Please read our disclosure at the end of this entry. All
figures in CAD unless noted otherwise.
This is our fourth in a series of entries on CGI Group, Inc. (
). We remain short CGI stock. We refer readers to our
articles on CGI, in which we discuss "cookie jar" accounting and
CGI's acquisition of Logica PLC.
In this note, we analyze the company's fiscal Q2 cash flows, we
estimate the magnitude of CGI's customer backlog cancellations
during the quarter, and we discuss Serge Godin's ownership stake in
Can a company juice short-term cash flows by managing
A company's level of working capital is a key driver of free
cash flow. A company that increases its level of working capital
produces less free cash flow, all else equal. In the long run,
working capital levels are driven by a company's growth and its
negotiating leverage with customers and suppliers.
But in the short term, management teams have tactics at their
disposal to reduce working capital and temporarily increase a
company's cash flows. Importantly, managing working capital to
juice near-term cash flow can involve tradeoffs that lead to
reduced cash flow, profits, or growth in the future.
One component of working capital that can be managed is accounts
receivable. Accounts receivable is a balance sheet account that
represents revenue that has been recognized and billed but for
which no cash has been received. The level of receivables
outstanding depends on a company's ability to collect from its
customers. Lowering the accounts receivable balance indicates
faster customer collections and leads to a one-time improvement in
There are several ways a company might temporarily manage its
accounts receivable to produce more cash in a given period:
- Pressuring customers to pay outstanding bills
- Refusing to provide additional services until outstanding
bills are paid
- Offering discounted future services to customers who pay
- Factoring receivables
Each of these tactics increases near-term cash flow but involves
a tradeoff - whether in customer service, future growth, margins,
Why do companies factor receivables?
Factoring receivables involves selling receivables to a third
party for their face value less a fee. When a company factors
receivables, management is choosing to receive less money from a
third party today instead of more money from customers in the
In some industries, factoring receivables is common only in
companies in financial distress that are in need of short-term cash
flow. For this reason, receivables factoring can sometimes be an
earnings quality "red flag."
Even when factoring receivables is not an earnings quality red
flag, the cash generated by factoring is not representative of the
sustainable earnings power of a business. When a company factors
receivables, it is simply shifting cash flow forward at a lower
margin that would have been received at a higher margin at a later
Did CGI juice fiscal Q2 cash flows by factoring
, we explained how "cookie jar" accounting manipulation will lead a
company to grow working capital over time. Growing working capital
leads companies to report earnings that are unsupported by
underlying cash flows.
In the last 12 months, CGI's growing working capital cut the
company's cash flows by over $543 million. But in fiscal Q2,
working capital impacted CGI's cash flows by less than $1 million,
resulting in $351 million in operating cash flows.
86% of the sequential improvement in CGI's fiscal Q2 operating
cash flow can be attributed to improved working capital
(click to enlarge)
Note 10 to CGI's fiscal Q2 financials supplies investors with a
breakdown of how each working capital account impacted CGI's cash
flows. There, we see that shrinking accounts receivable positively
impacted CGI's quarterly operating cash flow by $250 million.
Without this reduction in accounts receivable, CGI's fiscal Q2
operating cash flow would have been 71% lower.
attributes the decrease in accounts receivable primarily to "
the result of the completion and collection of billing
milestones on certain large U.S. contracts and the catch up of the
Q1 2014 system conversion impact of the France and Finland
billings… The collection of tax credits also contributed to the
Noticeably absent from this description is any mention of
Yet if investors look in the last paragraph of the very last
page of CGI's fiscal Q2 financials, under a section on financial
instruments, they will find that CGI factored nearly $75 million of
receivables. It is unclear why this factoring was not disclosed in
the cash flow section of the MD&A.
"During the six months ended March 31, 2014, the Company
sold some of its accounts receivable with a carrying amount of
$74,892,000 through a factoring agreement with two financial
institutions. The accounts receivable sold have been
derecognized since the Company has met the derecognition
criteria, even though the Company has retained some late
, in response to one analyst's questions, CGI management stated
that the company factors receivables regularly as a normal part of
In our research, we have been unable to find another single
mention of receivables factoring in CGI's entire history of
"We do, as a matter of course, have some factoring or
receivable programs in place, so there was just one particular
one that was of a little bit of a larger
size that we had specifically called out and here
disclosed. It is something that - this on
e is an annual activity. We were expecting to have the cash
in before the end of March. It will
we will be receiving it in this next couple of weeks here,
and I don't really see it as being a major issue. I don't see
it as an issue at all here. It's just something that we are
looking at trying to optimize the cash going forward."
