I am recommending the purchase of Tech Data Corp (TECD), which I believe can provide substantial upside over the next few years with comparatively modest downside risk. TECD is one of the largest wholesale distributors of technology products in the world with annual revenues exceeding $25 billion. This industry is not unknown to the VIC community as the largest global player, Ingram Micro (IM), was posted as a long idea last month by Hawkeye. For what it’s worth, we too like IM as well as ePlus, a value-added reseller of technology products, which we have posted to VIC previously and which continues to be among our largest positions.
Let’s start with the bad news, and to be clear, there is lots not to like about TECD. This is a low-margin, highly competitive space subject to the vicissitudes of the tech market. For its part, TECD has performed pretty miserably in the past year: last month, the company announced that it was withdrawing its financial statements for fiscal years 2011-2013 (January fiscal year) and would restate them “to correct improprieties primarily related to how the Company's U.K. subsidiary reflected vendor accounting.” Consequently, the company is in non-compliance with its requirement to file its 10K in a timely manner and thus has received the standard warning about potential delisting. This latest misstep follows a botched SAP implementation in the U.S. last year that cost TECD market share. Although the systems issues have been rectified, TECD had to sacrifice margin to recapture its lost U.S. market share. Did I mention that over 60% of the business is in Europe, and in case you haven’t noticed, the economy there isn’t exactly humming along. Finally, TECD management have overpromised and under-delivered, repeatedly disappointing the Street along the way. Add it all up and you have a stock that is down nearly 20% in the past year, hovering slightly above its 52-week low, and is in the Street’s penalty box, carrying mostly neutral ratings and a Sell from BAML (and from Goldman until they suspended coverage of the sector).
As for the good news, well the bad news IS the good news because IMHO it is all discounted in the stock, and then some. In other words, expectations are so low that not much has to go right for TECD for the stock to appreciate nicely. As an example, let’s take some the issues identified above and dissect them further. First, the restatement is concerning for all the obvious reasons—and the market responded accordingly, lopping some 10% off TECD’s market cap in the days following the announcement (and the stock is even lower today). However, the accounting problems were isolated in the UK subsidiary, and the company has already estimated that the restatements will impact total operating income over the three affected fiscal years by a total of only $30-40 million. In the scheme of things on a long-term horizon, this will likely prove to blip that doesn’t impact intrinsic value materially. As for the SAP debacle, this too was regrettable, but is largely yesterday’s news. The system itself apparently was not the issue but rather a poor job of rolling it with appropriate training tec. In any event, according to management (from last month’s earnings call and a presentation at the Goldman Tech conference), the US business has been hitting its sales plan and is steadily regaining market share without sacrificing price. As for Europe, TECD is the largest player in the market and has been increasing its market share steadily.
Adding to the noise in the numbers last year was an accounting change (regarding the presentation of sales of vendor warranty services and certain fulfillment contracts), costs associated with the exit from Brazil and Colombia, and the $365 million acquisition of Specialist Distribution Group (SDG), a $2.5 billion annual sales distribution business in Europe. SDG closed in Q4 and was dilutive to margins and earnings in the quarter, but it should be accretive going forward and is a good strategic fit.
Despite all of these challenges, TECD repurchased $185 million of stock last year, which is pretty significant for a company whose current market cap sits at just $1.6 billion. Indeed, since 2005, TECD has returned some $1.1 billion to shareholders through share repurchases.
As I indicated above, expectations for TECD are pretty low, and the company’s valuation is similarly undemanding at 4.4x current fiscal year EBITDA and less than 9x EPS, with a mid-teens free cash flow yield. Moreover, TECD trades at a discount to tangible book value. Despite TECD’s track record of share repurchases and acquisitions, it has managed to maintain a robust balance sheet, which today carries total debt of $519 million against $392 million of cash. The company funded the SDG deal with its first straight debt transaction, selling five-year notes with a 3.75% coupon. Even with its stumbles last year, TECD generated a 12% ROIC so the SDG deal should be nicely value-enhancing once it’s been fully integrated. [Thank you Chairman Bernanke!]
FD shares 38.0
Price (4/18) 43.48
Market Cap 1,652
Net Debt 127
FCF Yield ~17%
A few notes on the numbers are in order. I believe that over the next two years—barring significant deterioration in the global economy but also not assuming any significant acceleration either, i.e. more of the same muddle-through—that TECD can generate over $450 million of annualized EBITDA. By comparison, the company did $425 million in fiscal 2012 before it was beset by the litany of issues discussed above. On this basis, TECD should generate well over $300 million of free cash flow, which provides a very attractive free cash flow yield. As for free cash flow, it is highly erratic owing to short-term swings in working capital. However, over the past five years, TECD has generated nearly $1.3 billion of free cash flow after capex and cash acquisitions (note that for this figure I have excluded SDG which would skew the numbers since it closed just recently). If history is any guide, TECD will use this cash flow to reduce debt, fund tuck-in acquisitions and repurchase shares.
I do not hold a position of employment, directorship, or consultancy with the issuer. Neither I nor others I advise hold a material investment in the issuer's securities.
Completion of restatement and becoming current on filing requirements
Normalization of operating results and resumption of growth