That stock is GTSI (GTSI). Today, GTSI announced it has agreed to be bought for $7.75 a share. As I write this, the stock is trading at $7.71 a share. So shareholders can sell at very close to the offer price if they want to today.
The Ben Graham: Net-Net Newsletter’s model portfolio will simply keep its GTSI shares until the deal closes.
This is definitely not a suggestion that other shareholders do the same. It’s just a reminder that the Ben Graham: Net-Net Newsletter focuses on picking the right net-nets to buy rather than picking the right time to sell.
Something could go wrong between now and when the deal closes. An extra 4 cents of possible profit doesn’t do much to offset these risks. So it makes perfect sense for other shareholders to sell the stock today if they want to be done with GTSI.
Let’s look back at when the Ben Graham: Net-Net Newsletter bought GTSI.
The Ben Graham: Net-Net Newsletter discussed GTSI in its June 3, 2011, issue. And then the Ben Graham: Net-Net Newsletter’s model portfolio bought shares of GTSI on June 6, 2011.
The model portfolio bought 128 shares of GTSI at $5.02 a share. It also paid a $7 commission. So the total cost per share was $5.07.
The buyout offer is $7.75. So that’s a gain of $2.68. Or 53%. The stock is up 47% today. So, as you can see, virtually all of the gain came from the buyout announcement. GTSI was not a meaningful winner for the portfolio before today’s announcement.
The tender offer is expected to close in “the second or early third quarter of 2012.” By that time, the model portfolio will have held GTSI for more than a full year. So, the annual rate of return will be less than 53%.
Still, GTSI will probably have the best return of any net-net the Ben Graham: Net-Net Newsletter has owned so far.
Reasons for Buying
So why did we buy GTSI back in June 2011?
This is what I wrote:
“GTSI... is a mediocre company that just might make an excellent investment. Like all the stocks picked by this newsletter, GTSI is a net-net. That means the company’s current assets—cash, receivables, and inventory—minus all liabilities are greater than the company’s stock price.
However, unlike many net-nets—like last month’s pick, Lakeland Industries—GTSI has very little inventory on its balance sheet. So GTSI isn’t just a net current asset bargain. It’s actually a net quick asset bargain. Cash and receivables due within one year equal $11.79 a share. Total liabilities are $6.14 a share. That means the company has a net quick asset value of $5.65 a share. The stock trades for $4.95.
The fact that quick assets exceed the company’s stock price is GTSI’s main appeal. It’s a so-so business. Basically, GTSI is a glorified reseller of computers and related products to the federal government. It’s been around since the early 1980s. Going back to 1990, GTSI’s average return on assets has been around 2%. The company’s return on equity has averaged just under 6%.
Sales have dropped from more than $1 billion to around $660 million. This is partly due to a Small Business Administration (SBA) scandal back in October 2010. Small businesses get preferential treatment when bidding for government contracts. The Washington Post did a series exposing shady practices of government suppliers including GTSI. As a result, GTSI reached an agreement with the SBA where GTSI was allowed to keep bidding on government contracts if it made certain reforms.
GTSI executives resigned. The company took on a monitor. They’ve added programs to improve ethics. It looks like they’ve cleaned house. Many companies in GTSI’s industry abuse the spirit of SBA rules at the very least. To learn more about these dodgy practices as they relate to GTSI see our discussion of EyakTek...”
Here’s what I said about EyakTek:
“What about GTSI’s 37% stake in EyakTek?
It’s hard to value this stake. It’s carried on GTSI’s balance sheet—under the equity method of accounting—at $11.72 million or $1.21 a share. That would value all of EyakTek at $31.68 million. On an earnings basis, such a valuation would be conservative. EyakTek’s 3-year average earnings from 2008-2010 was $18.72 million. That suggests the company could be worth as much as $180 million. And GTSI’s stake in EyakTek alone could be worth close to $7 a share. Seven dollars a share is—after all—the initial offer EyakTek made to buy all of GTSI back in 2010. EyakTek’s offer was later raised to $7.50 a share. EyakTek dropped its offer when GTSI’s Small Business Administration scandal broke. However, such a lofty valuation—which would increase GTSI’s adjusted net asset value to around $14.50 a share—seems far too high for a business as mired in scandal and legal problems as EyakTek. This pessimistic appraisal is supported by GTSI’s own actions. GTSI has pushed EyakTek to wind-down its operations and liquidate. GTSI and EyakTek are negotiating a settlement.
The $1.09 a share adjusted value for GTSI’s EyakTek stake is our best estimate of EyakTek’s value in liquidation.”
On August 19, 2011 GTSI announced it sold its 37% stake in EyakTek for $20 million. That worked out to around $2.05 a share. Which is obviously more than the roughly $1.10 we estimated GTSI’s share of EyakTek’s value in liquidation would be.
But it’s not that different from how we told readers to think about EyakTek:
“What if GTSI sells out of EyakTek? What if EyakTek tries to buy all of GTSI again?
It’s hard to say. Think of it as a lottery ticket. For the purposes of this newsletter, we value GTSI at $8.69 a share. That assumes liquidation value for EyakTek. The upside on top of that in a buyout of GTSI’s EyakTek stake could conceivably be several bucks per GTSI share. It could add $5 a share to what GTSI is worth. But it’s such an odd, murky situation we don’t even like hinting at that kind of number. Instead just think of GTSI as being worth $8.69 a share plus a lottery ticket. Not bad for a $5 stock.”
Finally, you’ll note that we mentioned $8.69 a share as the value of GTSI. Yet GTSI is being sold for $7.75 a share. Does that mean you should hang on to your shares of GTSI in the hopes of a higher bid?
I don’t think so. The newsletter will hang on to its shares.
But I think it’s important to keep the margin of safety concept in mind. At around $5 a share, the upside to $8.69 made up for a lot of negatives.
Around $7.75 a share, the upside to that same $8.69 would not make up for much of GTSI’s negatives at all. Plus, GTSI already sold EyakTek. So there is no lottery ticket attached to the stock.
As I said in the opening of the newsletter issue that picked GTSI:
“GTSI is a mediocre company... Going back to 1990, GTSI’s average return on assets has been around 2%. The company’s return on equity has averaged just under 6%.”
That isn’t the kind of company you want to get stuck in. And at around $7.75, it seems like speculation to hope for a higher bid. It doesn’t seem like a good stock purchase on its own.
GTSI’s tangible book value is $8.63 a share. With a return on equity of only about 6% over the last couple decades, the stock really shouldn’t sell for more than tangible book.
So, that means the maximum upside from today’s stock price – $7.71 as I write this – is only about 12%. It seems like you could find 12% upside in safer stocks. So I wouldn’t hang on to GTSI because you are counting on a better bid. It could happen. But I’m not sure GTSI is an intelligent investment at today’s price.
That’s part of the Ben Graham approach. You buy something for 58% of what you thought it was worth and you sell it for 89% of what you thought it was worth.
No. I wasn’t right about the value of the stock. But I was right about making the investment.
That’s the Ben Graham way.
Check out the Ben Graham: Net-Net Newsletter