Datatec DTC
August 16, 2018 - 8:01am EST by
honeycreek
2018 2019
Price: 22.42 EPS 0 0
Shares Out. (in M): 243 P/E 0 0
Market Cap (in $M): 378 P/FCF 0 0
Net Debt (in $M): 6 EBIT 0 0
TEV ($): 384 TEV/EBIT 0 0

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Description

Datatec is a $378m market value South African listed IT company that trades in South Africa but generates the vast
majority of its revenues and profits in North America, Europe and Asia. The share price in USD has suffered from
the rand’s devaluation in 2018, even though Datatec has virtually zero exposure to South Africa.
 
Datatec was written up on VIC in May 2017 as an event trade after Synnex announced that it would purchase
Datatec’s Westcon Americas division for $600m plus a possible contingent payout and 10% of Westcon
International for $30m. The deal closed on September 1, 2017. After the transaction, Datatec paid a $350m special
dividend and continues to own 90% of Westcon International and 100% of Logicalis. We believe that Datatec is
available to be purchased at a 62.2% discount to intrinsic value (165% upside). Catalysts include a newly approved
share repurchase plan and a turnaround of the Westcon International business, which has suffered due to an
extended ERP implementation that was recently completed. Additionally, we believe that management’s decision
to sell 10% of Westcon International signals a desire to sell the remaining 90% after the business stabilizes
(management has also indicated this to us when we spoke). Following the sale of Westcon International, Datatec
would eliminate the remaining headquarters expense. In that scenario we believe Datatec could be 71.6%
undervalued (253% upside).
 
Business Description
Westcon is a global IT distributor. It was split into two parts for the sale to Synnex: Americas (North and Latin) and
International (Europe, Asia Pacific, Middle East, and Africa). The Americas portion was sold to Synnex for $600m
plus a contingent payout (still to TBD). Synnex also bought 10% of Westcon International for $30m with an option
to buy an additional 10% for another $30m. The Westcon business consists of two separate businesses: Westcon
and Comstor. Westcon distributes security solutions, unified communications, networking infrastructure and data
centers for a wide variety of manufacturers. Comstor focuses on Cisco and distributes Cisco’s full line of solutions
including Cisco ONE, security, collaboration, data center, SolutionsPlus and DevNet ecosystem partner
applications, Cisco services, software and IoT.
 
Logicalis is a value-added system integrator/reseller. Logicalis provides technical expertise to identify, install and
manage IT systems for its customers. They specialize in digital technologies, including data center, cloud services,
security and network infrastructure, workspace communications and collaboration and IT modernization. Logicalis
is run independently from Westcon and competes with Westcon’s customers. Logicalis is a growing, asset light
business with high returns on capital. The small blip in growth in 2015/2016/2017 is mainly due to weakness in Brazil.
 
  2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Sales 505,179 693,113 845,112 1,005,355 838,582 1,046,422 1,234,334 1,350,442 1,549,962 1,533,777 1,532,766 1,510,299 1,563,714
EBITDA 16,707 26,795 36,196 56,959 42,357 53,032 67,395 78,593 90,318 97,039 80,947 79,009 86,165
EBITDA Margin 3.3% 3.9% 4.3% 5.7% 5.1% 5.1% 5.5% 5.8% 5.8% 6.3% 5.3% 5.2% 5.5%
EBIT 11,546 18,783 26,141 39,313 25,203 31,340 42,609 54,697 67,523 74,165 56,355 54,422 59,483
EBIT Margin 2.3% 2.7% 3.1% 3.9% 3.0% 3.0% 3.5% 4.1% 4.4% 4.8% 3.7% 3.6% 3.8%
                           
Greenblatt IC     36,700 51,700 81,300 98,800 87,200 101,600 110,800 87,800 44,300 89,000  
EBIT/IC       88.9% 37.9% 34.8% 45.8% 57.9% 63.6% 74.7% 85.3% 81.7%  
 
Datatec also owns Analysys Mason, a small telecom focused consultancy.
 
Recent Events
Sale of Westcon Americas Datatec received $600m from the sale of Westcon Americas less $29m in taxes and
deal fees. In January 2018, the company paid a special dividend of $350m with a dividend scrip option. ~30% of
shareholders opted for the dividend scrip instead reducing the actual cash dividend to $245m. Of the remaining
cash, $250m sat at the headquarters as of February 28, 2018 and the rest was used to fund losses and pay down
debt.
 
