PSB Monthly Issue July 2010

Without further ado, here’s our single best penny stock idea right now…

Last year was horrible for the Outsourcing Industry.  It was the worst year since 2001, which is saying a lot.  You may recall 2001 was the year of the 9/11 terrorist attacks and the dot-com crash.

How bad was it?

Try this on for size.  2009 was just the second time in nine years the Outsourcing Industry shrunk.

The industry is measured by the total value of all outsourcing contracts. In 2009, the outsourcing market’s total contract value (TCV) dropped 13% to $74.5 billion.

It makes sense really.  Facing a potentially long and deep recession, companies raced to cut costs.  One of the first places CEOs began tightening the belt was outsourcing.

However, the industry downturn didn’t last as long as everyone feared.

Outsourcing began recovering in the second half of 2009.  The industry stabilized during the third quarter.  And by the fourth quarter, the industry was starting to grow again.

The fourth quarter figures were very encouraging.  TCV surged 47% from third quarter levels and increased 8% year over year to $24.7 billion.  It was the best quarterly performance since the second quarter of 2008.

What spurred the recovery?

Strong demand for information technology outsourcing led the way.  A surge in demand for outsourcing services in Europe, the Middle East, and Africa added momentum.  And a number of mega-deals that began in the third quarter came to fruition in the fourth.

While the recovery was not strong enough to overcome the extremely weak first half, the industry had clearly turned the corner.

Outsourcing sales pipelines are much stronger now compared to early 2009 levels.  The rate of new contract signings, which had slowed in 2009, has stabilized.  And the level of contracts coming up for renewal is up a hefty 29%.

So what’s the point of all this?

It looks like the worst is over for outsourcing.

We should see a return to growth in 2010.  By the end of the year, TCV should exceed last year’s levels.  And I’m not the only one who thinks so.  Industry experts are expecting a steady flow of new outsourcing contracts throughout the year.

In fact, we’re already seeing signs of renewed growth.

Check out these figures from the first quarter.  TCV jumped 25% year over year to $19.5 billion.  A slew of contract renewals, renegotiations, and expansions drove the increase.

This bodes well for the rest of the year.

Despite the emerging recovery, the leader in outsourcing advisory services is trading at bargain basement levels.

Yes, the industry leader is a penny stock.

Allow me to introduce Information Services Group (NASDAQ: III).  I’ll be referring to them as ISG from here on out.

I believe ISG could double in value over the next year.  And there’s substantial upside to my forecast if the global economic recovery accelerates.

Let’s take a look under the hood.

THE OUTSOURCING ADVISORY BUSINESS

ISG provides global outsourcing advisory services to companies around the world.  The company’s subsidiary— TPI — is the founder of the outsourcing advisory industry. They’re the oldest and largest out-sourcing data and advisory firm in the world.

ISG has been providing advisory services forinformation technology outsourcing (ITO) and business process outsourcing (BPO) for over 20 years.

ITO is where a client contracts a service provider to manage the client’s information technology infrastructure.  Service providers typically manage the client’s servers, networks, personal computers, applications, and data centers.  These contracts often last several years.

BPO involves the transfer of a client’s business function to an external service provider.  These functions are usually high-volume, automated activities like payroll processing, benefits administration, or customer service.  If you ever called your computer manufacturer for tech support, you probably experienced BPO first hand.

Why do companies outsource?

The simplest reason is the cost savings.  And ISG is very good at saving their clients money.  In the past 20 years, ISG has saved clients over $50 billion.

To put it more plainly, client’s saved an astonishing $70 for every $1 spent on ISG’s advisory services.  Clearly, ISG provides tremendous value to their clients.

What does ISG do specifically?

First, ISG assesses the client’s existing business practices.  Then ISG determines potential cost savings and designs the most appropriate operating organization.  Next they select service providers, negotiate outsourcing contracts, and manage the outsourcing program.

ISG also provides support whenever a client shifts operations to new outsourcing service providers.  And ISG monitors and manages each outsourcing relationship.

