GTSI Corp has been discussed a few times on this site, most recently as a company trading at a discount to its net cash balance! An activist looking to realize this value for shareholders recently contacted me, and agreed to do an interview and share for publication a letter he sent to GTSI's CEO Sterling Philips.
Alan Silberman is a former investment banker at UBS who subsequently worked for activist fund Outpoint Capital. Here's what he had to say on the topic of GTSI:
Saj: Who do you represent?
I have immediate control over 20,000 shares, which represent my holdings and those of my brother. Broadly, I believe I represent the views of all major value-oriented investors who believe that GTSI management and Board of Directors have acted irresponsibly in their fiduciary duty.
Saj: Representing just 0.2% of shares, what kind of sway do you think your group would have in steering management?
Realistically, my 0.2% should not have any sway with management. But I think they realize a few things that work in my favor. (1) That they have messed up and have a target on their back (2) That my views are shared by the value-oriented investors in the Company who collectively own approximately 31%.
Saj: What do you think Eyak is worth, since in your letter (published below) you state GTSI received a fraction of its worth?
GTSI received $20mm for its 37% stake in Eyak, which implies that they sold out at 1x 2010 earnings excluding the $28mm in net cash on Eyak’s balance sheet. That doesn’t seem like a fair price to me.
Surely, those cash flows will not be sustainable now that Eyak has graduated from its 8a status, but if you assume a gradual decline in Eyak’s business to a point in the future where it’s earning an average return on capital, the value of GTSI’s share should be worth from $35-50mm.
Of course, it’s difficult to sell a minority stake in a Company to a controlling shareholder because the majority holder has control of all cash flows. However, in this instance GTSI had a major bargaining chip in that it had a blocking position in Eyak’s operating agreement. GTSI could threaten to dissolve Eyak with its 37% ownership, and that should have allowed GTSI to extract more value out of its stake.
Saj: What has been management's response to this or previous correspondence? Do they appear to listen or do you get the brush off?
Management is very willing to talk to shareholders like me, but at the end of the day they only act on and are motivated by their own self-interest. One need only look as far as the stock price to see that the market has no faith in this management’s attitude towards shareholders - it trades at below net-cash. A look at the proxy statement explains the misalignment of interests between management and shareholders. Management compensation is tied largely to a doctored measure of earnings, not cash flow, so their motivation is to plow all money into acquisitions to increase earnings before tax without regard to whether the expansion destroys or creates value for shareholders. There is little incentive for them to buy back stock or issue a dividend because they can line their pockets by overpaying for businesses.
There has actually been a protracted history at this Company of feckless attempts by shareholders to change management’s attitude towards capital allocation. Over the years, there have been a string of value investors who have bought the stock because they thought it was cheap. A majority of them shared their views with management, and a minority have attempted activism by sending a letter or expressing views on conference calls. No one has gone to the lengths of waging a proxy fight because it costs a lot of time and money and the potential gain is relatively minute. So, investors sell the stock and management continues to benefit at the cost of the remaining shareholders.
Saj: Have you tried to contact other shareholders? (e.g. major shareholders include Chip Lacy Jr., T Rowe Price etc)
What I hope makes this time different than other activist attempts on this Company is that I have taken some time to try to build consensus among like-minded investors. The largest shareholder in this Company is Preston Athey who runs the small cap value fund at T Rowe Price. I have been talking to him about GTSI since I was a first year at Columbia Business School and he has sort of become my mentor in this situation. I have also been in touch with David Cohen at Athena Capital and Wil Harkey at Nantahala Capital. Together these guys own over 20% of the stock.
Saj: How do you feel about the $5 million repurchase authorization that was just announced?
This is a step in the right direction, but it doesn’t go far enough. All proceeds from the Eyak sale, $20mm, should be immediately returned to shareholders. This is a very competitive industry, with no barriers to entry. Any proceeds used for acquisitions will destroy value.