Struggles at Westcon - The remaining Westcon International business is facing difficulties on multiple fronts. As
with any ERP system upgrade, the implementation has been overdue and over budget. However, it’s important to
note that the company has gone live with the system in all geographies. Datatec first upgraded its ERP system in
North America in 2013. The International implementation is more challenging than North America as it is dealing
with dozens of countries compared to just the US and Canada. Additionally, Datatec concurrently did a business
process outsourcing implementation (subsequently abandoned) at the same time which brought its own issues.
Lastly, when they sold the America’s business they retained all the corporate level expense of Westcon and agreed
to keep all the support in place for one year to support Synnex at Datatec’s expense. This has left the company
with a bloated corporate structure that should begin being right sized in September 2018. All these issues
combined have left Westcon International losing money. In the 2018 FY (ends February), Westcon International
lost $72m in EBIT (before write downs) with 65% of the losses coming in the 2H as issues peaked. When the
company reported the Feb 2018 full year results in May they stated that business has improved and guided
towards breakeven in FY19. We gain confidence from the North America ERP implementation timeline which
severely disrupted the NA business. ERP implementation was complete in 2013 but it took 12-18 months to work
through the ensuing issues during which revenue fell 15% in 1H14 compared to 1H13 levels and margins fell from
3.9% in 2012 to 2.8% in 2014. After the implementation issues were resolved revenue rebounded by growing 75%
over the next 18 months and margins returned to normal from 2.8% in 2014 to 3.9% in 2016. The international
implementation is more difficult on many fronts and has faced more issues and worse financial results, but we gain
confidence from the North America case study and from the CEO’s open market purchase of $1.6m of shares in June
2018 and the CFO’s small open market in June 2018.
 
Share Repurchase The company recently had a special meeting to get approval to buyback 5% of the company’s
shares in the months leading up to the Annual Meeting. At the Annual Meeting a new repurchase plan will be put
in place. The company intends to use the $105m leftover ($350m-$245m) from the special dividend to repurchase
shares. At the current market value this would equate to buying back 28% of shares.
 
Valuation
We value Datatec using a sum of the parts analysis. There are three components to the valuation: Westcon,
Logicalis, and central/corporate.
 
Base Case:
We value Westcon International at $145m. This consists of a base valuation of $246m for their 90%. This valuation
is $2.7B in sales (achieved in 2015 and 2016) at a 2% EBITDA margin (achieved higher prior to ERP implementation)
at a 7.5x EBITDA multiple which results in a value of $405m. $405m less $131m in net debt is how we arrive at a
$273m equity valuation, of which they own 90%. Additionally, we assume an additional $110m in cash burn/value
destruction as they recover the business to be conservative. The last adjustment is an additional $9m in value from
an intercompany $90m loan from Datatec (100% owned) to Westcon Int. (90% owned). We feel this valuation is
very conservative and well below the $300m equity valuation at which Synnex bought the first 10%.
 
We value Logicalis at 14x EBIT (peer multiple average of Computacenter, Softcat,Bechtle, Atea, Dustin Group,
Proact IT Group, CDW Corp, Systemex, Insight Enterprises) which results in a value of $833m. Additionally, Logicalis
has net debt of $92m. This net debt is atypical and Logicalis is typical run with no debt. The debt is short term
working capital to fund for a special project that requires working capital and will unwind in a few years and
generate earnings along the way. Therefore, we do not view this debt as financial debt, but short-term funding
supported by inventory and do not subtract it from the value. Lastly, Logicalis only owns 66% of its Brazil subsidiary
which we estimate makes Datatec’s look through ownership of Logicalis’s consolidated financial results at 80%
(varies depending on relative strength of Brazil vs. rest of world). This results in a net value of $666m to Datatec.
 
Lastly, the corporate level has $309m in net cash, investments and loans and the Analysis Mason business which we
value at 7x EBITDA for $18m. We put a 10x multiple of the central headquarters costs of $13.5m for a value of -$135m.
$309 + 18m 135m = $192m.
 
Summing this up is $145 (Westcon) + $666m (Logicalis) + $192m (Central) is $1,003m compared to the market
value of $378m for a discount of 62.2%. Do note this does not include any value for the contingent payout of
Westcon Americas from Synnex. The period for this closed in February but the settlement in undergoing
arbitration. Synnex’s latest reserve for this payment was $33m in their 10-K in November, but no update has been
given.
 
