The following is a reprint of my December 13, 2007 RealMoney column.

Diebold (DBD), the maker of ATM machines and much-criticized automated voting machines, never seems far from controversy. It also has developed a habit over the last ten years or so of its share price swinging wildly back and forth between the $30’s and $50’s every couple of years. With the pendulum now back at the low end, traders may be tempted to hop on for the ride. Investors, however, should probably look elsewhere.

The Latest Controversy

Diebold topped out at $54.50 in late July, when it announced it would miss the deadline for filing its 10Q for the June quarter “while it seeks guidance from the Office of the Chief Accountant (the “OCA”) of the Securities and Exchange Commission with regard to its revenue recognition policy.”

After receiving said guidance, Diebold announced on October 2 that it would cease using the “bill and hold” method to record sales. The company helpfully added that:

The change in the company’s revenue recognition practice, and the potential amendment of prior financial statements, would only affect the timing of recognition of certain revenue. While the percentage of the company’s global bill and hold revenue varied from period to period, it represented 11 percent of Diebold’s total consolidated revenue in 2006. The company does not anticipate that the change in the timing of revenue recognition would impact previously reported cash provided by operating activities or the company’s net cash position.

Diebold will provide further information once it has completed an in-depth analysis of the most appropriate revenue recognition method and has reviewed it with its independent auditors and its audit committee. While the company cannot predict with certainty the length of time it will take to complete this analysis and review, it anticipates the process will take at least 30 days. Upon completing this process, Diebold will be in a position to provide updated revenue and earnings guidance for the full-year 2007.

At least 30 days later, the company announced its September quarter 10Q would also be delayed, as it is “in the process of determining the most appropriate method to replace its bill and hold practice, and has sought additional guidance from the OCA.”

Bill and Huh?

For the uninitiated, an SEC document describes what they are looking for:

Improper accounting for bill-and-hold transactions usually involves the recording of revenue from a sale, even though the customer has not taken title of the product and assumed the risks and rewards of ownership of the products specified in the customer’s purchase order or sales agreement. In a typical bill-and-hold transaction, the seller does not ship the product or ships it to a delivery site other than the customer’s site.

Diebold’s revenue growth rate in 2007 was 12.3%, and may have been mostly due to this questionable revenue recognition practice (as bill and hold sales were approximately 11% of total revenue in 2006.) Furthermore, since half the recorded revenue was service-related, the actual product sales may have even declined year/year.

Diebold’s chief rival, NCR (NCR) has noted that the upgrade cycle for ATM machines is in a lull. This is before any potential spending cutbacks by banks needing to conserve cash in the wake of the subprime crisis. It is hard to imagine the revenue growth getting much better.

Somebody Buy Them A Clue

As for “the most appropriate method to replace its bill and hold practice,” I don’t see why the company requires additional guidance from the OCA. They should recognize revenue when the customer accepts delivery of the product or service in question. In their own 10K they tell investors “for product sales, the company determines that the earnings process is complete when the customer has assumed risk of loss of the goods sold and all performance requirements are substantially complete.”

The fact that the company needs additional guidance when its own 10K describes the appropriate policy is troubling. Just as the previous CEO’s massive fund-raising activities for one political party cast doubt on the company’s objectivity when providing election equipment, the company appears to keep making mistakes that should be easily avoidable.

Shares are No Bargain

Now, just because the company keeps shooting itself in the foot doesn’t mean its stock is overpriced. Down 40% from the recent peak, it is worth asking whether the bad news is all priced in. Unfortunately, I don’t think it is.

For one thing, the stock is trading at 26x the 2006 earnings per share. Those are the most recent earnings figures available since the company is late filing its reports, and even they are likely to be revised lower following the restatements. The existing 2007 and 2008 consensus EPS estimates are most likely wishful thinking.

