangibles, would have been less
than $360 million in the trailing twelve months.
Are bullish sell-side analysts admitting that the bears
We were confused by a research note published by TD analysts
Scott Penner and Doug Taylor this morning that was written to
refute "bearish arguments" related to CGI's accounting. CGI bears
such as Deutsche Bank have argued that CGI's accruals will generate
earnings but no corresponding cash flows.
In today's note, the TD analysts argue that the bears are wrong,
yet they also write the following sentence: "
We believe that accrual accounting has given rise to about
$285mm of remaining working capital that will roll into income with
no impact on cash.
We are confused because the TD analysts appear to be confirming
the most important element of the bear story - that CGI's accruals
are creating a significant discrepancy between earnings and cash
Furthermore, the analysts do not indicate the source of this
$285 million estimate, nor do they address whether accruals have
created a discrepancy between earnings and cash flows in prior
The TD analysts also commit a very significant error in their
valuation model. They take the $285 million in "remaining working
capital that will roll into income" and add this number to their
target enterprise value to back into an implied EBITDA multiple
that is adjusted for the working capital drag.
In fact, the valuation effect of the $285 million depends on the
number of periods over which the analysts expect working capital to
expand by $285 million.
If working capital is expected to increase by $285 million in a
single year, then the figure should be multiplied by the analysts'
target earnings multiple. The TD analysts suggest investors use a
14x multiple in fiscal 2015 EPS. On this multiple, the negative
effect on CGI's valuation would be $3,990 million pre-tax or
roughly $2.6 billion after tax, rather than $285 million.
We suggest that investors relying on TD's research revise their
In this note, we have discussed the following:
- Organic revenue growth is a key input to any standard
valuation model. Organic revenue growth adjusts a company's
reported revenue growth for acquisitions.
- Sell-side analysts disagree on CGI's organic revenue growth
since the Stanley acquisition in 2010. Some analysts state that
CGI has grown organically over this period.
- CGI's own filings unambiguously show that CGI's businesses
experienced negative organic growth since the Stanley
- CGI's book-to-bill is used by analysts as a predictor of
future organic revenue growth. In theory, a book-to-bill above
100% should correspond to future revenue growth.
- CGI has reported a book-to-bill greater than 100% in every
fiscal year since 2008 even though CGI's businesses have seen
consistent organic decline since the Stanley acquisition.
Currency movements cannot account for this discrepancy.
- CGI changed its definition of "backlog" in fiscal Q3 of 2012.
We do not know the importance of the definition change.
- CGI generated negative free cash flow to equity holders in
fiscal Q1 of 2014, which was reported last week.
- In the trailing 12 months ended 12/31/2013, CGI's short-term
accrued compensation liability increased by over $200 million.
Had short-term accrued compensation remained flat in 12 months
ended 12/31/2013, operating cash flow before integration
payments, less the disbursements on PP&E, contracts costs,
and intangibles, would have been less than $360 million.
- A TD research note published this morning makes significant
errors in financial analysis and appears to concede that there
will be a significant discrepancy between CGI's earnings and cash
flows going forward.
In subsequent notes, we will analyze CGI's margins.
This article is for informational purposes only and is not
investment advice, and does not constitute an agreement, offer, a
solicitation of an offer, or a recommendation to purchase or sell
any particular security or pursue any investment or trading
strategy. This article should not be construed as legal, tax,
investment, financial or other advice. This analysis reflects our
current opinions regarding CGI Group, Inc. Funds managed by us
have an economic interest in the price movement of CGI Group,
Inc.'s securities and specifically a decrease in the price of CGI
Group Inc.'s shares. Our views and these economic interests are
subject to change and we expressly disclaim any obligation to
update the data, information or opinions contained in this
analysis. We acknowledge that there may be confidential
information in the possession of the companies discussed in this
presentation that could lead such companies to disagree with our
conclusions. Although we may do so, we do not expect to announce
subsequent changes in our thinking or economic interests
regarding CGI Group, Inc., but it is possible that there will be
developments in the future that cause us to change our holdings
in CGI Group, Inc.'s securities. We have based this analysis on
public sources, including CGI Group, Inc.'s public filings, which
can be obtained at
. While we believe the information presented in this article to
be accurate, we make no representation or warranty to that
effect, and we cannot guarantee that any projection or opinion
expressed in this article will be realized.
I am short GIB. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
Please see full disclaimer at the bottom of this article. This
article is for informational purposes only and is not investment
advice, and does not constitute an agreement, offer, a solicitation
of an offer, or a recommendation to purchase or sell any particular
security or pursue any investment or trading strategy. Funds
managed by us have an economic interest in the price movement of
CGI Group, Inc.'s securities and specifically a decrease in the
price of CGI Group Inc.'s shares.
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