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Stock Analyst Update

Unisys Is Stuck between a Rock and a Hard Drive

Until it solves its dilemma, investors should avoid the stock.

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Unisys  (UIS) is a dinosaur in a modern-day world.

The company's stock tanked Thursday, falling 37% to 14 9/16 after the firm warned that second-quarter earnings would fall far short of analysts' estimates. This disappointment is the latest in a string for Unisys shareholders and results from both the decline of mainframe computers and the company's inability to adapt quickly to the changing nature of the information-technology consulting industry.

As a leading manufacturer of expensive, high-margin mainframe computers, Unisys is in a tough situation. Sales of mainframes have declined in recent years as lower-end servers and even PCs are able to handle all but the most processing-intensive applications.

Because Unisys gets about 40% of its revenue from sales of mainframe servers and related software, this is not a happy trend for shareholders. In the first quarter, sales of these products declined 12% from the year-earlier period, and gross margins on computer and software sales fell to 46% from 53%.

To offset this, Unisys has tried to reinvent itself as an information-technology consulting firm. The big problems here are the plethora of competing firms offering similar services and the low margins in the consulting market, compared with those of the mainframe market. Niche startup firms such as Sapient (SAPE), Marchfirst (MRCH), and Scient (SCNT) and traditional technology consultants such as IBM (IBM), Electronic Data Systems (EDS), Computer Sciences (CSC), and Andersen Consulting are all vying for a piece of the pie.

So Unisys faces a quandary: Although margins are high on mainframe sales, the market is shrinking. Thus, the company must focus its energy on growing its services revenue, where margins are much lower. Investors should probably stay on the sidelines until the company finds a solution.

Mark Sellers does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.