The Short Case On Unisys: What Goldman Knew

On Tuesday, January 23 2007, Goldman Sachs downgraded Unisys from hold to sell. We all know that it is rare indeed for GS or any other of the big boys for that matter, to utter the word ‘sell’. What we found interesting is the timing. Unisys was due to announce earnings the following day, January 24, for Q4 2006. Did Goldman know something?

We waited for the figures and just in case they did know something, unsuccessfully attempted to open a small short position. After taking a look at the figures we figured out why Goldman is saying 'sell'. The market however is looking at the wonderful blissful suckers’ trap, pointing out that Unisys has gone from a loss to an all amazing .06 profit per share.

The bottom line is that Unisys is downsizing and in a big way. The only way to temporarily eek out a small paltry profit over the next few quarters is to continue cutting costs to a greater extent than the loss of revenue and profit margins. Don’t be fooled by the spin. The bottom line is as follows:

* Revenue is stagnant
* Operating loss increased from 2.8% in 2005 to 5.7% in 2006
* Gross profit declined from 20.2% to 17.5%

Perhaps less interesting, yet supporting the reasoning for the Goldman downgrade, is the Balance Sheet figure for “Stockholders' deficit” tripling from 32M to 96M in 2006. This is not a sign of a turnaround by any measure. You can spin a ‘downsize’ anyway you want, but eventually it catches up with you.

We were able to short on Thursday at $8.20.

Disclosure: Author is short UIS

Comments

[David Macaluso:]

Hyperanalysis does not become you. The market is ALWAYS right, and the market has buoyed this stock on a steady climb since July. Anyone who bought long in July, August, September and later is sitting on a substantial profit. Regardless of how you try to read between the lines or divine some deep meaning from a balance sheet, the market perceives that this company is making positive progress on their turnaround. The price of this stock will continue to go up until it stops going up. Your observations may be 100% accurate, but the market determines the price of a stock, the numbers do not.

2007 Jan 27 03:08 PM

[CrossProfit_:]

Thank you for your compliment.

You are absolutely correct in stating that this is not our usual format. At the time of publishing we could not confirm the Goldman position in UIS. Here is what is behind the scenes. GS can not issue a sell rating and continue to hold or accumulate shares – unless they’re looking for a big fat class action law suit.

As of 9/30/06, Goldman Sachs Asset Management held 7.7M shares or 2.3% of the float. In order to reduce their position substantially they had to first downgrade from hold to sell. Once issued, they are committed to selling a substantial part of their holdings within a reasonable amount of time. Normally this is no big deal. The way to go about it is to sell off 400K to 600K a day, taking a breather every 3rd day or so in order to sell off into strength. The problem that we noticed was the massive sell volume on Wednesday (6M) which meant that Goldman wasn’t alone. This also explains why we missed the boat on Wednesday as we waited to see ‘who’ and ‘how’ was selling.

Tudor Investment Corp. has been selling as well and the latest info we have is they hold approximately 4.9% of the float. When you put the two together, even if BlackRock and MMI pick up the slack, they will do so only on a 10+% pullback in order to average down their cost. As you can see, even if ‘the market’ (see last paragraph) wants this stock to go up, when two major shareholders start pulling out, you inevitably get a price correction. Tudor has not stated its intentions.

To put it another way, we usually do not get excited over a downgrade. It all depends who is downgrading, what their position is and note if it is a ‘hold’ or ‘sell’. We normally don’t bother to look into the ‘holds’. A ‘sell’ rating has to be carefully scrutinized. For instance, if UBS issued a sell, it wouldn’t mean much simply because they don’t own a significant amount of shares. Now if Brandes started unloading, that would be very noticeable as they hold nearly 15% of the float.

As per usual, the reason stated for the downgrade is just the salad dressing. Hardware sales are not the main part of UIS's business. The real reason is that the turnaround is not happening. In addition to reducing R&D by 30M, UIS also sold off Unisys Media for about 50M in Q4. In other words, UIS is selling off piecemeal in order to post a profit whereas the core business is still losing money. This wasn’t broken down in the last filing, but we do track UIS so we are familiar with the inner transactions throughout the quarter. There is more.

Even with all of the above and ten times the bad news, we would never short a stock that is so heavily held by major institutions. We are not suicidal. However when the institutions start pulling out – it’s time to get out or short.

The institutional holders are ‘the market’ for UIS, and as you correctly stated – “the market determines the price of a stock, the numbers do not”. The numbers apparently determine for ‘the market’ whether to accumulate, hold or sell.

Saul Sterman
CrossProfit

2007 Jan 27 04:36 PM

[David Macaluso:]

Microscopically analyzing UIS's balance sheet to inspect each numerical component is NOT the answer to forecasting which direction this stock's price is going. We already KNOW, the price is rising, and will continue to rise until the market perceives that the turnaround is not happening. There is not a linear formula to effect profitability. Downsizing is not bad. Selling an asset is not bad. Goldman is jumpy and tried to anticipate the general reaction to UIS's quarter, and they were wrong. The profit taking on Wednesday was consistent with a large number of shareholders waiting to see if the Jan. earnings number could create a bounce, and when it didn't they took profits that were available.
Unisys is a well connected, old firm with deep roots. If Goldman is uncomfortable holding UIS, so be it, lots of people would be. Until and unless there is a negative event of great proportion, the concensus is that Unisys is making positive progress. By definition, reestablishing profitability through the entire organization will skew balance sheet numbers. I don't doubt that there will be an eyebrow raising number or two on their balance sheet for a while to come. The market is speaking: UIS is intact and moving forward. This stock will top $10 before April earnings. There is no short play here.