So how about cash flow? After all, as the company points out, changing from the bill-and-hold method shouldn’t affect the reported cash flow from operating activities. Measuring free cash flow as cash from operating activities less capital expenditures, the $206 million in 2006 free cash flow represents an 8% yield on the current enterprise value. I would normally consider such a yield worth pursuing.

The problem is, I don’t think that cash flow is sustainable. A good chunk of it was due to the company reducing working capital, a strategy that can be taken only so far. I peg the sustainable rate of cash from operations at about $90 million less than was reported, and I also have questions about the rise in “certain other assets.”

Making these adjustments, the free cash flow starts looking more like $80 million, for a yield of just 3.1%.

With the financial statements raising more questions than answers, likely slowing and the valuation mediocre at best, Diebold looks like a stock to avoid.

William Trent currently has a short position in put options related to Office Depot (ODP).

NCR recently announced plans to spin out its Teradata data warehousing business. Already some are speculating it will be taken over – possibly before it even hits the public markets.

Teradata: is it buyout bait? – Blogging Stocks

The deal should take six to nine months to complete. However, according to a report from The Daily Deal [a paid service], Teradata may not even hit the public markets. That is, it could be bought-out.By private equity firms? Well, given Teradata’s cash flows – and long-term contracts – it would be attractive to a financial buyer. But, the company would also make a great fit for major tech companies, such as Oracle (ORCL - Annual Report), IBM (IBM - Annual Report) and even Hewlett-Packard (HPQ - Annual Report). All of these companies have been quite acquisitive.

In all likelihood, NCR considered the potential of a sale before announcing the spin-out. However, any sale would likely result in capital gains (and therefore taxes) while a spin-off could be tax free to shareholders. Furthermore, if the spin-out is achieved buyers would have to wait two years to get their hands on it, or the taxes would be due retroactively. So we are betting against a deal, though it is a possibility.

Furthermore, we would scratch HP from the potential acquiror list. As noted in a recent InformationWeek Article (Inside HP’s Data Warehousing Gamble, January 8, 2007), HP CEO Mark Hurd ran NCR (and the Teradata division) and CIO Randy Mott installed Teradata systems at both Wal-Mart (WMT - Annual Report) and Dell (DELL).  Yet despite their extensive experience they chose to develop an in-house data warehousing system, Neoview. The InformationWeek article notes:

Mott says HP considered Teradata for its [internal] data warehouse, as well as a “go to market partnership” with the company.

But HP engineers had been developing data warehousing capabilities… and Mott needed to give that project a look and determine quickly if HP’s in-house technology was ready for wide use. For four months in late 2005, his team ran test loads in the lab. The [HP] system worked to Mott’s satisfaction.

So while there may indeed be a buyout in Teradyne’s future, we are betting it occurs in three years or so, and doesn’t involve Hewlett Packard.

We’d venture to guess that not too many people follow both small-cap headset maker Plantronics (PLT) and large-cap enterprise software vendor Oracle (ORCL.) We do, which is probably the only reason we noticed this little gem. Both companies recently issued remarkably similar press releases, each extolling the other’s virtues.

Oracle Standardizes on Plantronics Wireless Headset Systems to Optimize VoIP Communications

“We evaluated numerous headset offerings to complement Oracle’s VoIP deployment, and the Plantronics Voyager 510-USB is clearly ahead of the pack for audio performance, ease of use and style and comfort,” said Mark Sunday, Senior Vice President and CIO, Oracle. “We are also very impressed with Voyager’s performance with Oracle Collaboration Suite. Now employees have a single wireless headset for all of their voice and data communications.”

Plantronics Standardizes Global Operations on Oracle(R) … – Yahoo! News (press release)

“We get a great deal of value and cost savings out of the Oracle system,” said Plantronics Vice President of Finance and Worldwide Corporate Controller Susan Fox. “The external auditors we work with have experience using the Oracle E-Business Suite and have developed proven methodologies for testing and verification. That expertise allows us to reap the benefits of economies of scale and avoid the process of educating auditors on the nuances of our system.”

