Stock Analysis of DST

DST Systems is largest mutual fund servicing and record keeping firm.

On the surface, DST has $6.8 GAAP per share earning in 2010, and $4.43 non-GAP per share earning, the P/E ratio is fairly good comparing to a $50 price.

However, its core business is declining. The registered accounts for Output Solutions declined 10% in 2010. Even though this core business represents only 48% of overall revenue, it is still could result in a 5% decline of revenue every year.

Looking deeply into its annual report and quarterly earnings conference calls, there are other details to be noted:

1. Like other software companies, its maintenance cash flow is bigger than income. The difference is around 50M in the last 5 years. Or $1 per share.

2. It has 1.4B long term investments. About $900M on stocks of 3 companies, and $500M on real estate. With 5% return on these, there are $70M look through earnings every year.

3. Combine #1 and #2, and add on to the non-GAAP earning $4.43, it gives a rough cash flow of $6.83, or 13.6% return each year.

4. However, since the business is declining, it needs to acquire new companies or buy-back shares to keep the per-share earnings from shrinking. The new growth on healthcare side and TRAC will offset the decline though. Plus, 10% decline in 2010 is a special case since it lost a big client which is 6.6% of their business. Also, it added another new big client in Canada. So conservatively, we can assume the business is declining 3% every year assuming no acquisition or significant re-investment. The actual figure is likely less than that. With 3% negative growth, the return is reduced to 10.6% assuming it can buy a business valued like itself in market, or its share price stay at or below $50.

So in conclusion, the conservative fair value is around $53. When doing evaluation, many people tend to forget about the look-through earnings on its long term investments, which is completely separate from its core business.

One of my favorite part is the CEO: Mr McDonnell. I don't know much about this person, but did some basic research on him. Here is what I usually do to study the top management:
1. Look at his basic profile:
He worked in this company for 37 years starting from 27 years old.
2. Hear what he said:
He mentioned many negative points about the company in the quarterly report and earning conference. He emphasized non-GAAP figures even though it is a lot less than the GAAP figure.
3. Watch what he did:
He provided good returns to share holders through share buyback, conservative acquisitions in the past. The share price 15 years ago was around $12 in 1995, comparing to the current $50, it is a 10% return each year, and its share price also goes steadily up if we exclude the impact from market index's fluctuations.

So he seems to be an honest person, with fairly good financial decisions in history.

The biggest individual holder (20% ownership) is ARGYROS GEORGE who seems to be adding to his position all the time for many years, and he also worked for this company for a couple of years in the past.

On the safety side (here "safety" means the probability of bankruptcy, or maximum downside under an extremely hash business environment), the long term investment is more than enough to cover the debt, not mentioning the relatively stable earnings.

For competitive strength, it is the largest mutual fund servicing firm. However, since the business is declining, this strength is not that important any more.

Overall, it is a good stable stock worth investing. The most significant draw back is the negative growth on core business, but with a good CEO, he should find a way to provide good returns to shareholders.

If Mr. Market allows us to buy this stock at $35-$41, it should provide a good safety margin and more appealing returns.

(Disclaimer: I don't own this stock at the moment, but is planning on initiating a position if the price is attractive)