Spruce Point Capital Reiterates a Strong Sell Forensic Research Opinion on Mercury Systems, Inc. (Nasdaq: MRCY)

NEW YORK, Oct. 17, 2018 /PRNewswire/ -- Report entitled "Cyber Systems Failure" outlines how Mercury faces 50%-60% downside risk to $20.60 to $25.75 per share because of rising cybersecurity costs and potential complications from replacing Super Micro Computer, Inc. (Supermicro) as its trusted "technology partner".

    --  Exposure Emanating From Supermicro, A Mercury Technology Partner:
        Bloomberg recently published an in-depth article highlighting how China
        infiltrated 30 major U.S. companies by inserting a tiny chip into
        (Supermicro) motherboards. Navy systems were mentioned specifically as
        an affected target. Mercury Systems and two of its recent acquisitions -
        Themis Computers and Germane Systems -  each sells servers and other
        related IT equipment containing Supermicro motherboards to the Navy and
        other military branches. All three listed Supermicro as a "Technology
        Partner" on their respective websites until last week, when almost all
        mention of the relationship was abruptly and surreptitiously removed
        without explanation.  The existence of Supermicro motherboards in
        Mercury's rugged servers presents difficult-to-quantify tail risks, but
        could force product recalls and expensive supply chain adjustments,
        among other costly actions. As a precedent example, the Navy placed
        restrictions on IBM's BladeCenter server line in 2015 over supply chain
        security concerns, less than a year after Chinese IT hardware
        manufacturer Lenovo acquired IBM's server business.


    --  Cyber Compliance Is Likely To Drag On Revenue Growth And Materially
        Increase Costs:  A recent GAO report entitled "DOD Just Beginning
        Grapple with Scale of Vulnerabilities" highlighted how testers playing
        the role of adversary were able to take control of systems relatively
        easily and operate largely undetected.  Based on conversations with
        industry experts, we believe that the requirements for winning
        government business will be (and are being) rewritten with an emphasis
        on cyber resilience and a much higher cybersecurity standard. We suspect
        that awards of new contracts are likely to be delayed as a result. 
        Based on our research, Mercury appears ill-prepared to address these new
        requirements given its relative shortage of cyber security personnel,
        and the fact that both its long-time CIO and long-time Chief Information
        Security Officer recently departed in August 2018.  We estimate that
        Mercury could have to spend up to 10% of revenue on cyber-related costs
        going forward, or otherwise make a costly acquisition to comply with
        these new customer expectations.  Mercury has quietly hinted at some of
        these concerns through subtle changes to its 10-K risk factors and safe
        harbor provisions, and through recent job postings in supply chain
        procurement and quality control.


    --  Deteriorating Financial Metrics, Undisclosed Signs Of Strain, And
        Evidence Of Misrepresentation: In our first report, we highlighted
        Mercury's risk of losing its small business status for government
        contracts.  Mercury lost this status earlier this year, which has
        coincided with rising inventories relative to backlog convertible to
        revenues in the next 12 months.  Mercury's gross margins have now fallen
        below its "low target" of 45%, and could compress further due to DFARS
        compliance issues and potential product recall costs from the Supermicro
        fallout. Additionally, Mercury recently amended its credit agreement for
        a third time in late September 2018, but never disclosed that it had
        amended the agreement previously in December 2017, just as it began
        factoring accounts receivable. Factoring accounted for a substantial 43%
        of FY18 operating cash flow.
    --  Mercury's Irrational Valuation Multiple Could Materially Contract:
        Mercury currently has the highest valuation in the Aerospace & Defense
        industry despite posting the space's weakest cash flow as a percentage
        of revenue and average organic revenue growth. Sell-side analysts see
        just 9.5% upside in its share price, but haven't factored in
        complications arising from its Supermicro relationship and rising cyber
        compliance costs. Taking these issues into consideration, and
        discounting Mercury's multiple to the industry average, we estimate 50%
        -60% downside.

The research report can be found on our website at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.

Spruce Point Capital has a short position in Mercury Systems, Inc. (MRCY) and stands to benefit if its share price falls.

About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.

Contact
Sean Donohue
Spruce Point Capital Management
sean.donohue@sprucepointcap.com
212-519-9813

Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.

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SOURCE Spruce Point Capital Management, LLC