To understand how value is being destroyed one can look at what management has done over the past 2 weeks. Sterling Phillips negotiated the sale of GTSI’s stake in Eyak at 1x cash flow and immediately announced the purchase of InSysCo at 7x EBITDA. Eyak is an Alaskan native organization with a legislative advantage in bidding for government contracts, and as a result exhibited ROIC of 100%. InSysco has none of these advantages and therefore posts average ROIC. GTSI sold its interest in a good company at too low a price in order to overpay for a bad business.
Management has exhibited a long history of destroying value and cannot be expected to do the right thing going forward.
End of interview
The following letter was sent by Alan Silberman to GTSI CEO Sterling Philips on August 31st:
August 31, 2011
Chief Executive Officer
2553 Dulles View Drive, Suite 100
Herndon, VA 20171
Dear Mr. Phillips,
My name is Alan Silberman and I am the advisor to entities that have acquired 20,000 shares of GTSI (the “Company”) common stock representing an interest of approximately .2%, which places us among the 25 largest reported investors in the Company. We made these purchases after completing an exhaustive due diligence process of the Company's products, pipeline and management effectiveness (the "Investigation"). Based on our Investigation, we have concluded that GTSI shares, currently around $4.30/share, trade at approximately half the value of our worst-case estimate of $8/share. In fact, we believe that GTSI is worth $8 alone based on its liquidation value, which means that the Company is theoretically worth more dead than alive. We believe this discrepancy is largely due to the overwhelmingly low regard held by the investment community for the management and Board of the Company, further evidenced by the Company’s most recent election of directors where Lee Johnson and Thomas Hewitt received less than 50% of votes cast.
We believe that the Company is at an important crossroads given the recent announcement of the InSysCo acquisition and Eyak stake sale, for which we believe GTSI received a fraction of Eyak’s true worth. We are mindful that value can be both destroyed as well as created and we would like to ensure that GTSI’s future strategic actions give the proper weight to shareholder interests.
We fear that GTSI will continue to use its cash balance for value-destroying acquisitions or to get into an ancillary business without a stockholder vote with the purpose of perpetuating the employment of management and the Board. As such, we believe that all cash proceeds received by GTSI as the result of any asset sales should promptly be paid to shareholders. Management and the board have demonstrated, over many years, their inability to turn valuable corporate assets into anything but shareholder value destruction and operating losses. We have no reason to believe that this will change going forward. To the contrary, the $3.5mm operating loss in the second quarter of 2011 coupled with the announcement of an acquisition while GTSI shares trade at a fraction of liquidation value, and accompanying management commentary congratulating itself for its enhanced focus on shareholder value creation, strikes us as both cautionary and delusional. As such, all proceeds from corporate dispositions should be distributed immediately to shareholders rather than left in the company for management to dissipate.
The good news is that, notwithstanding chronic mismanagement, we believe that GTSI today still has significant assets. GTSI is worth a minimum of $8/share by the following analysis:
Sale of Eyak for $20mm or $2.00/share
Purchase of InSysCo for $15mm or $1.50/share*
The core business today employs net liquid assets of approximately $45mm or
(*) Assumes that the purchase doesn’t create or destroy value
(**) This could prove conservative since at a run-rate of 500mm in revenues and an industry average of 1-2% net margin could produce $5-10mm in earnings. Valued at 9x, a discount to public peers, it could be worth $45-90mm or 4.50-9.00/share.
As most of GTSI’s value is in cash and short term receivables, a properly managed return of capital could offer some redemption for GTSI by recovering substantial value for its shareholders.
The long-term strategic plan currently contemplated by management is fraught with far too much execution risk and uncertainty - especially given the track record of this company. Therefore, these valuable assets should be monetized in the near-term for the benefit of the company's owners - and in no case should proceeds from these transactions be reinvested in high-risk development programs, with which management has had no tangible success throughout its tenure overseeing this company.
In closing, we would like to remind the Board of Directors of their fiduciary duty to shareholders, not management. Accordingly, should the Board fail to act or to communicate directly with us, we will take steps to replace the members as soon as practicable through the democratic process.
Thank you in advance for your careful consideration of this matter.
Disclosure: Author has a long position in shares of GTSI