Now, it’s quite likely that this was simply a way to share cost-free favors (talking each other up in a press release) as each business negotiated a standard supply contract. However, it is always something that should draw attention when two parties enter an agreement that may not be arms-length. It would be better to look at it and decide nothing is wrong than to overlook something that could potentially be a warning.

In Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Second Edition (aff. link) Howard Schilit has this to say about such deals:

On October 5, 1999 Microstrategy (MSTR) announced in a press release that it had signed a deal with NCR Corporation…. Under the agreement, MSTR invested in an NCR partnership and NCR returned the favor and purchased MSTR’s products. We refer to that practice as a “boomerang.” (p. 44)

Later, Schilit elaborates:

A two-way transaction means that you both buy from and sell to the same party. Questions should be raised about the quality of the revenue recorded on such transactions….

If, as a condition of making a sale, the buyer receives something of value from the seller (in addition to the product) the amount of revenue recorded becomes suspect. This may involve a barter exchange, offering the customer stock or stock warrants, or investing in a partnership with the buyer. (p. 80).

In the cases of Plantronics and Oracle, there were no specifics regarding the size of the deals or time frame over which they extend. Neither is a major (10%) customer of the other, so there is some limit as to how much the deal could help one or the other. Questions investors may want to pursue include:

1. Were the agreements similar in size? Revenue recognized from barter agreement is of lower quality (less likely to recur) than cash revenue.
2. Given that Oracle’s fiscal quarter ends in November, the arrangement could have allowed them to book last-minute revenue. If their revenue for the quarter misses or only slightly exceeds analyst estimates when they report next Monday, a good conference call questioner could ask how much this agreement contributed (particularly with respect to license revenue.)
3. Given that Plantronics is much smaller, they could potentially benefit more from the deal than Oracle but they are potentially in a less favorable bargaining position. Their investors might want more information regarding the size of the agreement for that reason.

Or, as we suggested earlier, it could all simply be PR fluffery. But even in that case it is best if investors know all the details.
Disclosure: Author is long Plantronics (PLT) call options and short Plantronics put options.

Talk about the tail wagging the dog. Election Systems makes up 8% of Diebold’s (DBD) sales and 80% (or more) of its headaches. Although the segment nearly tripled in size (contributing 5% growth to the overall company) one has to wonder if it is all worthwhile. With payment for many election systems tied up while partisans dispute the machine’s effectiveness (note to management: if you want to compete selling voting machines, don’t skew your political donations to one party) the cash flow has deteriorated despite rising revenue and net income.
China Casts Vote for Diebold ATMs (BusinessWeek)

A recent study by Princeton University that claims the panel door protecting the memory card on Diebold’s AccuVote-TS voting machine can be opened with a hotel mini-bar key has triggered howls of outrage all over the blogosphere.And citizen groups in California and Wisconsin have filed lawsuits to block the use of Diebold voting machines in the upcoming midterm Congressional elections. These headaches aside, Diebold President and CEO Thomas W. Swidarski can take solace in the fact that his company is on a tear right now selling ATMs to mainland Chinese banks.

Thanks to recent big orders from the Bank of China, China Construction Bank, and the mainland’s national post office which also does banking, Diebold has clawed its way to No. 1 on the mainland with a 30% market share. That is just ahead of ahead of rival NCR (NCR) and 15 or so Chinese domestic rivals. “Chinese banks are preparing to compete on a global basis,” says CEO Swidarski. “They are looking at how to automate their retail operations.”

Diebold is trading at a hefty enterprise value of 44x it’s free cash flow, compared to just 13x for NCR. However, we estimate that without the election systems segment free cash flow would improve and reduce the multiple for Diebold to just 19x. It would still be higher than NCR’s, but the difference would be much less. Plus, management would be able to focus on running the business rather than dealing with outraged partisans.
Now if only we could get the dog’s tail snipped…