GTSI Corp. (GTSI) is primarily a Value Add Reseller of IT 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), Panasonic (PC), Net App (NTAP), Dell (DELL), Citrix and Hitachi (HIT).
The performance of the company has been weak. The company has been able to generate income from operations just twice in the past six fiscal years and the stock reflects that. Margin compression in the hardware business has been the key factor driving profitability lower. The Oracle buyout of Sun Microsystems made matters worse as Sun had a big presence in the government. Oracle has a large sales force and that has limited the selling opportunities for GTSI.
The valuation here is pretty straight forward, right out of Graham and Dodd’s manual. 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 because nearly all 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 (see below for spreadsheet). 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 3 fiscal years was $21.4 million, $21.7 million, and $13.0 million. Note, the income isn’t taxed because EyakTek is a partnership and the income is taxed on owners’ tax returns. If EyakTek were a corporation, I assume 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 fiscal 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.
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 3 fiscal 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, in May 2010, 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 as EyakTek but 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.
In May, GTSI reported Q1 results that were weak but they did show some positive signs. Revenues fell over 30% year-over-year (y/y), the EPS loss, however, shrunk to $0.28 from $0.48 a year ago. More importantly, gross margin rose to 18.5% from 13.3% a year ago driven by improved margin on software sales and financing transactions. EyakTek’s performance also suffered as its revenues fell nearly 30% y/y and net income fell 25% to $3.0 million. On the bright side, the subsidiary also showed improvement in gross margin as that metric rose to 12.8% from 9.7% a year ago.
Athough the NCAV fell quarter/quarter, this is to be expected with a non-profitable company. On a positive note, the quality of its assets increased as the company now has much more cash on the books than before as you can see below - (click to enlarge).
There does not seem to be anything in the near future that will significantly improve the company’s performance 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. As of close Monday, the upside to a $9.33 target was nearly 75%.