We do not have the full details regarding all components of the
$250 million decrease in accounts receivable in fiscal Q2, so we
are unable to comment beyond the $75 million in receivables
We will leave it to the reader to determine whether factoring
$75 million of receivables, and disclosing this factoring on the
last page of the last paragraph of the financials, is consistent
with the actions a company would take to manage working capital to
juice short-term cash flows.
Can investors calculate customer backlog
CGI's fiscal Q2 earnings announcement showed a 105% book-to-bill
for the quarter. Sell-side analysts cited the bookings as a bullish
signal of future growth, as analysts believe that CGI will grow
revenues so long as the company consistently reports a book-to-bill
CGI does not provide investors with a full reconciliation of the
quarterly change in the company's backlog. The company only
backlog, bookings, revenue, and book-to-bill
. A full reconciliation would also include currency effects and
backlog cancellations, as follows:
By estimating the effect of currency movements, investors can
back into an estimate of backlog cancellations and build a full
Did customers cancel bookings that were in backlog
during fiscal Q2?
The Canadian dollar depreciated substantially relative to each
of the Euro, US dollar, and British pound in fiscal Q2. This
depreciation was a steady continuation of the depreciation that
took place in the trailing 12 months ended 3/31/2013.
When the Canadian dollar depreciates relative to other
currencies, CGI's reported backlog is adjusted upwards to account
for the portion of the backlog that is attributable to
The same is true for revenues in a given period. In fiscal Q2,
CGI reported organic constant currency revenues down -2% year over
year, while headline revenues were up 7% year over year. Thus, CGI
reported a 9.3% year over year currency benefit to revenues.
The depreciation in the Canadian dollar during fiscal Q2 was
less than the year-over-year depreciation reflected in the 9.3%
adjustment to constant currency revenue growth. We estimate that
the fiscal Q1 to Q2 currency impact to backlog was approximately
3%. Other investors may have different estimates, but there is no
question that CGI's backlog received a bump from currency.
With this 3% estimated currency impact, we calculate backlog
cancellations of approximately $500 million CAD, as shown in the
Will ongoing backlog cancellations limit future
Just as CGI is able to book new business every quarter,
customers cancel or renegotiate contracts every quarter.
Therefore, we propose "net bookings" and "net book-to-bill" as
indicators of future revenue growth. These figures adjust for
backlog cancellations by subtracting them from bookings to produce
With the estimated $500 million CAD in backlog cancellations, we
calculate a fiscal Q2 net book-to-bill of 87%.
This is substantially less than the 100% figure allegedly
required for organic revenue growth. (Even a 2% currency impact on
the backlog would imply a sub-100% net book-to-bill.)
We leave it to the reader to determine whether a company with an
87% net book-to-bill can, over time, expect to grow revenues.
Do CGI's cash flows justify the current
CGI's recent fiscal Q2 earnings report showed -2.3%
constant-currency revenue decline. This outcome continues a
multi-year period of organically declining constant currency
revenues at CGI.
As of May 2, 2014, CGI traded at 28x trailing 12 months free
cash flow, a significant premium to comparable companies on this
metric. Many of those comparable companies have grown revenues
Without having factored $75 million in receivables, CGI would be
trading at 32x trailing 12 months free cash flow, which would imply
an even greater premium to comparable companies on this metric.
Integration and restructuring charges at CGI have persisted
since 2010; but even if we add back integration and restructuring
charges, CGI trades at a 19x trailing 12 months free cash flow
multiple, which would still put CGI at a premium to comparable
companies on this metric.
We leave it to the reader to determine whether a 28x free cash
flow multiple is appropriate for an IT and business process
outsourcing company with a multi-year track record of negative
organic revenue growth.
How much stock is CGI's Executive Chairman
Serge Godin has some stock he would like to sell you.
Godin is the Executive Chairman and Founder of CGI Group, as
well as its former CEO. Former CGI employees report that today he
remains as active in the operations of the company as ever.
