February 25, 2005 - 2:15pm EST by
2005 2006
Price: 56.10 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,832 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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What's this? A stock profile in VIC that has a mind-numbing pe of - goodness gracious - 20x earnings? Are you out of your mind poster idea writer? Like most of my recent ideas, this is a good business trading at a reasonable price, and some of these ideas have done well (DG and LTD) while others (FII, GPS?) haven't.

Maybe the worst thing you can say about CDW Corp is that they don't have a moat and all they do is sell, and you'd be dead right. But why does this matter if a company is good enough to dominate the field? If you've ever been in a Walgreen's you'll understand the point here - what is it that makes Walgreen's different? It isn't the store itself, cause you could buy this stuff anywhere. It isn't necessarily the location, cause you can find a drug stores all over the place. So what is it then that makes the company successful? Execution, execution, execution.

Description: CDW markets a wide range of computer products via catalogs, the internet, and by tele-marketing. Yeah, you've read this correctly. They sell direct to commercial and government customers, and they do it by getting on the phone and working the lines. There is a particularly good profile (I think) of this company in Fast Company, Jan 05 issue, linked here (which I will avoid repeating):

Here's why I like the company:

1) Absurdly strong balance sheet. They finished 04 with 478m in cash, 580m in accounts recv, 126m in securities, and a grand total of 280m in total liabilities. Valuing the inventory at nothing, that's a 904 million. The entire market cap at 56.10 (the price my limit struck today) is 4.8 billion.

2) Free Cash Flow galore. Selling stuff to people, acting as a middleman, can be a good business. Ask any retailer worth its salt. CapEx for the last 5 years not including 04 was: 9.2-33-22.5-10.6-34.1. Cash flow (net income + d/a) for the past 5 years was: 105-173-184-201-190. Shareholder's equity has been 199-271-391-636-778-924-1061-1242

3) The leader in multi-vendor sales. CDWC is twice as big as the next largest competitor (Insight, which has a checkered operating history), though to be frank the company considers direct selling departments from Dell, HP, and others as the most serious threat. That FastCompany article does a good job in explaining why the company has a dominant share.

4) A reasonable valuation. Sure, it trades for 20x earnings here (21x with my version of options), but that's exclusive of the balance sheet. Maybe I wouldn't be as interested but cash is cash and that AR is mostly real enough. You can make you own calculations as to enterprise value.

5) Modest prospects for growth. Pegging the top line prospects here is extremely difficult. I could quote some old numbers at you (past 5 years per VL - 34% sales, 36% earnings) and some new numbers (VL suggests 14% sales, 16% earnings; some brokers suggest 10 to 12%. Recent sales numbers suggest low double digits, though the business does see cyclicality in their sales results and you should too. The company continues to add salespeople (lots of numbers in the 10K), with 2012 in the latest quarter. In a recent presentation, the company suggest that IDC estimate were for 224b for It market excluding consumer, with CDW portion at 112-124b, and while these are fuzzball type numbers they do suggest the company can continue to grow at at least a modest rate.

6) Significant Insider Ownership. Well, this is a bit of misnomer, as ONE GUY (Kransy) owns more than 20% of the shares. He sells from time to time too. The compensation levels in the proxy look pretty reasonable to me and the board seems pretty distinguished.

So what has to happen for the company to succeed? The things to monitor include:

a) Sales Force must continue to be Productive. This is a tough fuzzball to crack, but my guess is that the company culture that built the sales levels they have today (close to 6 billion) doesn't just fall apart tomorrow. I wish I knew more (haven't visited these guys - i am a dinky money manager with no money to travel the country) but their HQ offers on-site child-care and a fitness center, along with dry cleaning, private rooms for nursing moms and a series of English classes for those who need to speak the language better. Frankly, I wish I knew salesperson turnover here but you get the impression the company is highly respected (top industry ranking in most admired lists, blah blah). There is an increased emphasis on services and the like, though everybody is going to do that. I do know from personal experience as a user of technology that computers don't seem to be getting easier to use, and one glitch can ruin an entire day. There does seem to be a need.

b) They have to do something with that money. This is the part that worries me. They have started to pay a dividend (just once in the year to save money). They do buy shares, but not enough. This question was asked in the latest conference call and the CEO said mumbo-jumbo words about keeping the powder dry, being opportunistic, blah blah which I didn't understand. They don't usually acquire and when they did it was a dinky purchase of Micro Wearhouse in 03. If earnings grow by 10% for the next three years and CapEx - just fuzzballs here - are 60, 30, and 40 million (they are adding a new DC in 05) they could still add another 900m or so to the balance sheet. Then they'd have close to 2 billion.

c) Options. They aren't horrible, but it does dilute you. I calculate that they've given out 2.1% of their share count on average for the last 5 years but have also experienced a 35% cancellation rate. Management bot 303m in shares to 03 but only moved the share count from 90.86 to 86.175m. Share count went up in 04. They didn't buy shares in the most recent quarter. Plus, with option expensing coming in Q3-05, I'm not sure what if anything will change. At the very least, you have to figure they won't mess with company culture.

