1. Company Summary:
For 26 years, GTSI Corp. has been selling IT products to different levels of the U.S. government, with almost four dozen ongoing contracts currently. GTSI runs its own distribution center near Washington Dulles Airport, allowing for timely delivery of mission-critical applications. GTSI also offers lease options to allow government agencies to budget evenly distributed expenses. GTSI is now transitioning toward becoming an ongoing service provider (consulting, financing, support) rather than one-time product procurement and delivery.
2. Strengths and Weaknesses:
- The Government IT Procurement industry has high barriers to entry due to the weight given to past performance of contracts during the bidding process. GTSI has a 26 year history of strong performance for the government, as well as strong relationships at all levels of government and with key suppliers.
- GTSI owns 37% of Eyak Technology, LLC, which has shown substantial growth over the last three years (CAGR of Net Income of 46%, Sales of 21%). Eyak is capitalized similarly to GTSI, with strong NCAV, no long term debt. Eyak qualifies as a small business, affording it an advantage in government contract bids.
- GTSI has been actively returning cash to shareholders through its stock repurchase program. In 2009, GTSI returned $2.25m in this manner, repurchasing at average prices of $5.75 (Q1), $5.79 (Q2), $7.27 (Q3), and $6.43 (Q4), all above the current trading price of $5.50.
- GTSI’s revenues are concentrated in government procurement which may be cut substantially in the future should the different levels of government begin cutting expenditures in order to restore fiscal balance.
- GTSI’s transition from IT reseller to service provider is incomplete and creates some uncertainty as to the results of this transition on operations.
- GTSI relies on its reputation and relationships which are subject to erosion by scandal and difficult to rebuild. Such erosion could, in a severe case, lead to GTSI being barred from future bidding.
- In the March 5, 2010 analyst call, GTSI’s CEO indicated that the company plans to engage in M&A in 2010. This presents an operations and finance risk if poorly executed.
a) Intrinsic Value as Reproduction Cost of Assets
I adjusted the firm’s last quarterly balance sheet to estimate the cost of reproducing the firm’s assets. I added the estimated present value of operating leases as a non-current liability and a conservative 1x multiple of the 10-year average SG&A expense as a non-current asset to reflect the cost of reproducing the firm’s reputation, relationships and operational expertise. The result was equity valued at $16.54 per share (fully diluted).
b) Intrinsic Value as Earnings Power
I estimated earnings power using revenue from the last three and nine years and trailing twelve months as well as different time-weighted margin ratios. I calculated Free Cash Flow of $4.6 – 5.2m per year. Treated as a no-growth perpetuity using a WACC of 6.9%, I calculated the value per share to be between $7.69 and $8.46.
Estimated intrinsic value is between $7.69 and $16.54. It currently trades around $5.50, representing a 28% – 67% discount. Given the conservatism built into my valuations, this is a sufficient margin of safety.
Author Disclosure: At the time of publication, the author DOES have a position in securities of this company.