Tuesday, May 24, 2011

GTSI At Large Discount

GTSI Corp (GTSI) is a troubled company that is losing money and that operates in an industry with a weak outlook. These three items are a recipe for a beat-up stock price. But troubles don't last forever and costs can be reduced, so for value investors with a long-term perspective, GTSI may be a stock with strong upside potential combined with limited downside risk.

GTSI is an IT product re-seller that trades for $45 million despite net current assets of $67 million. But the balance sheet attractiveness doesn't end there, as the company has long-term receivables of $5.5 million and an equity investment in a company called Eyaktek carried at almost $12 million. This carrying value is likely an underestimate of this investment's fair value, as equity income from this investment in 2010 and 2011 Q1 was almost $8 million and over $1 million, respectively. Furthermore, following a dispute with Eyaktek's majority owner, it is quite possible that GTSI will sell its stake in this investment, which could turn this long-term asset into cash.

Of course, there's a reason this stock trades at such a large discount to its assets, so it's worth understanding whether the risks to this company are temporary or long-term in nature. First off, GTSI relies on various US government departments (mostly federal) for virtually all of its revenue. Considering that the US federal government deficit is huge and unsustainable, it is quite likely that revenues will take a hit in the coming years. So the question is whether GTSI can reduce its costs, if necessary, such that it can still be relatively profitable should business turn south.

To a large extent, GTSI operates on contract, which gives it some visibility into future revenues. This should help management align costs and revenues appropriately. Furthermore, most of the company's costs are in the form of re-sold hardware (from vendors such as Cisco, Dell and Microsoft etc.); clearly, these are variable costs. Finally, the company does not have any onerous recurring obligations. The new management team has also shown a willingness to cut costs when revenues aren't up to snuff, as evidenced by the more than 10% reduction in staff that occurred last month.

Having said that, that doesn't mean the company's earnings can't be negative over the coming quarters. Costs almost always fall only after revenues have already fallen, resulting in periods of negative earnings while cost cuts have yet to take effect. Furthermore, the company's continued involvement in a government investigation into its practices could not only result in fines, but will reduce customer interest in GTSI and add to costs, as the company complies with a new agreement with the government. Continued litigation with the parent of Eyaktek could also be costly, but hopefully the new management team is able to strike a successful deal on that front this quarter, as was hinted to in the company's latest conference call.

While the earnings over the next little while might be poor, they shouldn't meaningfully reduce the company's asset margin of safety. This is not an earnings play; rather, shareholders are purchasing assets at a discount. These are assets that should become free (to distribute or employ productively) if revenue shrinks. As such, the downside appears to be protected while the upside potential (from a distribution of capital, company sale or productive deployment of assets) is high at the current price.

Disclosure: Author has a long position in shares of GTSI


Floris said...

Fully agree Barel. I suspect a sale of the subsidiary will be the main catalyst for the shares this year and this should be at a pretty signficant gain vs. the current book value of the stake.

Anonymous said...

EyakTek wants to acquire GTSI. Looks like they see value too. Has this factored into your valuation?

GTSI just won a contract with the FAA so I guess they are complying with any new rules.


ps-I live close to Herndon, VA so I might just go check them out.

Saj Karsan said...

Hi Anon,

Eyak did want to acquire GTSI, yes, but I believe that might have been part of the posturing between these two companies as they disagreed over their respective investments in Eyaktek.