Value Investors Club / UNISYS CORP (UIS)

Description

Investment Summary:

Unisys is on track to resume an impressive operational and balance sheet restructuring that has been

obscured by a massive pension overhang and then interrupted by a Covid induced hiccup in the entire IT

service marketplace.

At the current price of 5-5.4x run rate EBITDA and with the pension issue largely in the rear view, UIS is

priced for substantial upside if the management team can deliver on the prospects for even a decent IT

services business going forward.

There are several upside shots on goal which may contribute to even greater returns for shareholders,

including new treatment for pension obligations under the various stimulus bills, realization of

substantial hidden value in deferred tax assets and a continued mix shift towards the growth markets of

digital workplace, cloud infrastructure and enterprise security.

We think UIS could double over the Next 12-24 months. At 7X the $320M Ebitda we expect by yearend

2021, UIS would trade at $22. This excludes any Value from potential Tax Assets ($1.5B) or Legislative Pension Relief.

Long Term we expect accelerating top line growth and EBITDA margins to continue to imprive from the

current mid-teens levels with a significant ramp in free cash flow as cash pension contribution drops to

only the $30M required for the international plans.

NOTE: Saltaire posted an excellent pitch on UIS back in Feb which seems like a lifetime ago. That

writeup is quite informative so I will attempt to avoid duplication but also add a number of important

updates and additional perspectives.

NOTE: my numbers are as of the Q3 results announced tonight (cc tmo) and adjusted/annotated for

various pro formas where appropriate/clarifying. I have been working on the write-up sporadically for a

few days and have tried to drop in the most current numbers where available. Follow Up to come after

the call tmo.

The basics:

Unisys (UIS): $12 X 72.3M fd shares = $868M mkt cap + $736M net debt (inc $1.05B pension) = $1.52B

TEV

Run rate: $2B revs, $280-$300 EBITDA, 5-5.5X EBITDA. TTM EBITDA including (Covid-Ugly) Q2-20 =

$275M. 2019: $2.2B revs and $319M EBITDA.

The $736M net debt includes $1.05B of net pension obligation so net cash ex pension.

Transformative deal: Q1-20 Sold US Federal IT sub for 13X TTM EBITDA, paid down debt, pre-funded

pension.

Business is rebounding post-Covid hiccup. Recently posted in an updated corporate presentation and

confirmed with solid (if optically messy) Q3 results. COVID impacted markets (Field Services, BPO and

Travel & Transportation) are still down substantially from last year but showed clear improvement from

the Q2 trough.

IT services: not just BPO legacy; legitimate and growing digital workplace (29% in Q3), cloud & infrastructure

(30%) and security. ClearPath Forward branding for highly secure operating environments for high-

intensity enterprise computing. The company will need to break out faster growing service offerings

and improve the relatively low Services Segment margins (5%) in Q3 to claim a higher valuation among

the IT services universe. The Technology division (15% of revs) reports high operating margins (30-40%)

but can be lumpy based on ClearPath Forward contract timing. Not arguing that this is a great business

by any means but it had been on an improving path prior to COVID and management is VERY clear on

what activities are adding LT value.

Pension Liability at YE 2019 exceeded market cap by almost 2x, but that is NET. Actual assets and

liabilities dwarf market cap and income statement impact is complex and viable, while cash flow impact

dominates cash flow statements. (I will develop the pension analysis further in the Q&A for those

interested.)

New stimulus bills include pension relief: 5% minimum discount rate on liabilities AND amortization

period extended to 15 years from 7 years. Huge Potential Positive. Generally supported by both

parties. Combined, the discount rate change would reduce the PBO (offsetting the recent decline in

rates which likely increased PBO) and the extended amortization would reduce the financial statement

hit. TBD, how this flows through for UIS with all the moving pieces. Note: UIS has also taken measures

to reduce the GROSS accumulated benefit through plan changes, buyouts, etc. Expect some color on

the call tomorrow.

Management - 3rd time’s a charm. If you succeed at first (and second), do it again! Peter Altabef has

sold two previous companies; will he do it again? While not specifically a part of our thesis at present,

this industry continues to consolidate and a cleaner UIS would be highly accretive to a potential buyer.

Note: Cap structure #s treat the 3/21 convert as equity (in share count, not in debt) as instrument is

short term and in the $.

Q3 Highlights:

$495M revs, up 12% Q/Q though still down 10% Y/Y. Covid impacted sectors still behind

last year but healing.

Adj EBITDA $74M (14.9% mgn) vs. $84M LY (15.5% mgn). Adj op mgn back up to 8.5% actually up versus

8.0% LY and about breakeven in the Covid impacted Q2.

FCF positive at $34M

Cash $774M after paying down $59M on prior precautionary revolver draw. Note Cash includes $200-

$285M potentially earmarked for Pension plan in 2020/2021.

Services Total Contract Value (TCV) up 4.3% Q/Q.

Non-GAAP EPS 51c versus 26c LY and a loss in Q2.

Pension Update: Pro Forma for just completed $485M Debt offering, UIS has “effectively pre-funded

substantially all currently-expected future contributions to the U.S. pension plan”. (explored further

below).

Pension:

The NET Pension Deficit was $1.75B at 12/31/19, but the GROSS Accumulated Obligation for

UNDERFUNDED plans was $6.9B and the GROSS Projected Benefit Obligation for all plans was $4.8B.

Plan assets were $3.3B. Thanks to the arcane world of pension accounting which incorporates discount

rates on future obligations (3.5%-4.50%), assumed returns on plan assets (6.8%), expected lives and in

UIS’s case the amortization into expense of a staggering $3B hole in the pension assets, the Company

recognized $93M of periodic pension cost in 2019. NOTE: all of the company’s “Adjusted” numbers

exclude the pension costs. Yes, it’s rose colored glasses for sure but it does illustrate the operating

results ex- the historical pension debacle, and the DO include the net pension obligation in the net debt

calculation.

I originally intended to do a deeper dive on the pension impact on cash flows and the p&l but the

company is coming out with all new #s given the sale of the Fed IT business and the intended funding of

the pension plan with some of those proceeds and the recent $485M debt deal.

NOTE:A careful reading of the just released Q3 deck seems to indicate that the Net Pension liability has

improved marginally as the intended debt proceeds appear to have largely offset an increase in the

pension obligation due to lower interest rates (discount rate). I will offer greater clarity after a follow up

with management. The company appears to have updated the slide for “current market conditions”

versus prior pro formas which used the 12/31/19 measurement date. It appears that the Pension Deficit

would have gone UP by $300M from YE 2019 through 9/30/20 before a $400M pro forma net reduction

from the Oct debt offering. I cannot presently reconcile why Net Debt which includes the pension

deficit does not reflect this estimated $300M deterioration. The debt offering should be net neutral to

net debt as defined. I hope to clarify following the conference call and a follow up with management.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued post COVID recovery in rev growth and margins

FCF ramp as US pension contributions end.

Stimulus Bill relief on discount rate and amortization period

Clarity on Realization of Tax Asset

show sort by

			2020	2021
Price:	12.00	EPS	0	0
Shares Out. (in M):	72	P/E	0	0
Market Cap (in $M):	868	P/FCF	0	0
Net Debt (in $M):	736	EBIT	0	0
TEV (in $M):	1,520	TEV/EBIT	0	0