Spruce Point Issues Strong Sell On NCR Corp. (NCR)

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NCR Corp. (NCR): Spruce Point Issues Strong Sell as first reported by ValueWalk, see the explain-er from Spruce and the full release below.

Spruce Point is pleased to issue a “Strong Sell” investment research opinion on NCR Corp. (NYSE: NCR) and is short shares of the company’s stock. Our presentation is accessible on our website. Please follow us on Twitter@Sprucepointcap for updates.

NCR is Facing Secular Headwinds; Its Levered Hardware to Software Transformation is Likely to Fail and it has Limited Strategic Alternatives

• NCR is selling investors on its ability to transform from a hardware to software provider while market fundamentals move rapidly against it; alternative and digital payment platforms (Square, Venmo, Apple Pay, Google Wallet, etc) are eroding demand for its core ATM hardware, while its “banking transformation” opportunity is a melting ice cube as retail banks close underperforming locations. There are plenty of recent examples of failed hardware/software transformations (e.g. IBM and HP)
• NCR has made expensive acquisitions to transform itself, paying an average EV/Sales and EV/EBITDA of 4x and 23x, respectively, for Retalix, Radiant, and Digital Insight. In Jan 2014, NCR acquired Digital Insight for $1.6 billion (5x sales and 16x EBITDA) and paid a $600m premium to what Thoma Bravo paid to acquire it from Intuit just 5 months earlier! It now appears that Digital Insight’s revenue growth and margin expansion have stalled, while leaving NCR with adjusted Debt/EBITDA over 5x
• We will present evidence to suggest NCR has botched its other acquisitions, has almost no organic growth, limited visibility in its business as it spins a meaningless backlog discussion, and has few strategic options to recover value by selling assets. NCR has been saying it is “evaluating alternatives” since October 2014, with no outcome
• Its close German competitor, Wincor-Nixdorf (recently pre-warned that it would not meet its 2015 financial guidance, and is also exploring strategic alternatives) – its stock swiftly fell by ~18%. Wincor has almost no debt, while NCR is levered to the brink
• NCR is handicapped by its mountain of debt and has most of its cash trapped abroad in foreign jurisdictions subject to taxation; it lacks the resources to acquire anything further, and its covenants may restrict its ability to do things like pay a dividend, or repurchase stock
• With a BB+/Ba2 S&P/Moody’s credit rating, NCR is deeply in “junk status.” As a result, “shareholder friendly” actions will be viewed negatively and could force a rating downgrade, thereby limiting future financial flexibility and increasing its cost of capital
• Lastly, we believe that since NCR drastically overpaid for all of its acquisitions, it is unlikely to receive anything near what it has paid to acquire Retalix, Radiant or Digital Insight

History Lesson: Many NCR Executives Came From Symbol Technologies, a Former Accounting Fraud

• NCR’s CEO Bill Nuti joined Symbol Technologies in 2002 as its COO during an accounting scandal and was elevated to its CEO. While not implicated as a conspirator, his record suggests he overpromised and undelivered a turnaround, while not having a clear handle on unresolved accounting problems
• Nuti recruited many former Symbol employees, including his lieutenant and Symbol’s Chief Information Officer (CIO) John Bruno, who Nuti hailed as a “visionary.” Bruno recently resigned from NCR along with at least a dozen senior NCR executives according to our research. Bruno appears to have covered up his role as Symbol’s CIO
• Using a behavioral analysis, we observe many striking similarities between what unfolded during Nuti’s tenure at Symbol and NCR’s current predicament including 1) hiring of numerous former Symbol associates 2) issuing overly optimistic guidance, 2) aggressive accounting, 3) questionable Brazilian dealings, 4) restructuring announcement, and 5) liquidation of shares ahead of stock declines

Numerous Signs of Aggressive Accounting: Adjusted Free Cash Flow, EBITDA, EPS Appear 30 – 70% Overstated

• NCR appears to be playing multiple accounting tricks to embellish its financials, and paint a picture of improving results. Our alternative view suggests otherwise. The most egregious case is management’s portrayal that its “Adjusted Free Cash Flow” should be adjusted for its “Discretionary” pension contribution “and Settlements” on a “pre-tax” basis. We believe its pension contributions should be evaluated on an “after-tax” basis and not include settlements. NCR’s management also changed its cash bonus plan to compensate itself on a flawed definition
• NCR has also made changes to its pension accounting, changed its benchmark discount curve, distorted its EBIT with various non-operating gains, under-reserved for doubtful accounts, and made tax valuation allowance reversals
• NCR’s financials are showing signs of stress. For example, its accounts receivable growth rate is outpacing sales, and its days sales outstanding is at a multi-year high. Furthermore, NCR established an accounts receivables securitization program in late 2014, and utilized $96m of the $200m facility. NCR appears to have classified the $96m as an operating cash flow, but we view it as a financing structure that inflates NCR’s continuing operating cash flow
• We believe NCR’s GAAP financials are littered with issues. Therefore, we believe NCR is best evaluated on a cash-basis by looking at its cash pension contributions and cash taxes. Our cash-based analysis suggests NCR’s Adjusted EBITDA, EPS and FCF are overstated by approximately 30, 40%, and 70%, respectively

NCR’s Pension Folly Supports Our Capital Allocation Criticism of Management

• NCR’s sold investors on its ability to deal with its large unfunded US pension. It raised debt at 5% only to shift its entire US pension to fixed income in 2012, and miss the greatest stock market rally in history. This supports our criticism that NCR has made poor capital allocation decisions
• NCR’s pension strategy had the stated goals of 1) reducing the GAAP/Non-GAAP differential of its financial results, and 2) reducing on-going pension contributions. Evidence suggests that NCR has failed on both counts. NCR has also continually misguided its actual vs. expected contributions since 2012
• NCR appears to be struggling with its international pension, which it claims is overfunded, yet it continues to make regular contributions labelled as “discretionary” but may be covered up as “settlements.” NCR announced it would enter into a complex and opaque pension buyout structure with insurance companies, which moves a majority of its pension assets to Level 3 and enables subjective valuation techniques

Insider Selling and Valuation Disconnect Point to Significant Downside

• The CEO and CFO own a pitiful 0.40% of the stock; CEO Nuti started increasing share sales in 2013 while touting the benefits of the Retalix deal, which in our opinion, has been a failure
• Wall Street sell-side analysts believe NCR’s shares are fairly valued, but have completely missed the accounting gimmicks, are basing its valuation on highly adjusted EBITDA/EPS figures. Not a single analyst even has a sell-rating
• The bulls see a team of activists capable of saving a sinking ship, but we see little value from unwinding NCR’s assets which were purchased at rich prices when they were growing
• Given NCR’s messy financials, we apply a sales-based sum-of-the parts approach, and reach a price target of $3 – $16 per share (40 – 80% downside). NCR is also richly valued at 51x trailing free cash flow basis; if it traded in-line with peers at 11 – 22x, there would be little residual value to shareholders
• Assuming no growth in 2015, and applying a peer average multiple of 14.5x – 16.5x to our Cash EPS of $0.66c and 7.5x – 8.5x to our $700m Adj EBITDA, we get to approximately $9 – $15 per share
• Overall, we see a realistic valuation reference range to NCR shares of approximately $9 – $16 (45 – 70% downside)


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