Tuesday, January 8, 2013

Unisys: All the Makings of Value

Global IT company Unisys has all the makings of a value stock. Its net cash position of $330 million provides safety in the event of a downturn and offers strong downside protection on the company's $760 million market cap. In recent years, the company has managed annual income of $200 million; it will not earn as much this year thanks to cutbacks in government spending, but the company remains solidly profitable.

Since a good portion of this company's revenues come from deficit-laden governments (e.g. 17% of Unisys' 2011 revenue came from various agencies of the US federal government), one might expect this company to be revenue-challenged going forward. But it appears as though the market has overreacted to the pessimistic side, as Unisys trades at a P/E of 6 despite a healthy net cash position.

But all is not what it appears to be. As per the company's notes to its financial statements, the company's pension fund is a whopping $1.5 billion in the hole! This means it will take many, many years of earnings to cover this shortfall, leaving shareholders little in the way of returns, but a whole lot in the way of risks.

Suddenly, the company's negative revenue outlook looms large, as fewer dollars will be available to cover what will amount to large pension expenses. In the next three years, the company will have to inject an estimated $35 million, $100 million and $170 million respectively, into its pension fund to meet its funding targets. If the company's pension assets fail to meet their expected returns of 7%+ (which is a high probability considering current interest rates), expect these funding requirements to be revised upward.

This serves as a perfect example of why investors cannot rely solely on screens to make investment decisions. A shrinking company with legacy pension assets makes for a situation where a considerable amount of the company's profits must be diverted from shareholders. As such, Unisys looks like a great company to have retired from, but not a great company one should look to own considering these liabilities.

Disclosure: No position

1 comment:

Srini Raja said...

I used to hold unisys and got a 3x return during the 2009 financial crisis. They are one of the early database technology developers and they hold lot of patents including very basic database stuff.

They are a good take over target for HP/Dell or IBM, but I think their pension liabilities are preventing others to acquire them. But one good company to keep in the radar especially if their market cap goes below 500m.