Description

Manchester is a computer hardware reseller. They buy hardware from the likes of Toshiba, Cisco, HP, & Compaq. They then sell the hardware to businesses that have placed an order with them. They will install and configure everything for an additional fee. The majority of their revenues come from the New York metro area.

Obviously, businesses aren't buying as many computers & hardware and revenues have been declining recently as a result. However, the economics of their business make it almost impossible for them to become unprofitable. Their business model works like this:

1) A business will say, "What computer hardware do we need to do what we want to do?"
2) Manchester determines what they need and buys it from the manufacturer.
3) Manchester marks it up and sells it to them.

As a result, they hold almost no inventory($7.5mm in inventory compared to $280mm in sales, which is 37 inventory turns/year). Unlike most IT companies, MANC is not at risk to inventory price declines. MANC's SEC data go back to 1992 and they have been profitable every year since. The CEO has been with them since their inception in 1973 and holds 58% of the company's stock. MANC has zero long term debt.

Valuation

MANC is a company that has a history of profitability and will continue to be profitable into the future. But the market is currently valuing MANC as being worth more dead than alive. Their net net working capital currently stands at $32mm. Yet the market cap currently stands at a mere $18.0mm. An investor in MANC stands to gain 78% if the share price simply returns to the NNWC level. Most companies that trade at such a large discount to NNWC are of much lower quality than MANC. NNWC level establishes a large margin of safety.

Now that we've established downside protection it's time to see what the potential upside is. I'm going to use 7x EBITDA as a measure of fair value. 7x FY01 EBITDA is less than their NNWC, so is MANC as compelling as it seems? I believe it is and I'll tell you why.

FY2001, especially the last two quarters saw a virtual suspension of spending on IT products(MANC's fiscal year ends July 31 so the last two quarters are February through July). Like it often does, the market is extrapolating the near-term past into the long-term future. FY2001 was not a 'normal' year for MANC, so it's necessary to try to get a picture of what 'normalized' EBITDA will be. FY2000 was also not a normal year, in that it saw an absolute frenzy of IT spending that will not be seen again for some time. I'm using FY1999 as a picture of what normalized EBITDA will likely be when the economy and IT spending recovers. FY1999 covers the second half of '98 and the first half of '99 and I believe it is a picture of normal economic times.

In FY99 MANC had EBITDA of $6.39mm. 7x EBITDA would yield a private market value of $44.7mm, or a return of 148%. I would consider this a conservative fair value for MANC.

Now for a slightly better-case scenario. In FY01 MANC had revenues 22.6% higher than in FY99. The reduction in EBITDA in '01 compared to '99 was due to margin pressure. Their cost of sales as a % of revenues stayed relatively constant; the margin pressure is a result of SG&A expenses that haven't fallen as fast as revenues have between '00 and '01. MANC has been lowering expenses but it remains to be seen how effective they will be in restoring margins. IF MANC can restore EBITDA margins to '99 levels then things get even better. This would yield EBITDA of $7.83mm(I assume revenues remain at '01 levels). 7x EBITDA would give a fair value of $54.8mm, or a return of 204%.

Conclusion

MANC is a boring business in an unloved industry but it is a compelling investment opportunity. Given their history of profitability and their discount to NNWC, their isn't much downside risk. Potential upside ranges from 78%-204%.

Catalyst

This is solely a play on valuation. A recovery in IT spending is the only catalyst that is apparent to me.