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Michael Luddy

HURN AT A GLANCE

P/E ► 9.87 AVG EV/EBITDA ► 5.57 AVG ROA ► 8.8% AVG ROE ► 14.1% AVG Debt to Equity ► 1.17 AVG Current Ratio ► 1.71 AVG Interest Coverage Ratio ► 5.98 AVG

 

 

 

 

 

 

Huron Consulting (NASDAQ: HURN) is a consulting firm speicalizing in financial analysis for M&A transactions and liability analysis for legal disputes. The firm also provides clients with operational consulting services aimed at helping them to reduce costs. Huron works with a broad range of clients including Fortune 500 companies and 50 of the largest US law firms.^[1] Huron had 1209 consultants at the end of 2007. ^[2]

Huron experienced immediate and dramatic growth as a result of the existing client relationships imported by both the original Arthur Andersen group that started the company in 2002 and by new consultants hired from other accounting firms. From 2002 to 2007, Huron's consultant headcount rose from 213 to 1,209, and revenues grew at a compounded annual growth rate of 55.9%. ^[3] Huron has supplemented this organic growth through the acquisitions of complimentary businesses, the most notable being a July 2007 $60.0 million cash purchase of Callaway Partners, an Atlanta-based financial and accounting services firm.

In 2007, Huron had a gross margin of 31.6% and an operating margin of 16.6% in 2007, both of which were the second highest in the industry, trailing FTI Consulting (FCN). ^[4] Huron uses a partnership model for its business structure which means that the firm's overall performance is weighted more heavily than individual consultant performance when determining compensation. Huron's consultants are paid less but the firm as a whole does better. However, aggressive recruiting by Huron's competitors has spurred top consultants to leave for better compensation opportunities.

Business Financials

Huron provides services through two segments: Financial Consulting and Operational Consulting. Huron's clients include corporations, law firms, academic institutions, health care organizations, and government entities.

Financial Consulting (30.9% of revenues, 35% of Operating Income)

Consultants in this practice provide economic and financial analysis and expert testimony regarding issues that arise from litigation, business disputes, and governmental regulations. Consultants also perform valuations on assets and transactions, and serve as interim management for distressed hospital systems. As of December 31, 2007, this practice employed 367 consultants and represented 30.9%% of Huron's total revenues. ^[5]

Operational Consulting (69.1% of revenues, 65% of Operating Income)

Consultants in this practice aim to help clients improve the overall efficiency and effectiveness of operations by enhancing revenue, reducing costs, and managing regulatory compliance. Huron seeks to understand each client's unique situation and thus give tailored advisory services to generate sustainable results. As of December 31, 2007, this practice employed 842 consultants and represented 69.1% of Huron's total revenues. ^[6] This segment can be further broken up into the following: Legal Consulting (17.8% of total revenue, 173 consultants), Health and Education Consulting (36%, 439 consultants), and Corporate Consulting (15.3%, 230 consultants).^[7]

Huron's strong revenue growth is attributable to the depth and breadth of its client relationships, the non-discretionary nature of its advisory services, and the firm's ability to maintain steady billing rates while rapidly growing its consultant headcount.

The following graph demonstrates Huron's revenue and operating income growth from 2003 - 2007:

^[8]

The utilization rate of consultants is a fundamental operating metric that gives insight into a firm's ability to generate consistent demand. A demonstrable trend in either direction may foreshadow under or over performance by the firm. In Huron's case, the growth in consultant utilization is evidence to the strength of Huron's relationships with clients and the advantages of a predominantly organic growth strategy. Acquisitions require a significant investment to integrate new consultants, and this inevitably reduces the amount of time current consultants can spend working on cases.

The following graph demonstrates Huron consultant utilization rate over the past six years:

^[9]

Key Trends and Forces

Record M&A Activity

Huron consultants are often called upon to advise firms involved in mergers in acquisitions because of Huron's strong corporate valuation practice. According to Mergers & Acquisitions, The Dealmaker’s Journal, the aggregate dollar value of completed M&A transactions increased approximately 38% from $997 billion in 2005 to $1,371 billion in 2006, the highest level since 2000. ^[10] A downturn in M&A activity would significantly and negatively impact Huron's performance.

