Description

Bull – (BUL.FP, €0.29, €272MM market cap.)

Overview:
Recent rights & exchange offerings, a large net cash position, low valuation, and strong FCF generation make Bull an attractive investment opportunity. Admittedly, a French technology company facing fierce competition deserves to trade at a discount to peers – but Bull’s discount is excessive. Investors and analysts in Europe have been burned by Bull in the past, leading them to write off the notion of an investment in Bull – which is part of the reason why the current opportunity exists. With the financial and operational turnaround nearing completion, we would argue that Bull deserves to trade at a higher multiple than the 1.8x 2004E EBITDA and 2.2x 2004E EBITDA-Capex implied by current levels. If you assume Bull trades to 4.0x EBITDA once the restructuring is finalized at the beginning of 2005, then the shares should trade around €.50 – over 60% upside from current levels in 6 months. This does not include any potential upside for redeployment of excess cash, gives no credit for the €2.8BN of NOLs and does not include any of the additional “hidden value” described below in valuation section. The large cash balance, generous FCF yield and very high probability of a successful restructuring being completed in the next several months also protects your downside.

Catalysts:
- Two thirds of the Bull restructuring were completed on 7/16/04 – new shares associated with rights offering & exchange of convertible bonds listed on Paris exchange last week.
- September 2004 – expected EU approval of restructuring plan clears the way for repayment of French government loan & finalization of balance sheet cleanup. The French loan is effectively being forgiven.
- Sometime after the restructuring plan is consummated, Bull will sell their 1.08MM shares of Groupe Steria (RIA.FP, €26.15). This value is not captured in cash & equivalents line on balance sheet.
- 2005 – Bull will have significant net cash and may return a portion of this to shareholders through a buyback or dividend.
- 2005 – Bull has expressed interest in doing small acquisitions in the software & services side of the business. Normally we would not view acquisitions as an attractive catalyst relative to a return of capital to shareholders, but to the extent that Bull can show top-line stabilization or accretive growth through m&a, this would be an incremental positive.

Business Overview:
Bull operates primarily in 3 businesses:
- server products - €582MM in ’03 revenues, 37% gross margins (€214MM).
- services - €345MM in ’03 revenues, 6.7% gross margins (€23MM).
- maintenance -€338MM of ’03 sales, 25.4% gross margins (€86MM).
Approximately 50% of total revenues are generated in France, 37% in the rest of Europe and the remainder primarily in North America and Asia (each around 6%). France also accounts for close to 80% of services revenues. The company has seen a dramatic improvement in operations over the last several years with SG&A as a % of sales coming down to 18.9% in ’03 from 26% in ’01. Headcount has also been dramatically reduced over that time from over 20k a few years ago to 7.7k in ’03 – and there are still further costs to be reduced. Bull did about €164k in sales per employee in 2003 which is slightly better than Unisys which did $158k in 2003. UIS is arguably not much better than Bull in terms of operating results but it trades around 5x forward EBITDA and 9x forward EBITDA-Capex. Bull’s gross margins have improved from 18.6% in 1H02 to 27.2% in 2H03 vs. UIS’s 2003 gross margins of 29%. Bull should benefit from the continuing trend of outsourcing & processing and recent trends suggest increasingly rational pricing in Europe.

While the server business is quite competitive, Bull does have several sources of defensibility. For starters close to 40% of their revenues come directly from the French government and France Telecom (controlled by French government). These revenues are unlikely to go away given that France’s de facto bailout was motivated primarily by a desire to preserve jobs, maintain Europe’s only computer company and of course - by their hubris. These 2 entities are also sizeable equity holders as are a number of Bull’s other key customers including Debeka, Motorola, and NEC – all of these companies want Bull to continue to exist and thrive. Bull also has a meaningful installed base of about 115k servers which means the maintenance side of the business should have some stability. In terms of replacement of the installed base, Bull’s recently launched high-end Novascale servers have been well received and the mid-range Express servers have also received high marks (according to a customer satisfaction survey conducted by Taylor Nelson Sofresa). Additionally, recent trends indicate the European server upgrade cycle may be starting to pick up steam.

Bull could represent an attractive takeover target for a number of strategic and financial players especially when considering the sizable NOL. Potential buyers include:
- NEC – Bull has had a JV relationship with the firm for over 20 years and they participated in the recent rights offering. NOL could be attractive for them and they would likely meet necessary criteria for transfer.
- Unisys – shares similarities in products and services offering and Bull would provide access to sticky customers in the European market (ie French gov’t).
- Dell could benefit from Bull’s higher-end Intel Application (IA) servers to diversify their existing lower-end IA offerings – they definitely have the financial flexibility to purchase Bull and could also probably utilize the NOL.
- Gores Technology approached Bull last year but couldn’t reach an agreement with management.