On Monday, May 5, 2014, CGI issued a press release stating that
Godin will sell up to 2.1 million shares of CGI stock. At the May 2
closing price of CGI's shares, 2.1 million shares would represent
over $80 million of CGI stock. A portion of the shares will be
donated to a charity, though the company's press release did not
specify the size of the donation.
CGI's press release states that "the maximum number of Class A
subordinate voting shares to be disposed of represents 6.4% of his
total number of securities in the company."
But investors may be interested to know that 2.1 million shares
represents much more than 6.4% of Serge Godin's economic interest
in CGI common stock. In May of 2008, Serge Godin
entered into a transaction
that hedged out his economic interest in 8.5 million shares of CGI
that he continues to own and control today. In other words, Godin
effectively shorted out 8.5 million shares of CGI while retaining
the right to vote those shares. Thus, Godin's economic interest in
CGI common stock is 8.5 million shares less than the equity
ownership figures shown on CGI's proxy statements.
We calculate that a 2.1 million share sale is equivalent to
roughly 9% of Godin's current economic interest in CGI common
Separately, we do not know of any plans by CGI to discontinue
its buyback program.
Why is CGI's Executive Chairman exercising his options
According to the same May 5 press release, 1.2 million of the
shares that Godin intends to sell will be acquired from the
exercise of stock options.
The release specifically states that Godin is exercising options
that expire soon:
"Serge Godin, Founder and Executive Chairman of the Board,
filed a notice of intention to dispose of, on or after May 13,
2014, up to 2,102,230 Class A subordinate voting shares of the
Company, including up to 1,238,230 Class A subordinate voting
shares acquired pursuant to the exercise of stock options.
Mr. Godin intends to exercise stock options granted to him
between 2004 and 2007 and that are nearing their expiry dates
due to pre-determined quarterly and other blackout periods
prescribed by the Company
and that limit periods during which stock options can be
exercised before their expiry and cancellation" [emphasis
We found this explanation strange because Appendix A of CGI's
most recent proxy circular discloses that as of September 30, 2013,
Godin held only 275,730 stock options that would expire in
Therefore, the expiration excuse offered by the company in the
May 5 press release can account for only 22% of the options that
Godin has set aside to sell.
(click to enlarge)
Why is CGI's Executive Chairman exercising his options
Standard financial theory says that one should almost never
exercise an option early. Theory does, however, provide a few
exceptions to this rule.
One scenario in which it would make sense to exercise a call
option early is when ((
)) you are unable to sell call options, including any you own, ((
)) you are unable to short stock, and ((
)) you have high conviction that the underlying security will trade
down in the future.
This set of circumstances and beliefs could explain Godin's
planned monetization of CGI options more than one year in advance
In this note, we have discussed the following:
- Companies have the ability to manage accounts receivable to
pull operating cash flows forward, and one method of managing
accounts receivable is to sell receivables. If a company sells
receivables, they receive less cash flow sooner versus more cash
- CGI sold $75 million of receivables in fiscal Q2. The
corresponding disclosure was made in the last paragraph of the
last page of the financials.
- On the earnings call, CGI management stated that they
regularly sell receivables. However, we have been unable to find
any other mention of the practice of selling receivables in CGI's
entire history of regulatory filings.
- We show how one bullish sell-side analyst published an
important factual error related to fiscal Q2 cash flows.
- CGI does not provide a reconciliation of bookings, revenues,
and backlog that includes adjustments for currency effects and
customer backlog cancellations.
- We estimate $500 million in backlog cancellations in fiscal
- With this cancellations estimate, we calculate a "net
book-to-bill" of 87%, which is substantially lower than the
reported 105% book-to-bill. Net book-to-bill adjusts bookings for
customer backlog cancellations.
- In fiscal Q2, CGI continued its multi-year pattern of
negative organic constant currency revenue growth.
- CGI trades at 28x LTM unlevered free cash flow, a significant
premium to comparable companies, many of which continue to grow
revenues organically. If CGI had not sold the $75 million of
receivables, it would be trading at 32x LTM unlevered free cash
- The Chairman of CGI, who remains involved in the day-to-day
operations of the company, has filed to sell up to $80 million of
stock, which is equivalent to approximately 9% of his economic
stake in common shares.
- The Chairman has also filed to exercise 1.2 million options.
CGI stated in a press release that he plans to exercise options
that will expire soon; however, 78% of the options that he has
set aside to exercise do not expire within the next year.
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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