2007 Jan 28 06:44 AM

[CrossProfit_:]

Thank you for your comment.

I would like to touch on a few points.

“Unisys is a well connected, old firm with deep roots.”

Agree. Most of the new long term contracts announced in the past quarter are with Government agencies both in the U.S. and Germany.

“…and will continue to rise until the market perceives that the turnaround is not happening.”

Disagree. According to some, including UIS, we are now in a wait and see mode. Q4 numbers show that the turnaround has not transpired until now. According to the conference call, UIS is saying to wait until Q2 2007 before passing judgment. The earliest time frame for tangible evidence that the anticipated improvement actually occurred is July, not April.

“…the consensus is that Unisys is making positive progress.”

Disagree. This was the consensus in October. We all want to believe that UIS is turning itself around this time. In late 2003, Merrill Lynch upgraded UIS stating “company has made 'visible progress' on turnaround plan, and believes largest hurdles are behind it”. Perhaps you forgot that we have all been to this ball game before. This time around, analysts, including ourselves, are taking a much closer look at the numbers. Telling us not to put too much emphasis on the numbers won’t work this time.

Originally we were supposed to start seeing the fruits of the cost-savings (downsizing) in Q4 2006. (Agree that ‘downsizing’ is not a dirty word). Miraculously, UIS posted a .06 EPS. It is this kind of accounting that has us all nervous. The profit is primarily from the sale of assets and not ongoing operations. If this is what UIS means by a turnaround this time, then they will lose all credibility for another few years. (It is not what they mean, just being sarcastic.)

“Downsizing is not bad” you say. Correct. However, when you spin a ‘downsize’ and think that analysts like Christine Pezino of J.P. Morgan haven’t figured out the other side of the equation is when questions begin to surface. To be more explicit, UIS shaved 4,900 jobs. In other words, there are fewer salaries to pay. There is no mention of the 500 workers that went with the sale of Unisys Media. I threw that into my previous comment so that those that are in the know would pick up on the (obvious) other side of the equation. Yes, 500 salaries are no longer payable, but so is the income that they generated. When the company comes out with statements insinuating that 4,900 people were on the books for years (doing nothing!) and therefore there will be a cost savings of 280M in 2007 (averaging $57,000 per person), you begin to wonder where all this is going. In jest, is USI going to outsource the outsourcing? On the one hand you have reduced the DEBIT side by reducing your salary expense. On the other hand you have to reduce the CREDIT side as well, otherwise known as lower revenues. Albeit, not all of the jobs cut generated revenue, as 30M was shaved from R&D in the last quarter.

“Selling an asset is not bad” you say. Correct. The problem is that you can only sell the same asset once. Julio Quinteros of Goldman Sachs is no fool. I guarantee you that Quinteros looked at the cash flow statement very closely. UIS Consolidated Statement of Cash Flow shows an increase in cash of $76.8M for 2006. To assess the quality of the cash flow, we took out reversible items, or what I like to term ‘BENT items’ (better execution next time). We are left with a $278M loss from operations that were covered by a $380M positive flow from the sale of shares in Nihon Unisys Ltd. (NUL) & other assets. Guessing that NUL is 350M (there is no breakdown & using original forecast) that leaves us with 30M from other assets which could possibly be classified differently.

NUL asset sale: 350M less Increase in cash: 76.8M = 273.2M.

In plain English this means that in reality, UIS had a negative cash flow from continuing operations of approximately $273.2M for 2006. Coincidently, 273.2M is almost the same as the 278M loss. (I know this is cutting a lot of corners!).

From the snapshot you might erroneously conclude that UIS had a positive cash flow for 2006. It is how the cash flow was generated that counts, not the balance in the bank. If I sell my house for $560,000 and now have 560 in the bank, I have increased my cash flow by 560. If I use 300 to pay my losses on Unisys stock (just kidding), I’m left with 260. So according to the UIS cash flow statement, I’m doing great because I have increased my cash flow by 260! Woops, I forgot, I’m out an asset called a house. (I know this is not a P&L statement, just assessing the quality of the cash flow.)

In conclusion and as a Monday morning teaser for Susan Chen (Merrill Lynch) who loves this stuff; has anyone noticed that the ‘Operating profit/loss percentage’ for 2006 doesn’t add up across? Hint, the 5.7% loss is correct.

Saul Sterman
CrossProfit

2007 Jan 28 02:40 PM

[CrossProfit_:]

Update on position in accordance with SA disclosure policy.

Short position was covered today 1/29/07 @ $8.5765 (4.6% stop loss). We will review UIS next week 2/05/07. Though this is the first stop loss to trigger in over a year (14.5 months to be exact), our golden rule is to wait a week before assessing.

For those that are unfamiliar with our investing philosophy, on short positions we use a 4.3-4.6 / 5.8-6.1 / 7.0-7.3 percent stop loss, depending on type of stock and time frame. On long positions we use 4.8-5.4 / 6.5-7.1 / 8.8-9.8.

Damn, we have to start over from scratch to break our old record…and we were so close – it hurts!

Saul Sterman
CrossProfit

2007 Jan 29 01:47 PM