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CACI: Wiping Off Abu Ghraib's Taint

By Amy Tsao When the nightmarish images of Iraqi prisoner abuse at Abu Ghraib began to emerge in May, few investors in Arlington (Va.)-based CACI International (CAI) would have guessed the information-technology services contractor had any kind of involvement. Why would it? After all, CACI's expertise is in organizing and managing data and IT systems for the government.

It turned out CACI had 10 employees working at the prison, performing interrogations. At least one of them was named in a military report as a direct culprit of the abuse. And while interrogations account for less than 1% of total revenues, the press reports have cost CACI dearly in stock value and public relations damage, figures Chris Penny, analyst at Friedman, Billings, Ramsey. "[Its] interrogation [business] definitely took investors by surprise," says Penny. (He doesn't own CACI shares, and the firm has no banking relationships with the outfit.)

NEW ARMY CONTRACT. CACI shares have been trading at $40, off their 52-week high of $53 and not far from the year's low of $36. The company's fundamentals have remained intact, so no one on the Street, even with the prisoner-abuse scandal, has yet to turn very negative. And over time, if CACI can shake off the Abu Ghraib connections, the stock might stage a comeback.

After the market close on Aug. 18, CACI reported earnings per share of 69 cents per share, handily beating analysts' consensus per-share expectation of 58 cents for the fiscal fourth quarter ended in June. "We should continue to see outperformance from the company," says John Mahoney, analyst at Raymond James. "It's a bellwether among federal IT services companies." (He doesn't own CACI stock. His firm has received fees for banking services.)

Even as the stock remains in the doldrums, signs are emerging that the clouds surrounding any CACI connection to the prison abuse in Iraq have begun to lift. In late July, a U.S. Army Inspector General report cleared CACI's interrogators of virtually all wrongdoing. And on Aug. 4, the army awarded CACI with an extension of its contract for interrogation services worth up to $23 million over six months.

On Aug. 12, CACI said its own ongoing internal investigation of its workers in Iraq has so far turned up no "credible or tangible evidence" of employees' involvement in misconduct at the prison or elsewhere in Iraq.

RECENT ACQUISITION. Management is expected to provide a positive outlook in its analyst call on Aug. 19 to discuss earnings, if recent upbeat comments from CACI's competitors in government tech support -- Anteon (ANT), Mantech (MANT), and SRA International (SRX) -- are any indication.

CACI execs are also expected to talk up the recent acquisition of defense intelligence outfit AMS. "This is a very profitable area in information management," says Mahoney. In the next fiscal year, such services will bring in roughly 17% of CACI's total revenues. In the year ending June 30, 2004, revenues are expected to be $1.1 billion and rise to $1.5 billion in fiscal 2005.

The outfit has been securing IT business from the Navy, Air Force, and Homeland Security Dept., and it recently won a large contract from the Social Security Administration. "CACI should have 20% to 25%-plus earnings growth for the next few quarters," says Joseph Vafi, analyst at Jefferies. (He doesn't own shares, and the firm has no banking relationship with CACI.)

WELL CONNECTED. While the overall defense budget is expected to flatten in coming years, CACI shouldn't be hurt badly. That's because "the military's priorities are becoming more technology-oriented...information matters more than big bombs and bullets," Vafi says. CACI should benefit from shifting resources toward various IT needs. He has a buy rating on the stock and sees a target price of $54.

Over the long term, the trend toward outsourcing of the government's IT needs shows no signs of letting up. "That's a long and well-established trend that will continue," says Mark Jordan, analyst at A.G. Edwards. He expects the Defense Dept. to spend heavily on communications and IT in the coming years. "That will probably grow at a mid-single-digit rate long term, which is pretty reasonable," Jordan says. (He doesn't own the stock, and the firm has no other disclosures to report.)

Still, the stock's decline over the last six months wasn't entirely a result of the prisoner-abuse disclosures, says Friedman Billings' Penny. He notes that the entire sector's valuations were sky-high for months. He downgraded CACI to market-perform in January and has a price target of $42. "Outside of the Defense Dept., it will be harder to catch a dollar now," says Penny.

Still, CACI has a proven track record and deep government connections. That probably bodes well for the long term. Tsao is a reporter for BusinessWeek Online in New York

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