Value Investors Club / Datatec (DTC)

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

show sort by

			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 (in $M):	384	TEV/EBIT	0	0