Bull Case:
The bull case for Westcon International is that it is sold to Synnex in 2 years for the same multiple as the Americas
business after sales rebound to $3B and EBITDA margins recover. Synnex paid 8x EBITDA before central costs for
Westcon Americas. Westcon Americas had ~$30m in central costs, which as previously mentioned stayed at
Westcon International. Synnex claimed they could put Westcon America’s on their platform at no incremental
costs and thus the EBITDA before central costs was the right multiple to look at. We assume that EBITDA before
central costs get to 3.4% margin which is the low end of margins from 2010-2014 where margins fluctuated
between 3.4% and 3.8% at what is now called Westcon International. This results in a valuation of $804.4m (3B x
3.4% x 8x). After adjusting for debt, the equity value is $672m and assuming this takes 2 years to occur results in
an NPV of $555.9m. We assume they own 80% of that and Synnex exercised their option to buy an additional 10%
for $30m. Additionally, we assume a $50m contingent payout from the Westcon Americas sales and that the same
restructuring/cash burn charges as the base case (-$110m) and intercompany loan adjustment (+$9m) which puts the
net value at $424m.
 
The bull case for Logicalis is the same with a peer multiple of 14x.
 
The bull case for central we assume that after the Westcon business is fully sold that all of the Datatec central
costs can be removed which adds $135m to the valuation).
 
In total, $423m + $666m + $327m = $1,416m. This results in a discount to intrinsic value of 71.6%.
 
Bear Case:
For the bear case we assume Westcon is unfixable and worth 0 and further reduce the multiple of Logicalis to 30%
discount to peers or a 9.8xEBIT multiple for valuation of $466m after minority interests. We also assume that
despite Westcon being unfixable, that the central costs at Datatec remain. This results a value of $581m compared
to the market cap of $378m for a discount of 34.7%.
 
Management
Lastly, it is worth noting that the CEO Jens Montanana founded the company in 1986 and owns $17.5m worth of
stock which aligns him with shareholders.
 
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Share Repurchase Plan

Turnaround of Westcon

Sale of Westcon

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    Description

    Datatec is a $378m market value South African listed IT company that trades in South Africa but generates the vast
    majority of its revenues and profits in North America, Europe and Asia. The share price in USD has suffered from
    the rand’s devaluation in 2018, even though Datatec has virtually zero exposure to South Africa.
     
    Datatec was written up on VIC in May 2017 as an event trade after Synnex announced that it would purchase
    Datatec’s Westcon Americas division for $600m plus a possible contingent payout and 10% of Westcon
    International for $30m. The deal closed on September 1, 2017. After the transaction, Datatec paid a $350m special
    dividend and continues to own 90% of Westcon International and 100% of Logicalis. We believe that Datatec is
    available to be purchased at a 62.2% discount to intrinsic value (165% upside). Catalysts include a newly approved
    share repurchase plan and a turnaround of the Westcon International business, which has suffered due to an
    extended ERP implementation that was recently completed. Additionally, we believe that management’s decision
    to sell 10% of Westcon International signals a desire to sell the remaining 90% after the business stabilizes
    (management has also indicated this to us when we spoke). Following the sale of Westcon International, Datatec
    would eliminate the remaining headquarters expense. In that scenario we believe Datatec could be 71.6%
    undervalued (253% upside).
     
    Business Description
    Westcon is a global IT distributor. It was split into two parts for the sale to Synnex: Americas (North and Latin) and
    International (Europe, Asia Pacific, Middle East, and Africa). The Americas portion was sold to Synnex for $600m
    plus a contingent payout (still to TBD). Synnex also bought 10% of Westcon International for $30m with an option
    to buy an additional 10% for another $30m. The Westcon business consists of two separate businesses: Westcon
    and Comstor. Westcon distributes security solutions, unified communications, networking infrastructure and data
    centers for a wide variety of manufacturers. Comstor focuses on Cisco and distributes Cisco’s full line of solutions
    including Cisco ONE, security, collaboration, data center, SolutionsPlus and DevNet ecosystem partner
    applications, Cisco services, software and IoT.
     
