Description

Ingram Micro is the largest global wholesaler of information technology (IT) products and
services. Over the past year, with a new CEO, Ingram made a number of operational
improvements which allowed it to improve its cash flow, capital structure, inventory
turns, and gross margins despite the collapse of much of the IT market. The stock market
has not properly valued these improvements. Using reasonable assumptions, Ingram could
triple earnings over the next 2-3 years. At 14, Ingram is just above book, down from its
all time high of 55 three years ago. My calculations (see pro-forma below) support a fair
value in 2003 of 23 to 36, based on a PE of 10 to 15. A pessimistic scenario that assumes
that high tech continues declining for the next two years supports a reasonable floor
of 10 for Ingram, with the company staying slightly in the black.

Ingram should be looked at as a distributor and consumer of high-tech products, not as a
manufacturer and developer of these products. As long as Ingram keeps its inventory under
control, rapid technological change is a positive factor to the extent that the change
stimulates demand.

As a former employee of and consultant to a mid-sized supplier to Ingram, I’ve had some
dealings with Ingram in the US and Europe. The new CEO, Kent Foster, took over in March
2000 and brought a renewed focus on asset management. The Ingram people I’ve met are
first rate and they are very focused on inventory management. I’ve spent much of the last
dozen years working on supply chain management in high-tech and have learned that good
inventory management can have an especially dramatic impact on the P&L in high-tech, as
Dell taught us. Improved inventory performance reduces scrap, obsolescence and warehouse
costs and iss one of the factors contributing to Ingram’s Gross Margin improvement,
despite the Q1 sales decline. I summarize Ingram’s recent inventory performance here:

Annual Annual
1999 ($000) 2000 ($000)
Revenue 28,068,642 30,715,149
COGS 26,732,479 29,158,851
Inventory Turns 7.7 10.0
Yearend Inv 3,471,565 2,919,117
Gross Margin % 4.8% 5.1%

In Q1 turns increased to 11.8, up from 10.9 in the prior year. Improving inventory turns
(and Gross Margin %) is especially difficult when sales are declining.
3/31/2000 3/31/2001
Revenue 7,796,350 7,193,489
COGS 7,430,154 6,809,294
Inventory Turns 10.9 11.8
Qtr End Inv 2,720,125 2,310,747
Gross Margin % 4.7% 5.3%

Two weeks ago, Ingram announced a cost reduction plan that includes the closing of a
distribution center and the downsizing of another. The improved inventory performance
helped Ingram do that. The plan will cost $15 million dollars (to be booked this quarter)
and will save $30-$40 million annually. In my pro-forma, I’ve assumed these saving to be
split equally between SG&A and COGS, with savings to be $10 million in 2001 and $30 million
annually in 2002 and beyond.

Last week, Ingram announced that Q2 revenues are expected to range from $5.8 billion to
$6.0 billion, down from $7.3 billion in Q2 2000. Income before taxes and non-recurring
items is expected to range from break-even to a loss of $10 million. It wasn't quite clear
to me whether that loss estimate included the $15 million dollar pretax charge I described
in the prior paragraph. While this revenue shortfall is more than I expected, I don't think
it changes the scenario for 2 years from now, especially if Ingram's inventory stays under
control. Market response to this announcement has been muted, considering the recent drop
in the market.

Inventory reduction along with the non-recourse sale of Accounts Receivable (described
later) has had a huge impact on cash flow.

Annual Annual
1999 2000
Cash Flow Provided by Ops 573,008 836,406
Purchases of Property and Equip 135,260 146,104
Cash Flow Provided by Ops less CapEx 437,748 690,302
Per Share 3.03 4.72
Reported EPS (including unusual gains) 1.21 1.51

Book value is around $12.85 per share. Subtract goodwill of $2.85 per share to get a
likely floor of $10 per share (consistent with Ingram’s recent low of 10.2). Ordinarily
for this kind of analysis one would heavily discount the value of inventory due to rapid
obsolescence and price declines; however, because of Ingram’s good inventory management
and the existence of price protection and return privileges, the inventory is of higher
quality than one might expect. In the event of a supplier price reduction, Ingram
generally receives a credit from the supplier. In addition, Ingram has the right to
return a certain percentage of purchases. There’s a tension between manufacturers and
wholesalers in negotiating the terms of price protection and return privileges. Over the
past few years terms have been getting tighter, but the recent consolidation of
wholesalers has increased Ingram’s leverage. There’s no denying that Ingram is exposed to
inventory risk to the extent that vendor protections are not available on all products or
quantities and are subject to time restrictions. In addition, vendors may become
insolvent and unable to fulfill protection obligations to Ingram and under those
conditions those vendors’ inventory at Ingram might become a total loss. That’s why high
inventory turns are a key factor in Ingram’s turnaround.

Several factors have led to significant consolidation among information technology
distributors. Tightened terms and conditions from manufacturers, reductions in the number
of authorized distributors, a high level of price competition in 1999 and early 2000, and
changing business models (e.g., direct selling to a fragmented market via the Internet)
have driven weaker competitors from the market. Recently, four significant players within
the information technology distribution industry (MicroAge, CHS Electronics, Inacom, and
Merisel) have substantially exited or have consolidated with other players within the
distribution market.