Operational Challenges in the Health Care Industry

Huron is a leading provider of consulting services within the Health Care industry. Huron has provided services to 50% of the nation's largest Health Care systems, and strengthened this practice with the acquisition of Aegis Advisors, a strategic consulting firm focused specifically on advising healthcare providers. The constant changes in rules and regulations surrounding Health Care administration, including rising insurance premiums and the increasing number of uninsured citizens, has driven demand for Huron's services, and continued challenges in this industry will positively affect Huron's results.

Rise in Volume and Monetary Stakes of Litigation

The heightened focus on corporate mismanagement, fraud-related investigations (following the Enron and WorldCom scandals), and ongoing SEC regulatory activity drive demand for external advisory services. The volume of this activity, along with litigation arising from business disputes, does not necessarily correlate with the economic cycle. Specifically, Huron's legal consultants have seen consistent demand as these conditions require firms to focus on better managing risks in the litigation process.

Regulatory Reform

As a result of increased regulatory complexity, firms engage consulting firms to provide objective and independent expertise. According to Glass Lewis & Co., an institutional investor advisory firm, the number of financial restatements by U.S. public companies reached 1,195 in 2005, an increase of 95% from 2004.^[11] In addition, an increasing number of boards of directors have been forced to examine historical financial records or address allegations of fraud by conducting internal forensic investigations. This has driven demand for Huron's market leading financial consulting practice, as its highly respected consultants are called on to support firm's internal investigations.

Globalization

The increasing globalization of the economy drives business consolidations and compliance requirements. Multinational firms are seeking to establish global footprints and expect consulting firms to assist them along the way. Globalization stands to generate increased demand for external advisory services, although Huron currently has no material international presence. Huron faces significant challenges in building an international platform, but it nonetheless represents a significant growth opportunity for the firm.

Competition

Market Overview

External consulting services brought in approximately $125 billion globally in 2006, and over the last several years spending on these services in the U.S. has grown at an annualized rate of nearly 7%, significantly outpacing GDP growth. ^[12] The consulting industry is loosely divided into four categories that feature highly fragmented competitive landscapes:

• Human Resources Consulting: Mercer International, Hewitt Associates, Towers Perrin, Deloitte Consulting.
• Information Technology (IT) Consulting: Accenture, BearingPoint, IBM Global Business Services.
• Outsourcing / Staffing Consulting: Robert Half International, Manpower, Korn/Ferry International.
• Operational and Financial Consulting: McKinsey, Boston Consulting Group, Bain, Booze Allen Hamilton, Watson Wyatt, Huron Consulting Group, FTI Consulting, CRA International, LECG, Navigant Consulting, Exponent, Corporate Executive Board Company.

Huron's closest peers are the independent consulting firms that provide similar financial and operational consulting services to many of the same clients. As the "Big 4" accounting firms continue to bleed market share in the financial and operating consulting market, a tremendous opportunity exists to become the dominant provider of these advisory services. This market has several unique characteristics:

1. Demand is typically non-discretionary and insensitive to economic cycles, but is highly volatile quarter to quarter, as the work is largely case or project-based.
2. Price is typically not relevant in a firm's decision in choosing a consulting firm, as these fees are rounding errors in high stakes litigation cases or restructuring efforts. Moreover, seeking the cheap option in forensic investigation of financial records can be seen as a failure of due diligence for boards of directors. Thus, clients choose consulting firms based on organizational or individual consultants' reputations.
3. Consulting requires little capital investment or working capital requirements, thus resulting in low levels of debt and strong free cash flows , which provide important performance and valuation metrics.

Relevant Peer Group

• FTI Consulting is a global consulting firm that addresses financial, legal, and operational issues for a diverse range of clients. As of December 31, 2007, it employed 1954 consultants and generated annual revenue of $1.001 Billion. ^[13]

• CRA International is an economic, financial and management consulting services firm. As of December 31, 2007, it employed 771 consultants and generated annual revenue of $394.6 Million.^[14]

• Navigant Consulting is a provider of regulatory, financial and operational advisory services. As of December 31, 2007, it employed 1,944 consultants and generated annual revenue of $681.2 Million.^[15]

• LECG is a provider of expert services that include economic and financial analysis, testimony, litigation support and strategic management consulting. As of December 31, 2007, it employed 308 consultants and generated annual revenue of $370.4 Million.^[16]