    Logicalis is a value-added system integrator/reseller. Logicalis provides technical expertise to identify, install and
    manage IT systems for its customers. They specialize in digital technologies, including data center, cloud services,
    security and network infrastructure, workspace communications and collaboration and IT modernization. Logicalis
    is run independently from Westcon and competes with Westcon’s customers. Logicalis is a growing, asset light
    business with high returns on capital. The small blip in growth in 2015/2016/2017 is mainly due to weakness in Brazil.
     
      2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
    Sales 505,179 693,113 845,112 1,005,355 838,582 1,046,422 1,234,334 1,350,442 1,549,962 1,533,777 1,532,766 1,510,299 1,563,714
    EBITDA 16,707 26,795 36,196 56,959 42,357 53,032 67,395 78,593 90,318 97,039 80,947 79,009 86,165
    EBITDA Margin 3.3% 3.9% 4.3% 5.7% 5.1% 5.1% 5.5% 5.8% 5.8% 6.3% 5.3% 5.2% 5.5%
    EBIT 11,546 18,783 26,141 39,313 25,203 31,340 42,609 54,697 67,523 74,165 56,355 54,422 59,483
    EBIT Margin 2.3% 2.7% 3.1% 3.9% 3.0% 3.0% 3.5% 4.1% 4.4% 4.8% 3.7% 3.6% 3.8%
                               
    Greenblatt IC     36,700 51,700 81,300 98,800 87,200 101,600 110,800 87,800 44,300 89,000  
    EBIT/IC       88.9% 37.9% 34.8% 45.8% 57.9% 63.6% 74.7% 85.3% 81.7%  
     
    Datatec also owns Analysys Mason, a small telecom focused consultancy.
     
    Recent Events
    Sale of Westcon Americas Datatec received $600m from the sale of Westcon Americas less $29m in taxes and
    deal fees. In January 2018, the company paid a special dividend of $350m with a dividend scrip option. ~30% of
    shareholders opted for the dividend scrip instead reducing the actual cash dividend to $245m. Of the remaining
    cash, $250m sat at the headquarters as of February 28, 2018 and the rest was used to fund losses and pay down
    debt.
     
    Struggles at Westcon - The remaining Westcon International business is facing difficulties on multiple fronts. As
    with any ERP system upgrade, the implementation has been overdue and over budget. However, it’s important to
    note that the company has gone live with the system in all geographies. Datatec first upgraded its ERP system in
    North America in 2013. The International implementation is more challenging than North America as it is dealing
    with dozens of countries compared to just the US and Canada. Additionally, Datatec concurrently did a business
    process outsourcing implementation (subsequently abandoned) at the same time which brought its own issues.
    Lastly, when they sold the America’s business they retained all the corporate level expense of Westcon and agreed
    to keep all the support in place for one year to support Synnex at Datatec’s expense. This has left the company
    with a bloated corporate structure that should begin being right sized in September 2018. All these issues
    combined have left Westcon International losing money. In the 2018 FY (ends February), Westcon International
    lost $72m in EBIT (before write downs) with 65% of the losses coming in the 2H as issues peaked. When the
    company reported the Feb 2018 full year results in May they stated that business has improved and guided
    towards breakeven in FY19. We gain confidence from the North America ERP implementation timeline which
    severely disrupted the NA business. ERP implementation was complete in 2013 but it took 12-18 months to work
    through the ensuing issues during which revenue fell 15% in 1H14 compared to 1H13 levels and margins fell from
    3.9% in 2012 to 2.8% in 2014. After the implementation issues were resolved revenue rebounded by growing 75%
    over the next 18 months and margins returned to normal from 2.8% in 2014 to 3.9% in 2016. The international
    implementation is more difficult on many fronts and has faced more issues and worse financial results, but we gain
    confidence from the North America case study and from the CEO’s open market purchase of $1.6m of shares in June
    2018 and the CFO’s small open market in June 2018.
     
    Share Repurchase The company recently had a special meeting to get approval to buyback 5% of the company’s
    shares in the months leading up to the Annual Meeting. At the Annual Meeting a new repurchase plan will be put
    in place. The company intends to use the $105m leftover ($350m-$245m) from the special dividend to repurchase
    shares. At the current market value this would equate to buying back 28% of shares.
     
    Valuation
    We value Datatec using a sum of the parts analysis. There are three components to the valuation: Westcon,
    Logicalis, and central/corporate.
     