Increasingly, suppliers and resellers pursuing global growth are seeking distributors
with international sales and support capabilities. Only 2 wholesalers have anything close
to a worldwide presence: Ingram and Tech Data. These are basically the only players in
the US and I think they are both smart enough not to re-ignite the price wars of a few
years ago. Markets outside the United States, which represent over half of the IT
industry's sales (and 40% of Ingram’s sales), are characterized by a more fragmented
distribution channel. While Ingram and Tech Data are major players outside the US (Ingram
is the leader in Canada, Mexico, Germany and other countries) the chances of a price war
outside the US are higher than domestically.

Because of the high investment in inventory, warehouses, and information systems there’s
high barriers to entry. Long term, however, it would not surprise me to see Amazon enter
into part of this market but it is even more likely that Amazon would establish a
partnership with Tech Data or Ingram Micro (as it did with Ingram Books when it first
started). Amazon will not be enthusiastic about spending lots of money in hard assets.

Some of Ingram’s vendors will continue to try to replicate the Dell Direct to Consumer
model and that could hurt wholesalers. Typically, these manufacturers outsource the
distribution part of the process. For example, Ingram provides fulfillment services
for Dell’s third party product sales.

42% of Ingram’s Year 2000 sales were generated from products sourced from just 3 vendors.
No single customer accounts for more than 4% of Ingram’s sales.

Ingram has an arrangement where it transfers several hundred million dollars of U.S.
trade accounts receivable to a trust, which in turn sells certificates representing
undivided interests in the total pool of trade receivables without recourse. This has had
a big positive impact on its cash flow. In Q1, the expenses associated with the program
cost $8 million and are included in Other Income. I have separately listed these expenses
in the pro-forma below

Total debt (both on and off balance sheet) declined by 10% in 2000. On Balance sheet debt
as of Q1 was $514 million. Including off balance sheet debt, total debt was $1.33
billion, according to Ingram’s press release but I haven’t been able to exactly arrive at
the $1.33 billion from the 10Q. According to Ingram total debt was reduced by $120
million in the quarter.

PRO-FORMA (MOST LIKELY SCENARIO)

1999 2000 2001E 2002E 2003E
Revenue 28,068,642 30,715,149 28,000,000 32,200,000 37,030,000
COGS 26,732,479 29,158,851 26,504,556 30,429,000 34,993,350

SG&A 1,115,854 1,202,861 1,249,900 1,302,645 1,367,777

Gains on Securitities, etc
195,065 102,622 0 0 0

Cost cutting plan Charge
20,305 0 15,000 0 0
Net Interest Expense 97,353 80,199 65,000 65,000 65,000
Expenses related to AR Sales
7,223 13,351 31,536 36,267 41,707

Pretax Earnings before Extraordinary
Gain on Repurchase of Debentures
290,493 362,509 134,008 367,088 562,166

A) Pretax Earnings w/o Security Gains etc...
95,428 259,887 134,008 367,088 562,166
Income Tax on (A)@ 38.5%
36,740 100,057 51,593 141,329 216,434
(B) Net Income w/oSecurity Gains
58,688 159,830 82,415 225,759 345,732

Shares Outstanding 144.49 146.21 147.00 147.50 147.50
Basic Earnings (B) per share w/o Security Gains
0.41 1.09 0.56 1.53 2.34

Equity 1,966,845 1,874,392 1,956,807 2,182,566 2,528,298
Return on Average Equity
8.3% 4.3% 10.9% 14.7%

Inv Turns 7.7 10.0 10.8 12.0 13.0
Year End Inventory 3,471,565 2,919,117 2,459,580 2,535,750 2,691,796
GM% 4.8% 5.1% 5.3% 5.5% 5.5%
SG&A % 4.0% 3.9% 4.5% 4.0% 3.7%


Assumptions:
2002-2003 revenues increase 15% annually
2001 SG&A at Q1 run rate less 10 million from cost cutting plan; 2002-2003 increase 5%
annually after taking into account $15 million annual cost cutting plan

Cost relating to AR Sales program based on Q1 run rate (0.113% of sales)

Improvement in GM% based on impact of improved inventory turns (reduced scrap,
obsolescence, warehouses. GM% in Q1 2001 was 5.3% up from 4.7% in prior year despite
revenue decline of 8%.
PRO-FORMA PESSIMISTIC SCENARIO
2003E
Revenue 24,000,000
COGS 22,680,000

SG&A 1,200,000

Gains on Securitities, etc 0

Cost cutting plan Charge 0
Net Interest Expense 65,000
Expenses related to AR Sales 27,031

Pretax Earnings before Extraordinary
Gain on Repurchase of Debentures 27,969

A) Pretax Earnings w/o Security Gains etc... 27,969
Income Tax on (A) at 38.5% 10,768
(B) Net Income w/oSecurity Gains 17,201

BasicShares Outstanding 148.00
Basic Earnings (B) per share w/o Security Gains 0.12


Inv Turns 12
Year End Inventory 1,890,000
GM% 5.5%
SG&A % 5.0%

Catalyst

New CEO, Improved Inventory Turns, Cash Flow from Operations(net of CapEx) much higher
than Earnings, Consolidation of Industry completed in the U.S.