Competing Organizational Structures

Demand for financial and operational consulting services is non-cyclical and has shown no signs of slowing down. Thus, the key determinant of these firms' future success is their ability to contain costs, especially costs related to consultant hiring, compensation, and retention. These firms operate under two distinct organizational structures that determine how consultants are paid:

• The Star Model (LECG, CRA International,Inc. ): In this model, consultants receive a majority of their hourly billing fees as direct compensation. This, combined with a decentralized structure and minimal hierarchy, gives consultants significant independence and autonomy. This model creates an attractive environment for top talent, and allows the firm to provide unique services that are difficult to imitate. However, compensation is based on individual work, not firm profitability, and thus there is no collective effort to build organizational brand equity or realize economies of scope.

• The Partnership Model (FTI Consulting, Huron Consulting Group , Navigant Consulting): In this model, consultant revenues are pooled and distributed based on partner status. This, combined with a bureaucratic hierarchy designed to maximize operational efficiency, forces consultants to work to improve overall firm performance. Revenue becomes less case-driven, as demand is not tied to individual consultants but to firm reputation. However, this organizational standardization can lead to a commoditization of services, and the extra layers of management can dissuade top talent from joining the firm.

Relative Performance

The following graphs compare the relative revenue growth, operating margins, free cash flow levels, and consultant utilization rates of these competitors:

^[17]

^[18]

^[19]

^[20]

References

1. ↑ HURN 2007 10-K, pg.5
2. ↑ HURN 2007 10-K, pg.31
3. ↑ HURN 2007 Annual Report, Selected Financial Data, Page 21
4. ↑ HURN 2007 Annual Report, Selected Financial Data, Page 21
5. ↑ HURN 2007 10-K, pg.31
6. ↑ HURN 2007 10-K, pg.31
7. ↑ HURN 2007 10-K, pg.31
8. ↑ HURN 2007 10-K, pg.31
9. ↑ HURN 2007 10-K, pg.31
10. ↑ HURN 2007 Annual Report, Business, Page 11
11. ↑ HURN 2007 Annual Report, Business, Pages 9 - 10. [1]
12. ↑ Royston Greenwood, Roy Suddaby; Professional Service Firms. [2]
13. ↑ FTI 2007 10-K, pg.39
14. ↑ CRAI 2007 10-K, pg.24
15. ↑ NCI 2007 10-K, pg.17
16. ↑ XPRT 2007 10-K, pg.39
17. ↑ FTI Consulting 2007 Annual Report, Financial Statements and Supplementary Data, Page 65 [3]; Huron Consulting Group 2007 Annual Report, Selected Financial Data, Page 20 [4]; CRA International 2007 Annual Report, Selected Financial Data, Page 22 [5]; Navigant Consulting 2007 Annual Report, Selected Financial Data, Page 16 [6]; LECG 2007 Annual Report, Selected Financial Data, Page 25 .[7]
18. ↑ FTI Consulting 2007 Annual Report, Financial Statements and Supplementary Data, Page 65 [8]; Huron Consulting Group 2007 Annual Report, Selected Financial Data, Page 20 [9]; CRA International 2007 Annual Report, Selected Financial Data, Page 22 [10]; Navigant Consulting 2007 Annual Report, Selected Financial Data, Page 16 [11]; LECG 2007 Annual Report, Selected Financial Data, Page 25 .[12]
19. ↑ FTI Consulting 2007 Annual Report, Financial Statements and Supplementary Data, Page 65 [13]; Huron Consulting Group 2007 Annual Report, Selected Financial Data, Page 20 [14]; CRA International 2007 Annual Report, Selected Financial Data, Page 22 [15]; Navigant Consulting 2007 Annual Report, Selected Financial Data, Page 16 [16]; LECG 2007 Annual Report, Selected Financial Data, Page 25 .[17]
20. ↑ FTI Consulting 2007 Annual Report, Financial Statements and Supplementary Data, Page 65 [18]; Huron Consulting Group 2007 Annual Report, Selected Financial Data, Page 20 [19]; CRA International 2007 Annual Report, Selected Financial Data, Page 22 [20]; Navigant Consulting 2007 Annual Report, Selected Financial Data, Page 16 [21]; LECG 2007 Annual Report, Selected Financial Data, Page 25 .[22]