Description

SYNNEX is an undervalued technology services company with two distinct segments: a technology distribution business which is the third-largest in the world, and a business process outsourcing operation that is the second largest in the world. 

These two segments have together generated a stable earnings stream that has grown at a 15%+ CAGR over the last 5, 10, and 15 years, yet the company has rarely earned a fair multiple for such significant growth in excess of the market. SNX currently trades at just 9.9x NTM earnings. 

This valuation and growth profile alone would be attractive to us, but the company has just recently announced plans to separate into two publicly-traded companies, which could serve as a catalyst to unlocking the historical valuation discount, presumably ascribed because the market never could understand why these two unique businesses should be together.

I see over 40% upside to fair value in the stock.

As background, the technology distribution business is much like that of Tech Data, which was recently acquired by Apollo Global Management, after Apollo topped another bid from Warren Buffett in the sale process. Warren Buffett described Tech Data as follows to the Wall Street Journal:

“It was our kind of business. It’s one you can understand. I may not understand all of the products that they sell and I may not understand what the customers who buy the products do with them, but I do understand the middleman's role.”

I would recommend Buffett take a look at SYNNEX as well!

SYNNEX’s tech distribution business distributes over 30,000 products from over 400 manufacturers ( like HP, Cisco, and Microsoft) to roughly 25,000 value-added resellers and retail customers. Their product line includes IT peripherals, networking equipment, consumer electronics, software, security, data center solutions, and cloud services. SYNNEX provides a highly-valuable role as the middleman in this industry, operating as a highly efficient, outsourced sales force for the OEMs, and providing end customers with bulk purchasing discounts, inventory, financing, and product advice. 

A reasonable concern with a technology distribution business would be that the company could carry huge inventory risk, as technology products face constant price pressure and risk of disruption, but the company actually has limited balance sheet risk, with significant price protection guarantees from OEMs and return rights. In addition, payables more than cover inventory. 

The technology distribution business contributes 80% of the company’s revenues, and about 55% of operating income, and is growing slightly faster than the IT market overall, in the low-to-mid single digits.

The BPO business (Concentrix) has been built over the last 15 years through multiple acquisitions, which the company has very effectively integrated and improved, frequently returning declining businesses to growth, such as in their most recent acquisition of Convergys. The business provides a wide range of customer relationship management services, such as live and automated customer call centers, online chat support, outbound sales and marketing, as well as back office services like billing, payments, and insurance claims management. The company has focused on industries such as healthcare, banking, and technology which require more investment and domain expertise, and have stringent compliance requirements. These characteristics create high barriers to entry, drive higher margins, and lead to very sticky customer relationships. The average client has been with Concentrix for over 12 years. Concentrix serves over 80 Fortune 500 companies, as well as many of the world’s biggest and fastest-growing startups, with over 200,000 employees, speaking over 70 languages, in 40 countries. This business contributes about 20% of SYNNEX’s revenues, and about 45% of operating income, and is also growing in the low-to-mid single digits.

While an odd pairing, these two businesses have combined to create a high-quality, resilient franchise with mid-teens returns on tangible invested capital over the past ten years. The company grew earnings through the financial crisis, and as mentioned, has generated consistent mid-teens earnings growth over the last 15+ years. 

While the company has been a successful acquiror and integrator in its past, driving double-digit earnings growth, going forward, I model organic growth alone, with revenue growth in the low-to-mid single digits, and earnings growth in the mid-to-high single digits, resulting in a five-year forward earnings power of just under $22/share. I apply a terminal multiple of 9x, which is roughly a discounted market multiple, and adjust for dividends and net debt to arrive at an estimate of fair value of approximately $190, or about 40% upside from the current stock price.

The company believes that its valuation has been hampered by the market having a hard time understanding or properly classifying the business because of its two disparate segments, and believes that by separating into two public companies -- targeting the second half of this year -- this valuation overhang will lift. Hence, some analysts may believe a SOTP methodology is more appropriate.

This may prove true, and the initial reaction to the company’s announcement on Jan 9 of their plans to separate was very positive, but the SOTP methodology is not my preferred method, as it’s driven by peer valuations, when I would argue long-term earnings growth should drive multiples, not peers which may be lower quality earnings generators.

Nevertheless, SNX appears to trade at nearly a 50% discount to BPO comps (or the comps trade at a nearly 100% premium), and a mid-teens percentage discount to technology distributor comps, supporting the view that there is a significant conglomerate discount applied to SNX, which could be unlocked with a separation.

Note, there are differences in consensus growth expectations in the 2020-2021 timeframe between SNX and its peers, but SNX has been intentionally culling its customers in the BPO segment to focus on higher quality and higher growth verticals, and expects to return to 3-5% topline growth when this is complete. I do not believe there are any material, structural differences in long-term growth potential for either of SNX’s businesses with peers.

The planned separation into two separate public companies may be one way to unlock the value in this company, but a purchase by a private firm would not be a surprise either, as the private market value of the tech distribution business has been well established, not just with Apollo and Berkshire Hathaway’s interest in Tech Data, but also with the largest tech distributor in the world, Ingram-Micro, which has changed hands several times in recent years at multiples above what the public market has ascribed. HNA purchased IM in 2016 for $6bn, or at a 10.8x trailing ebitda, and in 2019, HNA sold ~50% of IM to RRJ for $4 bn. 

Whether it’s a separation, a sale to private equity, or my base case which is business as usual, I’m comfortable that SYNNEX’s consistent, above-market earnings growth will be accurately reflected in the valuation, eventually.

Catalyst

Continued earnings growth.
Spin-off in 2H20 or sale of a segment.