Other pitfalls seem pretty obvious:

1) They need customers. You have to have customers to sell stuff to, and sales in 2000 to 2002 were pretty blah (better than multi-brand competitors).

2) HP is a big chunk of sales. Almost 30% so a change in HP's strategy could hurt. CDW also benefits from vendor financed cooperative advertising reimbursement grants.

3) Analysts messing with it. A recent brokerage report I saw hurt the stock cause the analyst decided to being down the long-term valuation on the stock, presumably because the top line growth rate here is not as fast as it used to be. There was no discussion of the balance sheet, free cash flow, or anything else important so I'm not particularly interested in validating that opinion, though CDWC has gone nowhere but down in the past year and the stock is a volatile one.

4) Margins have reached a peak. Every other time net margins reached 4.3% they went down (4.2% latest). This is true, but I assume over the next three years or so that margins will fluctuate around historical levels.

That's it. Here's some other misc details:

Historical Spreadsheet Review
Cash in 97 was 79m, in 04 was 478m
Minimal increases in liabilities
SE increases: 199-271-391-636-778-924-1061-1242
Lowest Margin: 3.7% in 1996
Highest Margin: 4.3% in 2002
Highest Annual Sales Gain: 50% in 2000
Lowest Annual Sales Gain: 8% in 2002
Share count down every year since 2000
CapEx last 5 years not including 04: 9.2-33.0-22.5-10.6-34.1
CF last 5 years not including 04: 105-173-184-201-190
ROE well above 20

PE Range: 48.2 (2000) to 11.9 (1998)
Last year was 26.7-20.1
PB Range 12.3 (2000) to 2.9 (2003)

Institutions own 60.6m of the proj 83m shares
IPO in 1993
No defined pension plan

• Targeting large customers
• Opening local sales offices
• Offering preloaded software, custom configurations, other services
• Salesforce is 30% larger than a year ago
• Takes a while for new hires to pick up accounts
• Far and away the largest computer reseller
• Goal is to growth sales 10% faster than market

Q4 Detail
• ADS for Q4 was 23.55m, up 10% yoy on one extra billing day
• Strength in SMB continued
• CPU refresh remained core driver of growth
• Corporate sector sales were 1.15b, as ADS grew 8.7%
• Public sector at 353m, ADS of 5.51 up 14.5%
• Software was 17% of mix, PC at 15%, with notebooks at 14; printers 12; desktops and servers up 25% with 31% increase in units; video, memory, input devices, data storage, and software products up 5 to 10% yoy
• Ended quarter with 2012 salespeople, up from 1880 in Sep, and ahead of goal to hire 50 to 75 net new hires by end of year
• Commercial customers were 98% of sales
• Didn’t buy shares in the quarter; primary objective is to offset options
• Recv at 35 days with higher mix of federal biz; target is now 33 to 35 days

Analyst Day
• Believes share is only 4%
• Will refrain from publicly discussing 10% more than market target (maybe too much optimism before)
• IDC estimates are 224b for IT market excluding consumer, with CDWs at 112-124b
• Long-term operating model consists of gm in the 14.5-15.25 range, opm in the 6.5-7.0 range
• HP is 27-28 of company’s sales
• Believes that Dell and direct sales initiatives from OEM is greatest competitive threat
• Will consider future acquisitions opportunistically
• Corporate sales – 77% - achieve 3.25b ytd, which is up 29%; focus on medium size (100-500 employees) thru traditional sales model and large space with variety of sales methods include territory account managers, inside sales, and system engineers; doubled number of TAM in 2004; also leverages its 180 specialists in medium to large segments, which provides up-sell and cross-selling opportunities; in small segment, biz tends to be more transactional in nature
• Another focus is to broaden services portfolio; from pre-packaged software, extended warranties, upgrades, break and fix
• Direct web is 27% of sales; majority done thru customer extranets, which help drive loyalty, improve the purchase experience, and ramp sales
• Not much impact from Dell in printer market since these are aimed at consumers
• Public business is CDWG, winning 30 major contracts in 04 valued at 1m; in federal sector, has 15 contract wins to date;
• Top 300 vendors account for 99.9% of sales; Diamond are 74%, Gold are 15%; sources roughly 50% of product direct, 50% from distribution; DC is currently at 80% capacity; another DC in works for 05; will be in Western part of country;
• Cash will be used for business growth and potential acquisitions, pay dividends (only once a year to lower transaction costs), and buy shares;

Sees sales growth of 12% in 05
Sees 3.09 for 05, but 2.77 with options

Customers in 03
-10% in Illinois
-34% in Eastern US
-20% Southern US
-14% Midwest US except Illionis
-1% outside US

fwiw, this is currently my largest holding


Forces of Gravity recognizing that a companys with tons of cash generating lots of cash shouldn't trade at a modest multiple even if they are a sales organization, assuming management doesn't do something stupid with their capital
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