As you can see, the company is a full-service outsourcing advisor.

But here’s what sets ISG apart from the competition…

The company has the most extensive databases of outsourcing related market intelligence.  They obtained this priceless data through twenty years of market research and client engagements.  No other firm in the industry has a data treasure trove like this.

ISG’s data is the key to providing superior outsourcing advisory services.  The data underpin operational assessments, strategy development, deal structuring, and negotiations.

This is a huge advantage for ISG’s clients.

No wonder the International Association of Outsourcing Professionals recently named ISG the number one outsourcing advisory firm in the world.  Clearly no firm in the industry has better experience, scale, or data than ISG.

Let’s now take a peek at ISG’s financial performance.

THE NUMBERS

ISG bottomed out in the third quarter of 2009.  Since then, revenue, net income, and earnings per share have been moving steadily higher.  It certainly looks like the beginning of a recovery to me.

Now the industry is starting to recover as well.  This should help ISG’s financials to improve even more going forward.

The company’s certainly doing all the right things to promote growth.  Strategic investments are broadening the company’s geographic footprint.  And they’ve expanded into new markets.

Thanks to these efforts, the earnings outlook for this year and next is very good.

Analysts are expecting earnings to surge 63% to $0.28 per share in 2010.  And they’re forecasting earnings growth of 29% to $0.36 per share in 2011.  These are very high projected growth rates compared to the industry average of 15%.

If ISG can stay on track to meet or beat these estimates, the shares should surge higher.

In addition to a strong growth outlook, ISG has a great balance sheet.

Short-term liquidity is no problem at all.  The business is throwing off about $11 million in cash per year.  And as a result, the company’s sitting on a cash hoard of $37.8 million or $1.18 per share.

Thanks to this robust cash flow, the company has a hefty current ratio of 7.1x.

ISG is carrying long-term debt of $69.8 million, but it’s nothing to worry about. They’ve reduced debt by 16% over the past year.  And their debt to equity ratio is just 0.53.

INVESTMENT RISKS

Of course, an investment in ISG does involve some risks.

ISG’s growth depends on the economic recovery continuing.  Any disruption could hurt the company’s business.

Europe being ISG’s second largest market is another risk.  The European debt crisis and a potential double dip recession could slow ISG’s growth rate.

A third risk is the company’s reliance on a few large customers.  The loss of one or more of these customers could harm ISG’s ability to grow.

DOUBLE YOUR MONEY WITH ISG

ISG is perfectly positioned to skyrocket from here.

The company is the clear market leader in the outsourcing advisory services industry. They have the most extensive market intelligence, scale, and experience.  And they have a long history of providing excellent service while cutting their clients’ expenses dramatically.

The company has weathered the worst of the recession and come out stronger. They’ve reduced long-term debt, cut operating costs, broadened their geographic footprint, and expanded into new markets.  As a result, revenues and earnings are rising once again.

Despite all these positives, the shares are badly misvalued by the market.

At a recent price of $1.98, the shares are trading at just 7.1x the 2010 estimate. That’s very low for a company expected to grow earnings 14% annually over the next five years.  In fact, ISG’s PEG ratio is a measly 0.52.

In other words, ISG is trading at a 48% discount to their projected growth rate.

The shares are also mispriced on a price to book (P/B) basis.  Right now ISG is sporting a book value of $4.15 per share.  That yields a P/B ratio of 0.48… well below the industry average of 1.5.

And last but not least, the shares are misvalued on a price to sales (P/S) basis.  The company’s P/S ratio of 0.48 is way under the industry average of 0.80.

Clearly, the shares are misvalued any way you slice them.

Based on my analysis, I expect the shares to trade up to at least $4.10 per share.  Buy ISG now for potential gains of 107% or more.

ACTION RECOMMENDATION

BUY Information Services Group (NASDAQ: III) up to $2.28 per share.

• Move Taseko Mines (AMEX: TGB) from Hold to Buy (up to $4.25)

Category: PSB Monthly Issues