Restructuring Details:
The Bull restructuring consists of 3 moving parts – a rights offering for existing shareholders, an exchange offering for convertible bonds and the forgiveness of €517MM (fully accrued amount) in loans provided to Bull by the French government in 2001 and 2002.

Equity Rights:
Bull announced a rights offering for equity holders of 440MM new shares at €.10 per share at a ratio of 2.6 to 1. Approximately 94.4% of the existing 170.2MM shares participated. This resulted in 418MM new Bull shares listed for trading on 7/16/04. The company received €42MM in cash proceeds from the rights offering. Almost all of Bull’s major shareholders participated in the rights offering – noteworthy holders include NEC (a major technological partner - holds around 11%), Debeka and France Telecom (large clients - hold around 14% combined), Axa Private Equity and Artemis (2 investment funds – hold around 10%), Bull management (around 8%) and the French Government (holds around 3%).

“Oceane” 2.25% Convertible Bonds:
Holders of the “Oceane” convertible bonds had the option to exchange each bond for either 20 shares outright or 16 shares outright & 16 €.10 warrants. 10.77MM of the 11.5MM bonds outstanding chose the 16 shares & 16 warrants option, 201k of the bonds chose the 20 shares option and 521k of the bonds did not select either option (presumably they’re still tucked away in mattresses across France). These un-exchanged bonds will remain outstanding at a 90% reduction to economic value (maturity extended to 2033, coupon dropped to .1%). As a result of the “Oceane” restructuring, there were 176.4MM new Bull shares on 7/16/04 along with 172.4MM €0.10 warrants listed on the Premiere Marche. The warrant exercise period runs from 7/16/04 until 12/15/04 will eventually result in €17.2MM of cash proceeds to the company assuming full exercise. Post-exercise former bondholders will control approximately 37% of Bull.

French Government Loan:
The French government prevailed over the EU in their efforts to ensure Bull will receive state restructuring aid. This allows Bull to avoid bankruptcy, restructure the balance sheet and preserve 7,700 jobs (very politically important in France). Bull announced a couple of weeks ago that the EU is expected to formally approve the proposed restructuring in September 2004. Based upon public statements made by the EU and the fact that 2 of the 3 components to the restructuring were completed last week, there is little to no risk the EU rejects the proposal. After the expected EU approval in September, Bull will be able to complete the final step of the restructuring. EU regulations state that Bull must repay the existing French loans before the French gov’t can grant them new state aid, so the company will likely obtain a bridge loan to take out the government loan as soon as the EU’s official approval is received in September. Then, in early 2005, the French government will provide restructuring aid of around €517MM to repay the bridge loan (€517MM consists of €491MM accrued gov’t loan value at 12/31/03 plus €26MM of accrued interest for 2004). The deal is structured in this way because it complies with the EU’s 10 year limitation on giving state restructuring aid to a company. The last time France “officially” provided this aid to Bull was 1994 (the 2001 & 2002 gov’t loans were deemed an “extraordinary circumstance” by the EU so they don’t count as restructuring aid…go figure). Though somewhat convoluted, this process is the same as the French government forgiving the loans.

For providing the restructuring aid, the French government will be entitled to 23.5% of annual EBT above €10MM for an eight year period following the year ended 12/31/05. The company determined this liability will amount to €50MM. They come up with this balance sheet liability by assuming stable annual EBT in the €30MM-€35MM range, which means the government will get €5MM-€6MM per year *8 years = €40MM - €48MM – so call it a €50MM liability. Please note that there are neither minimum nor maximum payment requirements to this earn-out, so if Bull has EBT under €10MM they pay nothing to the government. Although they could theoretically pay the government significantly more than the assumed €50MM – the outperformance implied by this scenario would be welcomed.

Pro Forma Capitalization & Valuation:
After the exchange & exercise of the warrants, there will be 937MM shares of Bull outstanding. The shares are currently trading at €.29 = €272MM market cap. At the end of 2003 Bull had €174MM in cash & equivalents on the balance sheet and another €32MM in the “other investments” line of the balance sheet. These investments consist of €28MM of market value in Groupe Steria stock, (RIA.FP – on balance sheet at book value of €20MM) and a €12MM book value equity stake in NEC Computers International BV (subsidiary of NEC Corp). Since Steria is publicly traded we include it in the table below –just to be conservative we are not assigning any value to the NEC Computers equity since it is a non- public sub of NEC Corp - but it definitely has some value. Bull has NOLs of €2.77BN that are not captured in the valuation below - €1.8BN of these NOLs are long-term with “indefinite” expiration – this makes Bull a potentially attractive takeover target (Gores Technology Group approached Bull last year to discuss a buyout that the company rejected). We do not know the exact breakout of NOLs by country, but believe them to be transferable to a buyer with similar operations in the same countries as Bull. Apparently the definition of “similar operations” is pretty loosely defined – meaning there is some latitude as to who could take Bull over. Additionally, there is probably additional hidden value buried within Bull – for example they own real estate in Italy rumored to be worth over €30MM – this equates to 10% upside to the equity alone. Who knows what other pockets of value are buried within Bull.

