GTSI Corp. (GTSI) is primarily a Value Add Reseller of information technology (IT) products and solutions to departments and agencies of the U.S. federal government, as well as to state and local governments and prime contractors. The company resells products from technology companies such as Cisco (CSCO), Microsoft (MSFT), Oracle (ORCL), Hewlett Packard (HPQ), and Dell (DELL).
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Source: Company filings and my estimates
Because of the recent lumpy earnings history, I believe that the classic Graham & Dodd NCAV valuation method is the most appropriate model to use. I valued deferred costs, other current assets, and other assets at zero because I don’t think they would have any value in an event of liquidation. I didn’t include any value for depreciable assets because it is harder to value them, but they should have some value. Accounts receivable are going to be worth near what they are on the books for, because most of them are amounts collectible from the U.S. federal, state and local governments and prime contractors that are working directly on government contracts. In the company’s 10-K, GTSI noted that credit losses have been insignificant.
The investment in EyakTek provides the upside to this valuation. GTSI owns 37% of EyakTek and records the value of the company on its balance sheet using the equity method. The net income for EyakTek for the past three years was $21.4 million, $21.7 million, and $13.0 million, respectively.
(Note: The income isn’t taxed because EyakTek is a partnership and the income is taxed on owners’ tax returns. If EyakTek was a corporation, I assumed that it would be taxed at the standard 40% corporate tax rate. For the ongoing earnings, I decided to take the average earnings of the past five years because it is a relatively brand new firm and there is some uncertainty regarding earnings after it exited the Small Business Administration’s section 8A program. I decided to use an earnings multiple of 8 to be conservative.)
Source: Company’s filings and my estimates
As you can see, EyakTek has experienced significant earnings growth over the past six years and may provide significant upside to my estimate.
Below is a sensitivity analysis of what would happen to the value of GTSI’s shares depending on what earnings multiple one thinks is fair for EyakTek.
Source: Company filings and my estimates
There is also upside to this estimate from what one expects ongoing earnings to be.
The company has been an above average performer since the start of its operations. It also has generated a significant amount of cash. Free cash flow has been higher than net income the past three years. Part of the reason the company has been able to generate such growth is because it has a more even split between the service and product businesses compared to GTSI.
The company has benefitted from its status as an Alaskan Native organization until recently. This had allowed it to take part in the SBA’s Section 8A program. This program gives minority-owned firms preferential treatment on government business. However, last May, the company graduated from the SBA’s development program. It has yet to be seen what kind of impact this will have on results. So far, though, there has been no material impact on EyakTek, though net income did fall from 2009 to 2010. But that may also have been due to the change of mix of business, as the product business had revenue growth of 50% while the service business stumbled and revenues fell by more than 20%.
There currently is ongoing litigation between EyakTek and GTSI, as GTSI wants more of an influence on GTSI’s business due to its large stake in the company. Last fall, EyakTek offered to buy GTSI for $7.50 a share before withdrawing due to GTSI’s board rejecting the offer. I applaud it for rejecting the offer, because that would have been below what the company is worth. Although the proposed takeover may have been a defensive move, I think it’s obvious that there is value seen in GTSI.
The performance of the company has been weak. The company has been able to generate income from operations just twice in the past six years. Margin compression in the hardware business has been the key factor driving profitability lower. The recent Oracle buyout of Sun Microsystems made matters worse, as Sun has a big presence in the government. Oracle has a large sales force and that has limited the selling opportunities for GTSI.
The performance of EyakTek has helped GTSI’s bottom line significantly over the past six years, but obviously this is not enough. The company is focused on moving into the service business. The new CEO, Sterling Philips, has a mandate to do that. However, I think this has to be done very carefully not to destroy value.
On 10/1, the company received notice from the Small Business Administration that GTSI had been temporarily suspended from any future federal government contracting. On 10/19, GTSI entered into an administrative agreement with the SBA pursuant to which the SBA lifted the suspension it had imposed on GTSI. Although the suspension was lifted, GTSI agreed that it will not obtain or attempt to obtain any new federal government contracts, subcontracts or any business, which in any capacity -- whether directly or indirectly -- is intended to benefit small businesses. Following that, the CEO and general counsel both resigned.
The company has said that it was impacted from the 18 days of no business. GTSI has seen some residual effect but is aggressively going after the business it lost.
This company does not have a strong position and the margin compression will continue in the product business. However, the value here is too much to ignore. Any small improvement in the company’s operations, or management’s move to unlock value, should help propel shares higher. Although I estimate that the shares are worth $9.43 a share, there is additional upside that should come from the EyakTek investment.