Saloman tecd research report for today; has im stuff in it.....
TECD: Raising Estimates and Price Target; Reiterate Buy (1H)
Salomon Smith Barney
Friday, May 21, 1999
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--SUMMARY:--Tech Data--Wholesale Information Technology Distribution *Tech Data announced this morning that it has won a $1.4B/yr exclusive contract with GE Capital Info Technology Solutions under which Tech Data will take over the procurement and fulfillment of almost all of GECITS' products. *Tech Data was selected based on its 1) global reach, 2) mgmt, 3) IT systems, and 4) financial strength. Tech is one of only two distributors which possesses all of these qualities. *We believe this announcement will be the first of many. This and Compaq's Distributor Alliance announcement will encourage other resellers/systems integrators to outsource their product procurement/configuration as well. *We are raising our estimates for both fiscal 2000 and 2001. *We reiterate our Buy rating on Tech Data with a new price target of $50. --EARNINGS:----------------------------------------------------------------- FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Actual 01/99 EPS $0.46A $0.54A $0.63A $0.64A $2.27A Previous 01/00 EPS $0.53E $0.55E $0.52E $0.77E $2.37E Current 01/00 EPS $0.53E $0.55E $0.56E $0.79E $2.43E Previous 01/01 EPS $0.66E $0.69E $0.72E $0.81E $2.88E Current 01/01 EPS $0.68E $0.72E $0.72E $0.85E $2.97E Previous 01/02 EPS $N/A $N/A $N/A $N/A $N/A Current 01/02 EPS $N/A $N/A $N/A $N/A $N/A Footnotes: EPS are fully diluted. --FUNDAMENTALS:------------------------------------------------------------- Current Rank........:1-H Price 05/20/99......:$39.37 Prior Rank..........: Target Price........:$50.00 P/E 01/00...........:16.2X 52 Wk Price Range...:52.43 - 14.62 P/E 01/01...........:13.3X Proj. 5yr EPS Grth..:N/A% Return on Equity 99.:15.00% BookValue...........:$18.61 LT Debt-to-Capital..:42.48% Dividend............:$N/A Revenue 2000........:$17025.00 mil Yield...............:N/A% Shares Outstanding..:57.00 mil Convertible.........:No Mkt. Capitalization.:$2244.09 mil Hedge Clause(s).....:# Comments............: --OPINION:------------------------------------------------------------------ THE AGREEMENT GE Capital Information Technology Solutions (GECITS) is the third largest systems integrator/corporate reseller in the United States, with slightly more than $2 billion/year in product revenue (numbers one and two are Inacom and CompuCom, respectively). GECITS offers suites of information technology solutions to large corporations worldwide; the company's offerings include IT infrastructure management, network design and integration, software licensing, IT asset management, disaster recovery and more. According to this agreement, Tech Data will assume responsibility for the procurement, vendor management, configuration, fulfillment and logistics for almost 100% of the technology products that GECITS incorporates into solutions for its customers, effective August 1, 1999. The exclusive agreement is for a 3 year term and is currently limited to the U.S. Tech Data will assume the lease on GE Capital's 200,000 sq foot Frederick, MD warehouse and purchase all leasehold improvements. This warehouse has 40,000 sq feet dedicated to assembly and configuration, with a capacity of several hundred thousand systems annually. Tech Data will offer jobs to all existing GECITS employees at the warehouse. The additional Frederick, MD capacity assures that Tech Data's service levels to existing customers will not be adversely affected. While the agreement with GE is currently limited to the U.S., we believe that Tech Data was selected partially based on the company's strong presence in Europe and worldwide. The agreement positions Tech Data very well to compete for GE's configuration and fulfillment business in other geographies. This is the largest contract in Tech Data's 25 year history and the largest outsourcing agreement in the history of the channel. We believe that this agreement, along with Compaq's recently announced Distributor Alliance Program (see 5/10/99 call note - "Tech Data Selected As One of Four Compaq Distributors in North America") will encourage other corporate resellers/systems integrators to pursue similar arrangements. We believe that Tech Data and Ingram Micro are the best positioned distributors to win these outsourcing contracts. Resellers/integrators will demand 1) global reach, 2) financial health, 3) management, and 4) IT systems and logistics capabilities from potential outsourcing partners. Tech Data and Ingram Micro are the only two distributors worldwide who meet all four of these requirements. Indeed, Tech Data management confirmed that GE considered just two wholesale distributors for this deal (Tech Data and Ingram Micro). THE SIGNIFICANCE OF THE AGREEMENT This agreement is not an isolated incident--it is the result of the collective soul-searching currently underway within the corporate reseller/system integrator channel. In the post-Dell world, resellers are being forced to re-evaluate their value-add within the IT sales and fulfullment chain, and they are concluding that product procurement, configuration and fulfillment ARE NOT THE BEST USE OF THEIR SCARCE RESOURCES. Specialization is at the foundation of our modern economy; it assures that capital is employed in the most efficient manner. Is it more efficient for thousands of dispersed resellers to carry out duplicate procurement, configuration and fulfillment efforts, or for all resellers to outsource these functions to a few distributors with 1) core competency in these functions, and 2) sufficient volumes to achieve significant economies of scale? If all resellers outsourced procurement, configuration and