RealMoney Silver - Too Many Questions to Recommend DBD

Too Many Questions to Recommend DBD
By Bill Trent
RealMoney.com Contributor
12/13/2007 10:52 AM EST

Diebold (DBD) , the maker of ATMs and much-criticized automated voting machines, never seems far from controversy. It also has developed a habit over the last 10 years or so of its share price oscillating wildly between the $30s and $50s every couple of years. With the pendulum now 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 (SEC) with regard to its revenue recognition policy."

After receiving said guidance, Diebold announced on Oct. 2 that it would cease using the "bill and hold" method to record sales.

As you can see through the previous link, the company helpfully added that the change in revenue recognition would only affect certain revenue, and that it anticipated that further analysis of said revenue recognition would take at least 30 days.

Then, 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 over year.

Diebold's chief rival, NCR (NCR) has noted that the upgrade cycle for ATMs 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 fundraising 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 26 times 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, cash flow likely slowing and the valuation mediocre at best, Diebold looks like a stock to avoid.