Description

I believe Ingram Micro (“IM”) represents an attractive opportunity to invest in a dramatically undervalued company that has several positive earnings drivers over the next two years.  IM is the largest wholesale distributor of technology products in the world with revenues expected to top $40 billion this year.  The business has performed well in the past year in a tough environment and I believe the company has reached an inflection point.  I estimate cash EPS should grow from around $2 in 2012 to ~$2.50 in 2013 and ~$2.90 in 2014.  As this strong earnings profile is better appreciated by the market, I believe IM’s stock should approach $30 over the coming 18 months, representing a greater than 50% return from the current stock price.  Additionally, I believe the downside risk in the investment is very low as IM trades at around tangible book value, and book value will grow at a fairly high rate as return on equity will almost certainly improve to the low teens in the coming year. 

I originally wrote up Ingram Micro in April 2010 at roughly the same price that it is trading today.  Since then, the company has (1) generated around $850 million of net income (roughly $5.50 per share), (2) hired a new CEO that I think is already vastly improving the business and (3) completed a highly accretive acquisition that I believe will drive strong EPS growth and better utilize the company’s balance sheet. 

Over the past several years, IM’s stock has languished despite generating significant profits owing to (1) general industry concerns around tech hardware spend, (2) a botched IT implementation in its Australia subsidiary that led to significant losses and (3) concerns around the company’s ability to integrate its recent acquisition of BrightPoint.

In October 2012, IM acquired BrightPoint, a distributor and servicer of devices for the wireless industry, for $870 million.  I believe the acquisition will prove to be a positive for the stock as the company is utilizing its significantly overcapitalized balance sheet to drive meaningful earnings and ROE improvement through a highly synergistic transaction.  I believe the acquisition, with synergies fully ramped in 2014, will improve cash EPS by around $0.50 or 25% from 2012 levels.  Additionally, I believe the losses in the company’s Australian subsidiary should be eliminated in the coming 18 months and the company’s break-even Brazilian subsidiary should turn profitable this year. 

$3+ of Cash EPS by 2015

Key Points

• Attractive Business.  IM has a stable, leading market position with tremendous competitive advantages through its scale.  The business has been very steady, never having anything even approaching an unprofitable quarter as a public company, a period that includes both the recent financial crisis and the technology downturn of 2000 to 2002.  The company is not at the mercy of any specific tech hardware trend as the company is able to readily switch product in its channel based on customer demand.  Return on invested capital has tended to average around 12% to 13%, well above the company’s cost of capital.  The business is well positioned in high-growth markets like China, India and Brazil and the business has been growing organically well above GDP.  I conservatively forecast the Base Business (which I define as excluding the dynamic cases of Australia, Brazil and BrightPoint) to grow at 2.5% per annum.  With continued growth in logistics businesses and operating leverage, I believe it is possible for this number to be closer to 5%.

• New CEO.   In early 2012, IM replaced its CEO.  I believe the new CEO, Alain Monie, is a big upgrade and he has instilled a new sense of urgency in the company.  He was the former COO and ran the APAC business from 2004 through 2007.  He is also on the board of Amazon.  Since he has taken over, the company’s performance has improved despite a tough demand backdrop.  Management is now heavily compensated on shareholder returns and I have a high degree of confidence in management’s ability to drive operating improvements.   

• Australia Turnaround.  An ERP upgrade in 2011 to Australia’s acquired legacy system resulted in disruptions and order delays, dramatically impacting sales and profitability.  In 2010, Australia generated $25 million of operating profit for IM.  By 2011, Australia generated a loss of more than $50 million, a $75 million drag on profitability.  In 2012, losses were cut to $40 million and management is very focused on returning the business to breakeven in the next year.  Australia still generates more than $1.2 billion in annual revenues and should ultimately turn into a profit contributor once again. 

• Brazil Profitability.   IM’s Brazilian operations were a drag on operating profits in 2011 ($20 million loss) before breaking even in 2012 following a 50% increase in sales and a dedicated turnaround effort.  Brazil is expected to be profitable in 2013 and should grow nicely over the next several years.

• Accretion from BrightPoint.   The acquisition of BrightPoint will drive significant EPS growth and materially improve IM’s ROTE profile.  BrightPoint focuses on mobile distribution (cell phones and tablets) and has significant overlap with IM’s tech distribution footprint.  Cost-cuts alone will drive $55 million of incremental profit.  Additionally, expanding BrightPoint’s presence into markets where IM is already dominant (such as China and Canada) should drive meaningful revenue synergies (which management has not quantified and I exclude from my projections).  From the end of 2009 through Q3 2012, IM averaged an ending net cash balance of around $550 million, more than 15% of the current market capitalization.  The sizeable net cash position depressed IM’s ROTE, which has historically averaged ~10%.  A good portion of BrightPoint’s business is derived from higher-margin, less capital-intensive logistics services which, when coupled with the synergies, will expand IM’s ROE above 12%.  I believe this should help re-rate the shares to a valuation considerably above book value.

• Tangible Book Value Provides Downside Protection.   At the end of 2012, IM had tangible book value per share of $19.  Stated book needs to be adjusted for intangible assets and an $84 million non-cash deferred tax liability associated with the BrightPoint deal that will be released as the intangibles are amortized.   This book value consists mostly of inventory and receivables, both of which are very liquid assets and money good.  The nice thing about the tech distribution model is that if revenues slow, the business releases a lot of working capital and produces significant cash flow.  For example in 2008, IM generated around $470 million in free cash flow (over 15% of the current market cap).  Not only do I think book should grow at a double-digit rate in the future from EPS, but I also think management is likely to resume share repurchases next year as the company approaches a net cash position.  Between 2008 and 2011, IM repurchased around $600 million of shares, and I believe that increased profitability and management’s focus on total shareholder return (a newly added executive comp metric in 2012) will drive prudent capital allocation.

Valuation and Price Targets

At a multiple of 7x EBITA (equating to barely over 10x cash earnings and 1.2x tangible book), the stock would trade at around $30 per share in 2014.  This multiple is a discount to many other distribution companies (ARW, AVT, MCK, ABC, CAH, CORE and SYY) and a premium to where its smaller tech distribution peers (TECD and SNX) currently trade (which are also arguably very cheap right now).   I think that IM’s market leading position, coupled with the tailwinds from the factors discussed above, warrant a premium multiple to the other tech distribution comps.  Finally, I think it is unlikely the stock will trade below tangible book given the improving ROTE profile.  Tangible book should be around $24 by the end of 2014, which is over 20% above the current price.

Catalyst