Description

MCSi, Inc. (MCSI) is a provider of audiovisual integration products to small and medium sized businesses. Prior to this focus, MCSI was engaged as a reseller of audio visual and computer products. MCSI is also a failed roll-up which engaged in quesitonable financings and is currently under the cloud of shareholder litigation. In spite of the obvious taint this implies and which is illuminated by the facts below, I am recommending purchase of the equity as it possesses very interesting risk/reward characteristics.

Investment Thesis:

Book Value-
MCSI has a market cap of approximately $11.5mm, and book equity of $105mm. This is a price to book of approximately .11X, and gives a nice backstop against unforseen impairment. (See Operating Leases BELOW for a more conservative number). Further, this low valutaion provides potentially significant upside.

Asset Quality-
MCSI has $263mm ($12.17 per share)of assets of which approximately $190mm ($8.99 per share) are current; 71% of total assets are current. MCSI reported taking $32mm in inventory valuation, AR, and supplier realignment chareges as of Dec 31. Long-term assets are PP & E, as MCSI wrote off the entire goodwill balance of $161mm.

Bank Line-
With it's Q4 EBITDA loss, MCSI was in violation of the covenants on it's $113 bank line (net of cash). On 4/4 an interim forebearance agreement was announced with the further delineation that the total o/s was approximately $90mm (net of $5mm cash). Also commensurate with this release, a new CFO with turnaround experience was announced. (The President and CEO was replaced in early March. More on this BELOW). Using a standard lending forumla as of the 12/31 numbers, it was a resonable bet the bank would work and will continue to work with MCSI, as 80% of receivables and 50% of inventory yields a lending base of approximately $100mm.

Operating Leases-
In the 2001 10-K, MCSI reported minimum operating lease payments (undiscounted)for 2003 and on that total to $38mm. MCSI however divested it's product sales line in 2002 and presumably some of the lease payments with that divestiture. Adding back an arbitrary (and hopefully conservative) $30mm ($1.40 per share) in operating lease liability with no offsetting assets leaves MCSI with book value of $3.50 per share, and a price to book of .13X.

Shareholder Class Action-
MCSI faces a contingent liability with its shareholder class action lawsuits surrounding two seocndary offerings completed in 2001. In July of '01 sold 4mm shares at $11.50 per share and on December 19, 2001 MCSI sold 5.2mm shares at $22.88 per share. Then Chairman and CEO Mike Peppel also sold 300,000 shares in this December offering. At the time of the December secondary, MCSI had YTD 3rd Q net income of $12.2mm, and expressed enthusiasim about its prospects. On Feb 26, 2002 MCSI reported an "unexpected" 4th quarter drop in sales of 30%, and reported a net loss for FY 2001 of $10.7mm. On April 26, MCSI announced the sale of of it's computer products division (to what turned out to be a corporate officer) and took a $45mm charge to earnings. Shareholder litigation will probably be strengthened by the current SEC investigation which was announced on 2/14/03.

Management Change-
On March 6, 2003 MCSI added to new BOD members, and promoted Timothy Chrisman to Chairman of the BOD. On March 12, 03 Mike Peppel resigned as CEO and as a member of the BOD. A recently appointed BOD memeber, Gordon Strickland, replaced Peppel as CEO. Further, along with the 4/4 announcement of an interim forbearance agreement, the CFO was replaced.
I believe that Mr.Peppel was ill prepared to lead the current version of MCSI, with it's current focus on integration of audiovisual products. Prior to the purchase of the assets of the bankrupt Intellisys in Nov 2000 and the sale of a computer products division in April 2002, MCSI's focus was as an acquirer of businesses that distributed tech and av products priced under $2000. Now it is an integrator, requiring longer sales cycles, internal control/coordination, and fiscal controls. Strengths it appears Peppel lacked.

Concerns-
The write-down of the entire balance of goodwill is a concern. Did Peppel buy soley for the economics of the roll up and not the underlying business? MCSI has a long history of disposing of businesses at a loss. Addtionally, the audiovisual business is under pressure from the likes of WebEx in which internet based meetings can be held on individual computers as opposed to conference rooms fitted out by MCSI and others. FInally, will MCSI have the liquidity needed to turn itslef around before special charges to an EBITDA loss? Finally, the 2002 10K should be wathced closely for signs of outright fraud.

Summary-
Classic deep value play; extremely low price to book should provide some protection. Severe management stumbles in the past, though the BOD has reacted admirably in activating new BOD members and top management. Company has too much debt, but the load could/should be manageable. The company has attracted an apparantly successful activist investor, Steel Partners, which filed its 13D on 2/26/03, and which indicates purchases were made at significantly higher prices. If MCSI stabilizes at $300mm a year in sales (40% lower than FY 2002)and earns 2% net margins, MCSI's eps could be between $.25 and $.30 per share. At 5X eps a target of $1.25 to $1.50 is not unreasonable.

Catalyst