NCR Corp.: Major Accounting Issues, Excessive Leverage And Limited Strategic Alternatives Point To 45-70% Downside

Spruce Point is pleased to release an investment research opinion on NCR Corp. (NYSE: NCR ) with a " Strong Sell " opinion.

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In Spruce Point's opinion, there are numerous reasons to be extremely cautious of investing in NCR. We are short the stock for the following reasons:

I. NCR is facing secular headwinds; its levered hardware to software transformation is likely to fail, and it lacks viable 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 such as Apple Pay (NASDAQ: AAPL ), Google Wall (NASDAQ: GOOG ), Square , Venmo , and soon, Samsung Wallet ( OTC:SSNLF ) 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).
The company 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 January 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 leverage of approx 5.1x Debt/EBITDA, according to Moody's.
We will present evidence to suggest the company has botched its other acquisitions, has almost no organic growth, and limited visibility in its business as it spins a meaningless backlog discussion.
Its close German competitor, Wincor-Nixdorf ( OTCPK:WNXDF ), 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. NCR is already viewed as a junk credit by S&P and Moody's (BB+ stable /Ba3 negative). A foolish move to institute a dividend/buyback would risk a credit rating downgrade by the agencies and further increase its cost of capital and likelihood of default.
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.

II. 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 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 a major stock decline.

III. 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.
The company 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, the company 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 the company's continuing operating cash flow.
We believe NCR's GAAP financials are littered with issues. Therefore, we believe the company 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.

IV. NCR's Pension Folly

NCR sold investors on its ability to deal with its large unfunded U.S. pension. It raised debt at 5%, only to shift its entire U.S. pension to fixed income in 2012 and miss the greatest stock market rally in history. This supports our criticism that the company 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 ongoing pension contributions. Evidence suggests that NCR has failed on both counts. NCR has also continually misguided its actual vs. expected contributions since 2012.
The company appears to be struggling with its international pension, which it claims is overfunded, yet it continues to make regular contributions labeled as "discretionary," but which may be covered up as "settlements." NCR announced that 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.

V. 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, and are basing their 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 unrevealing 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 a 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 14.5-16.5x to our cash EPS of $0.66c and 7.5-8.5x to our $700m Adj. EBITDA, we get to approximately $10-15 per share. Overall, we believe the shares have 50-66% downside.

Disclaimer: This research presentation report expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation report. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC's control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC's research is at your own risk. You should do your own research and due diligence before making any investment decision with respect to securities covered herein.

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To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of NCR Corporation or other insiders of NCR Corporation that has not been publicly disclosed by NCR Corporation. Therefore, such information contained herein is presented "as is," without warranty of any kind - whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All rights reserved. This document may not be reproduced or disseminated in whole or in part without the prior written consent of Spruce Point Capital Management LLC.