Description
Softcat plc is an IT reseller in the UK. It floated in 2015 on the LSE and is now a constituent of the FTSE 250. It is headquarered in Marlow outside London and is the competitor with the best orgnanic growth in the UK market when compared to their competitors (Computacenter, Capita, CDW, SCC). I believe that while this is a business that is based on good execution rather than having an intrisic moat, it will continue to grow faster than the market and with its asset light business model will be a good compounder delivering double digit returns for investors for the future as it has in the past.
The key part of the investment thesis is that Softcat has a very strong and successful sales culture, and as they have invested heavily into new regional sales offices, they will continue to enjoy strong growth in revenues and earnings as those offices become more mature and sales per agent metrics improve for the new offices.
What is the Softcat business?
As a value added reseller of IT, Softcat is differentiated from its competitors in that it focuses on the small medium businesses and smaller companies. It also sells a mix of not only hardware but quite a bit of services and software. all revenues come from the UK.
Segmentation by Type of Customer
% of Revenue
SMEs (also called SMBs or mid market) 52%
Public Sector 35%
Big companies (Enterprise) 13%
As you can see, most customers are small, medium enterprises. Mid-market is defined up to 2000 desks.
The way Softcat thinks, it is that about 70% of the business is corporate, 30% is public sectors. 70 people out of our 470 sales people focus on public sector. Most of our resources of technical capabilities support both of these efforts.
Segmentation by Products and Applications
Business Unit Revenues % of Total Gross Margin
a) Hardware 37% 15%
b) Software 15% 18%
c) Services 48% 21%
Geographical segmentation
% Revenues
a) UK 100%
Customer Interface
Customers
In total, Softcat has about 1000 employees. They sell bundled services and do consulting on offerings from Cisco, Lenovo, MSFT, Sophos, and many more product companies etc. Softcat has about 12,000 customers as of FY2015 year end.
In public sector there is a framework agreement, where Softcat faces a tendering process.
In the SMB space it’s a fluid situation. The IT manager might call Softcat up and say that they need a bunch or laptos or they might say in 1 year we need more data center capacity and we have a long conversation about this. It becomes less price competitive. They might say, our CEO has fears about security, can you come and talk about that to our team. It’s frequent conversations that crystalize into a deal.
2 or 3 times a year we will engage with them for GBP 15,000 worth of business. Ad-hoc is a lot. Of the work. 2% of revenues come from professional services and managed services. On average the revenue per customer is GBP 55,000, and the gross profit per customer is GBP 10,000.
Sales
470 are corporate and 70 are public.
The sales model is that Softcat only recruits graduates, never experienced sales people from competitors. They train each graduate for 1 month before they put them into the sales floor. Their base salary is very low at GBP 19,000 / annum. But each sales person can keep 20% of their gross profit.
This means at year one the total comp could look like GBP 19,000 base + GBP 8,000 bonus.
In year 4, this would look like GBP 23,000 base + GBP 60,000 bonus.
So people who are good, this ramps up quickly. Not many people make it to year 5, but at that time total comp is like GBP 150K. Our incentives are directly aligned with theirs.
There is a relentless continuous improvement. The sales people have to win an account and then grow that relationship over time.
Attrition rate in first 2 years, is 50% over the first 2 years cumulative i.e. we lose 50/100. We will lose 7/100 in the next 2 to 3 years. Then it’s less than 10%.
KPIs
a. Gross profit is 85%
--> This very strong sales culture is unique to this company and the direct alignment of the sales force with the company's profitabiliy is the area we believe will continue to allow the company much better growth and profitability than most of its peers.
b. In fact, an account manager has complete autonomy how to price to customers. He just cannot sell at a loss but that is the only limitation. This culture of entreneurship is quite different than what we found in most of their competitors.
Logistics
The business is asset light.
Vendors will sell almost all of the things directly. 60% of the stuff they buy off distributors (like Avnet) and they will deliver and 30% they buy directly from vendors (like HP) and those will deliver the produc to end customers.
Virtually nothing is held as inventory of Softcat.
Competition
Softcat estimates that they have a 6% market share in the UK based on CRN 2015 Top 100.
For big business/public competition would be CDW or Trustmark, big company with lots of public sector experience.
In the mid-market its CDW and Bites, possibly Insight.
For commodity software, Insight has good process for selling en masse. So for really price sensitive customers this is a big advantage.
For the most part because there are personal relationships in the SME space, Softcat doesnt have to compete on price as strongly as some of their peers.
Sustainable Demand Growth
Historical growth had been over 15% p.a. for the last decade. They grew from a small business to a business with GBP 600 million market cap.
Although I do expect this to come down a bit, their strong sales model and strong investment in new business in the last 2 years should mean quite a few more years of growth. They have grown mainly by taking market share, and at a 6% market share today of the UK market, we believe there is more room to go.
ROTCE is something > 20%.
The way the business is driven is very much a decentralized format. This is shown by the fact that individual sales teams can determine their own pricing and strategy for sales. Only the results matter, specifically gross profits.
Overall, I believe that Softcat is positioned as well as it has been in the last few years in the UK market and based on its strong investment into new offices in Edinborough and in the UK will continue to see much better growth than peers.
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
The retirement of the CEO Martin Hellawell several weeks ago has been accompanied by a ~20% drop in share price. I feel that based on current valuation and what I believe the growth will be, that Softcat will deliver strong double digit returns in the next 5 years for shareholders and that this dip is an opportunity to buy.