We assume liabilities of €50MM associated with the restructuring aid, €32MM for A/R securitization (6/30/04 est.), and €26MM for restructuring reserves.

Pro Forma for Restructuring:
Cash at 12/31/03 €174MM
Proceeds from equity rights €42MM
Proceeds from warrants €17MM
1H04E FCF €20MM
Groupe Steria stock to be sold €28MM
Total cash & equivalents €264MM
Less
Liability for French gov’t earn-out (€50MM)
Restructuring reserves (€26MM)
A/R Securitization (6/30/04 est) (€32MM)
Net Cash Position: €156MM

PF Shares outstanding 937MM
Share Price €0.29
Market Value of Equity €272MM
Enterprise Value €116MM

2004E EBITDA €65MM
2004E Capex (€12.5MM)
2004E EBITDA-Capex €52.5MM

“Interest Expense” (explained below) (€10MM)
Taxes €0
Free Cash Flow €42.5MM

EV/2004E EBITDA 1.8x
EV/2004E EBITDA-Capex 2.2x
EV/2004E FCF 2.7x
2004E FCF yield to equity 16%

Operational Outlook:
On a 6/22/04 conference call, management guided for 2004 EBITDA around €65MM and 2004 Capex of €10MM-15MM – probably closer to the low end of the range. Management says that post-restructuring, “interest expense” will be around €10MM per annum – about half of this “interest expense” will be put toward the €86MM of unfunded pension liability that existed at 12/31/03 (which is why pension liability is not included in debt) – the other component consists of assumed interest under the a/r securitization – which appears to be a little bit high relative to our current estimated balance. Bull says they might use some of their excess cash to reduce the pension liability so expected annual contributions may be lower and FCF higher. The company will not pay taxes for a very long time –the €2.77BN in NOLs ensures this. Bull should generate FCF of around €40MM-€45MM in 2004 and given the decent outlook for revenue stabilization over the next year or so, this FCF number should considered reasonably sustainable. If there is upside to the revenue numbers as implied by management’s comments from a few weeks ago (see below), then this FCF could be higher – either way, this company will generate significant amounts of cash.

One of the key negatives to the Bull story has been the declining top line. However, the calculation that delivered a €50MM liability associated with the government loan restructuring implies that EBT will be stable around €35MM– which provides some comfort on the company’s outlook. Additionally, Bull has been able to maintain stable EBIT numbers for the last few years through margin improvements in spite of top line declines. Management believes revenues will stabilize and grow over the next couple of years. Though revenues for 2004 will likely be down from 2003, there are some specific drivers for 2005 that may bring revenues back up. One is the expiration of a non-compete agreement with the European (non-France) services subsidiaries Bull sold to Steria at the end of 2001. Management believes this represents an addressable market of several hundred million euros. The company should also be able to win new business more easily once the restructuring process is completed – not only will management be able to focus on the business, but customers will no longer be afraid to sign longer-term contracts for fear of Bull going away. There is also evidence of a nascent recovery in Global IT spending – in any case our thesis calls for stable FCF, not growth.

Comps:
Competitors include IBM, Dell, Unisys, Sun Microsystems, Cap Gemini, Atos Origin, Groupe Steria, Logica and HP among others. Most of these companies trade at substantial premiums to Bull with the average forward EV/EBITDA multiple in the high single digit range. Bull’s multiples of 1.8x EBITDA and 2.2x EBITDA-Capex are too cheap in spite of the small size and continued challenges the company faces. Groupe Steria trades around 5.0x 2005E EBITDA and 7.8x 2005E EBITDA-Capex, UIS trades around 4.8x 2005E EBITDA and 9.2x 2005E EBITDA-Capex. Please note that both sets of metrics imply meaningful growth in EBITDA – 20% growth over 2003 for UIS and 40% for Steria - we are looking for Bull to only remain flat. Bull’s projected EBITDA margins of roughly 5% imply no improvement over 2003.

Catalyst

Restructuring