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10/19/2001
10:27 AM
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Taking Stock: Unisys Has Sound Fundamentals And Looks Good For Patient Investors

Weak vertical markets will offset Unisys' outsourcing growth.

IBM gets most of the ink these days, but there are a lot of older programmers out there with strong sentimental feelings for Unisys (UIS-NYSE), a diversified IT solutions provider. Fortunately, sentiment and investment fundamentals sometimes align.

Unisys just reported its third-quarter earnings to little fanfare or excitement. After all, why should anyone care when the prices of technology stocks have been so horrible recently? Following in line with many other technology companies, Unisys reported weak earnings during the third quarter, along with a substantial workforce reduction of about 3,000. As usual, the numbers are a little deceptive.

First, the layoffs may not be as meaningful as the numbers indicate. Though Unisys will make staffing cuts, it also will hire in other service segments. The net result will probably be fewer than 3,000 layoffs in the fourth quarter. To keep things in perspective, we're talking about a company with close to 37,000 employees.

The positives for the company remain the same. It's in a favorable new-product cycle. Unisys' new mainframe--the ClearPath series--represents the best of the old Burroughs and Sperry-Univac lines. Its high-end ES7000 CMP server is holding its own. Most important, service revenue continues to grow because of the growth in outsourcing, despite a tough business environment. This is especially important because services represent more than three-quarters of total revenue. As IT spending picks up in the latter half of next year, I expect that Unisys will be a direct beneficiary.

Unfortunately, despite a strong product-cycle beginning, not everything will go as planned. Expectations for the new mainframe rollout are already being lowered, given weakness in both domestic and international markets. Though outsourcing and network services are going well, the company can expect weakness in many of its vertical markets, including the depressed airline and telecom industries. Despite strong relationships with equipment makers such as Dell Computer and Hitachi, demand for the ES7000 server is still heavily dependent on overall business IT capital budgets.

Revenue for the third quarter was $1.38 billion, down 6% year over year, and yielded earnings per share of 7 cents. Service revenue was $1.05 billion or 76% of total revenue, growing 0.3% year over year.

The growth in outsourcing, though still in double digits, is offset by declines in network services and system-integration services. Technology revenue was about $330 million, or 24% of total revenue. Technology sales declined more than 21% year over year. Assuming revenue for the fourth quarter comes in around $1.6 billion, total revenue for 2001 will be about $6 billion, flat year over year.

Management projections for fourth-quarter earnings per share is 10 cents to 15 cents, much lower than the Wall Street consensus of 22 cents. Expense control has been critical for the company and remains a primary goal. Gross margins have declined dramatically, from about 35% last year to 28% this year.

The positive offset to declining gross margins is an operating-expense ratio that has declined more than 200 basis points year over year, primarily because of lower sales, general, and administrative expenses. Those three expense categories have declined from more than 20% of sales last year to about 18% in 2001. Operating margin was 3.2%, down from 5.4% last year.

For next year, I expect revenue growth to be in the 3% to 4% range given new management guidelines and business uncertainty. Earnings per share for next year will be around 75 cents--at least they're making money. Book value is around $7 per share, and debt-to-equity ratio is a reasonable 20% (down from more than 50% in 1998).

Despite the sluggish economy and a bleak outlook for the next three to six months, I like Unisys' value at $9, with a price target of $12 a year to a year and a half from now. The risk-to-reward ratio favors the investor with patience.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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