Description

Datatec, a company with a $38 market cap, is well situated to benefit from the need by major corporations to achieve large scale, and rapid, IT deployment. The company offers integration and configuration faster and with greater reliability than any of its competitors. During the past six months, Datatec has closed almost $80 million in new business, and at a meeting with management indicated it was “comfortable” with fiscal 2003 (April) revenues of $88 million and EPS of $0.14 per share (note that all earnings estimates are untaxed). For fiscal 2004, we believe EPS should approach $0.30 per share, however, if the company is successful (and we believe they will be) in obtaining a very large government contract, EPS could top $0.45 per share. With the shares trading at less than 8x times years estimated earnings and less than 4x the lower end of our fiscal 2004 projection, we believe the risk/rewards in these shares are unusually favorable.

So what is deployment? Datatec recently provided the following example of one of its deployment contracts. A national insurance provider needed to install Cisco routers to its 16,500 offices. Datatec configured the routers (Cisco 2524 routers), did the required wiring and cabling, the necessary equipment setup and testing, and then custom configured over 250 units per day with just two individuals, and ultimately installed the routers at 500 locations per week. This large deployment was completed in less than the budgeted eight months time frame, with a perfect equipment performance rate.

Datatec estimates the worldwide deployment market at $72 billion, and that the potential market that they address at about $35 billion with about an 80%/20% split between computing and networking. This overall market is growing at about 15% per annum. From Datatec’s viewpoint, the major business drivers are VOIP (voice over the internet), migration to windows XP, wireless, retail store infrastructure (includes new and refurbished stores), and POS (point-of-sale) systems.

As a result of the technology downturn, Datatec has significantly reduced its operating structure. The result, according to management, is that the Company has a quarterly fixed cost of $6.7 million. With $20.6 million in quarterly revenues, Datatec would break even (with $1.1 million in D&A, cash break even is $19.5 million). The Company has indicated that incremental sales above break even should yield at least a 30% margin (although we believe the incremental margin may be closer to 35%).

Datatec’s indirect relationships (where it is named by the manufacturer to deploy their equipment to a specified customer) include AT&T, Cisco, Hewlett Packard, IBM, NCR and Verizon. Companies that use Datatec for deployment include, CVS, Diebold, Fleet, Lowe’s, Starbuck’s and Wells Fargo.

In recent months Datatec’s business has exploded with almost $80 million closed in just the past six months. Moreover, management is optimistic that it will receive an unusually large (for them) government contract, which could result in a multi-year contract potentially worth tens of millions of dollars.

For several weeks Datatec’s shares traded with the letter “E” after its normal symbol DATC. (It was because of this designation that I chose to wait to recommend these shares until it became clear that this designation would likely be removed). NASDAQ placed the “E” on these shares to reflect the company’s late filing of its 10K and subsequently its July 10Q. The delay was caused by the company being forced to switch auditors from Arthur Andersen to Deloitte Touche, who had to review the reclassification of expenses previously taken (the recently completed review uncovered no material differences). Several days ago the company filed its 10K, and we expect the 10Q to be filed within three weeks, which should hopefully result in the “E” being removed from its symbol.

Datatec’s balance sheet indicates a leveraged company. However, we believe that with the move to profitability (in the April quarter Datatec earned $0.04 per share, and we believe all quarters of fiscal 2003 will be profitable), the company should be able to fund its needs. At April 30th the company had a working capital deficit of $4.9 million, long-term debt of $2.9 million, and stockholders’ equity of $2.3 million. The company has a revolving line of credit with IBM Credit Corp. (at fiscal year-end $14.5 million was outstanding), and a $3 million term loan. IBM has told the company that it does not intend to renew these lines beyond August 1, 2003. Datatec is actively seeking a replacement and we believe will have little trouble in doing so.

With 35 million fully diluted shares outstanding, Datatec has a market cap of but $38 million and an enterprise value of $55 million. If the company achieves $88 million in revenues and EPS of $0.14 per share (we believe there is meaningful upside to these numbers) it would mean the shares are trading at but .4x revenues and a P/E multiple of but 8x. Based on our fiscal 2004 forecast of $110 million in revenues and EPS of $0.30 (excludes the government contract we believe they will obtain), the valuation borders on ludicrous.

Catalyst

1) Rapid new business ramp being converted into significant revenue and earnings growth.
2) A potential major new contract win which could be announced in the current fourth calendar quarter.