    Base Case:
    We value Westcon International at $145m. This consists of a base valuation of $246m for their 90%. This valuation
    is $2.7B in sales (achieved in 2015 and 2016) at a 2% EBITDA margin (achieved higher prior to ERP implementation)
    at a 7.5x EBITDA multiple which results in a value of $405m. $405m less $131m in net debt is how we arrive at a
    $273m equity valuation, of which they own 90%. Additionally, we assume an additional $110m in cash burn/value
    destruction as they recover the business to be conservative. The last adjustment is an additional $9m in value from
    an intercompany $90m loan from Datatec (100% owned) to Westcon Int. (90% owned). We feel this valuation is
    very conservative and well below the $300m equity valuation at which Synnex bought the first 10%.
     
    We value Logicalis at 14x EBIT (peer multiple average of Computacenter, Softcat,Bechtle, Atea, Dustin Group,
    Proact IT Group, CDW Corp, Systemex, Insight Enterprises) which results in a value of $833m. Additionally, Logicalis
    has net debt of $92m. This net debt is atypical and Logicalis is typical run with no debt. The debt is short term
    working capital to fund for a special project that requires working capital and will unwind in a few years and
    generate earnings along the way. Therefore, we do not view this debt as financial debt, but short-term funding
    supported by inventory and do not subtract it from the value. Lastly, Logicalis only owns 66% of its Brazil subsidiary
    which we estimate makes Datatec’s look through ownership of Logicalis’s consolidated financial results at 80%
    (varies depending on relative strength of Brazil vs. rest of world). This results in a net value of $666m to Datatec.
     
    Lastly, the corporate level has $309m in net cash, investments and loans and the Analysis Mason business which we
    value at 7x EBITDA for $18m. We put a 10x multiple of the central headquarters costs of $13.5m for a value of -$135m.
    $309 + 18m 135m = $192m.
     
    Summing this up is $145 (Westcon) + $666m (Logicalis) + $192m (Central) is $1,003m compared to the market
    value of $378m for a discount of 62.2%. Do note this does not include any value for the contingent payout of
    Westcon Americas from Synnex. The period for this closed in February but the settlement in undergoing
    arbitration. Synnex’s latest reserve for this payment was $33m in their 10-K in November, but no update has been
    given.
     
    Bull Case:
    The bull case for Westcon International is that it is sold to Synnex in 2 years for the same multiple as the Americas
    business after sales rebound to $3B and EBITDA margins recover. Synnex paid 8x EBITDA before central costs for
    Westcon Americas. Westcon Americas had ~$30m in central costs, which as previously mentioned stayed at
    Westcon International. Synnex claimed they could put Westcon America’s on their platform at no incremental
    costs and thus the EBITDA before central costs was the right multiple to look at. We assume that EBITDA before
    central costs get to 3.4% margin which is the low end of margins from 2010-2014 where margins fluctuated
    between 3.4% and 3.8% at what is now called Westcon International. This results in a valuation of $804.4m (3B x
    3.4% x 8x). After adjusting for debt, the equity value is $672m and assuming this takes 2 years to occur results in
    an NPV of $555.9m. We assume they own 80% of that and Synnex exercised their option to buy an additional 10%
    for $30m. Additionally, we assume a $50m contingent payout from the Westcon Americas sales and that the same
    restructuring/cash burn charges as the base case (-$110m) and intercompany loan adjustment (+$9m) which puts the
    net value at $424m.
     
    The bull case for Logicalis is the same with a peer multiple of 14x.
     
    The bull case for central we assume that after the Westcon business is fully sold that all of the Datatec central
    costs can be removed which adds $135m to the valuation).
     
    In total, $423m + $666m + $327m = $1,416m. This results in a discount to intrinsic value of 71.6%.
     
    Bear Case:
    For the bear case we assume Westcon is unfixable and worth 0 and further reduce the multiple of Logicalis to 30%
    discount to peers or a 9.8xEBIT multiple for valuation of $466m after minority interests. We also assume that
    despite Westcon being unfixable, that the central costs at Datatec remain. This results a value of $581m compared
    to the market cap of $378m for a discount of 34.7%.
     
    Management
    Lastly, it is worth noting that the CEO Jens Montanana founded the company in 1986 and owns $17.5m worth of
    stock which aligns him with shareholders.
     
    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Share Repurchase Plan

    Turnaround of Westcon

    Sale of Westcon

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