|Shares Out. (in M):||39||P/E||8||8|
|Market Cap (in $M):||3,250||P/FCF||8||8|
|Net Debt (in $M):||-600||EBIT||650||675|
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Amazon – While Amazon presents a threat to many companies in the distribution space, Tech Data is not likely to be one of them. Amazon’s business model relies on quickly getting customers the products they know they want at cheap prices. By contrast, Tech Data’s business model focuses on leveraging its 14k employees to provide education and support to customers that are installing complex systems. As one industry participant stated: “No, I do not think Amazon is a threat” If we’re talking simple product, Amazon will chip in (with a computer or tablet). But, what do you do when you get the product? You have to install the software and integrate to other hardware – so unless Amazon hires and builds 2,000 system engineers, they will not be able to compete.”
Software – Another fear around TECD is that they will lose importance as the industry moves towards the cloud and away from hardware purchases. First, TECD is still involved with software as they get a fee for integrated software onto hardware that they dispense. For example, if you purchase a server with a firewall program, an operating system, and virtualization software, TECD will actually integrate those different products for you. Plus, some folks forget that with the cloud there is always hardware installed at some location, even if it is offsite for the end user.
Avnet Deal – In late 2016, TECD announced the acquisition of Avnet’s enterprise business which added a similar, but more specialized, higher margin enterprise business. This was a good deal for them on different fronts. It increased their exposure to data centers, which tend to have more project-based work and should be a beneficiary of a move towards cloud-based growth. The broader purpose of the deal also makes real sense, and it is so that “solution providers can fulfill all of their product and service needs in a single place” (TECD CEO). It also adds depth on the higher touch and higher complexity end of the distribution business. Avnet’s business ran with much less inventory and generated OM’s near 3.5% vs TECD at 1.4% as it provides more specialized project management solutions. While TECD does 50k transactions per day, TS does only 1k. As TECD’s CFO has said: “it’s a move toward higher value from a business model perspective…the value segment of the market has better financial attributes than the volume segment.”
From a financial perspective, TECD was under-levered with Net Cash to EBITDA of 1x prior to the Avnet deal. That increased to 2x Net Debt after the deal and has subsequently been brought back down to below 1x, so they can resume share buybacks (at 8x EPS!). Because they were so under-levered, the accretion on this deal was massive with next-year EPS expected to be over $10.50, up from under $6.50 in 2016.
4Q17 Earnings – the stock sold off nearly 20% after its earnings announcement in early March. 4Q Sales and EPS actually came in better than expected, but the 1Q forecast was below expectations and they tweaked their full-year operating profit estimate down. Interestingly, the implied EPS for next year went up because of a lower tax rate to ~$10.85 (from $10.60 that they expected for next year as of their Investor Day in October 2017). There were some concerns about vendor pressure, but we believe this is part of their normal business operations and sometimes result in volatile earnings over the short-term. As the CEO said on the call: “it’s been like that forever. This isn’t a unique moment in time. It’s just the way the [distribution] channel and the direct [salesforce] works together”. Plus, they achieved their target debt-level 6-12 months ahead of plan and can now commence returning capital to shareholders through stock repurchases.
Valuation and Forward Earnings – for the year-ending January 2019, TECD First-Call EPS is $10.50. We prefer to look at 5-year forward earnings and apply a 9x P/E multiple. We think they can grow EPS 10% sustainably. That would result in 5-year forward earnings of $17.50 and a fair value of ~$160. This would equate to roughly 15x next-12-months EPS, which I think is reasonable in today’s market.
Earnings reports and stock repurchases.
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