Sell CGI Group, says 4Front Capital’s Dushan Batrovic

4Front Capital Partners analyst Dushan Batrovic says many analysts simply applied CGI’s pre-Logica valuation multiples across the combined new entity. That, he says, is too simplistic.

On August 20th, CGI Group (TSX:GIB.a) completed the acquisition of London-based Logica Plc for $2.64-billion.

The market liked the move, and some analysts raised their price target on CGI following the news. On May 31st, the day the proposed pickup was announced, shares of CGI rose 14%. What’s more, the company passed struggling Research in Motion to claim the title as Canada’s most valuable tech stock. CGI’s stock continued a strong run for the remainder of July and August, hitting a high of $26.71 Wednesday.

One analyst who doesn’t agree with the street’s rosy view of the acquisition is 4Front Capital Partner’s Dushan Batrovic. Batrovic says many analysts simply applied CGI’s pre-Logica valuation multiples across the combined new entity. That, he says, is overly simplistic because Logica was actually larger than CGI and traded at a multiple lower than CGI’s 8x EBITDA and nearly 13x earnings. Perhaps, says Batrovic, Logica traded at a discount for a reason. The company has “…vast exposure to a troubled region (Europe), slower growth and a lower margin profile” he noted. Instead, Batrovic applied different multiples to the different business units in a sum-of-the-parts analysis. The numbers he arrived at prompted him maintain his target price on CGI Group at $23, but downgrade his rating on the stock from HOLD to SELL.

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CGI was founded in Montreal in that city’s Olympic Year of 1976. The Company’s name is an acronym for Consultants to Government and Industry. The Logica acquisition was the second major one for CGI in two years. Midway through 2010, CGI picked up Stanley, an Arlington, Virginia based systems integrator for a billion dollars.

Batrovic says he examined twelve companies in the IT services space. What he found, he says, was unsurprising. Companies with higher margins, such as Accenture, IBM and CGI before the acquisition of Logica, tend to trade at EBITDA multiples above 7.5x. Those with lower margins, such as ManTech, SAIC and Cap, trade at approximately 4-5 times EBITDA. Batrovic says CGI’s EBITDA margin, which was 19% prior to Logica, has dropped to 14% with it. This, he says, places the company in the middle of its peer group. But the recent run in the company’s shares means it is trading at the very top of this range, which doesn’t match the reality that is has actually become a relative laggard.

At press time, shares of CGI Group on the TSX were down 2.64% to $25.80.

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