fulfillment to a few distributors, they would all reap the benefit of being able to share these costs....net, net, there would be no duplication of cost or effort. The major inhibitor to programs like Compaq's Distributor Alliance or GE's outsourcing has been large reseller/integrators' legacy dependence on hardware sales as a major source of revenue. Corporate resellers have historically, and continue, to take a 7-10% mark-up on PC hardware and they derive between 75-95% of their total revenue from hardware sales. In the near-term, corporate resellers are understandably reluctant to relinquish this revenue stream; such an action would represent nothing short of a fundamental change in their business model. Longer-term, however, we believe that corporate resellers/systems integrators have two options: 1) exit the product business altogether and outsource procurement, configuration and fulfillment to a wholesale distributor who is willing to perform these functions at one half the cost (3-5% gross margin versus 7-10% for the reseller), or 2) continue losing market share to Dell AND eventually to the direct sales efforts of CPQ, HWP and IBM. Until recently, Compaq, HWP, IBM and other IT suppliers had no alternative but to sell their products through resellers/integrators whose strategy was to maintain artificially high gross margins at the expense of market share. CPQ, HWP, IBM and other IT suppliers are now realizing that they cannot afford to let resellers charge a 7-10% mark-up, and as a result they are going "direct" to large accounts. In most cases, "direct" will include the help of a co-located distributor for product configuration and fulfillment. Corporate resellers need to reevaluate their true value-add in the IT sales and fulfillment chain. Where does, and will, resellers/integrators offer unique value?....service and support. We believe yesterday's announcement by GE is a landmark one...one which takes us one step closer to the ideal IT sales and fulfillment paradigm (see our July 1998 report entitled "The PC Sales and Fulfillment Model of the Future...and It's Not Purely Direct"). There will be many more such announcements during the coming 12-18 months which will provide two benefits to the best positioned distributors: 1) incremental revenue from the reseller who is outsourcing; and eventually, 2) revenue from other wholesale distributors who are forced out of the market by their exclusion from such agreements. FINANCIAL IMPACT The GE agreement will produce $1.4 billion annually in incremental revenue for Tech Data beginning August 1, 1999. While the gross margins on this deal (3-4%) will be lower than Tech Data's average (5.8%), operating expenses will also be lower based on the very high volumes inherent in the business. According to CFO Jeff Howells, pre-tax margins on the GE business are in line with Tech Data's average (1.20-1.25%) and with the company's goals. Because Tech Data is merely assuming GE Capital's lease, the required initial investment should be minimal; CFO Jeff Howells has stated that the deal should NOT be dilutive to earnings during 2Q99 (July quarter) prior to the first revenue stream. The incremental working capital required for the agreement is also minimal. Wholesale distributors like Tech Data typically finance inventories entirely with payables, which will be the case with this agreement as well. In most cases, however, Tech Data is forced to finance its receivables with debt; as part of the GE arrangement, Tech Data is paid almost immediately. Net, net, the GE deal will require minimal incremental working capital and, despite the lower gross margins associated with the business, should produce very attractive returns on invested capital. RAISING EARNINGS ESTIMATES We are raising our F2000 and F2001 estimates for Tech Data to reflect the impact of this announcement. We are raising F2000 from $2.37 to $2.43 and F2001 from $2.87 to $2.97. Our new estimates imply 22% earnings growth during F2001. We believe there are several potential sources of upside to our revised estimates. First, as we said at the time of Compaq's Distributor Alliance announcement, we believe that Tech Data could potentially earn more than its proportionate share of the revenue placed in play by the DAP announcement based on its 1) global reach, 2) strong management, 3) rock solid IT systems and logistics capability 4) strong balance sheet, and last but not least, 5) its lead with co-location and configuration in co-location. Second, we believe our estimates regarding the incremental revenue accruing to Tech Data from the GECITS deal are conservative. And, finally, we expect more such announcements during the coming 12-18 months. VALUATION AND PRICE TARGET Tech Data's forward twelve month price-earnings multiple has risen from 9X to 15X in one month. The company's core valuation range since 1991 has been 11-21X forward twelve earnings. While our previous target multiple was 14X, we now believe that Tech Data shares deserve a multiple at least in the mid-point of their historical range, or 16X. Not only have the Compaq DAP and GE agreements prompted a significant acceleration in earnings growth during F2000 and F2001, they have also demonstrated unequivocally that the best positioned wholesale distributors will be an increasingly important link in the IT supply chain and that consolidation will regain momentum. Moreover, 16X still represents a significant discount to Tech Data's F2001 EPS growth rate of 22%. Our 16X target multiple implies a new twelve month price target of $50, or 26% upside from the current share price. IT'S NOT TOO LATE TO BUY...REITERATE BUY (1H) RATING Despite the 70% rise in shares of Tech Data since our initiation of coverage on April 8, 1999, we reiterate our Buy (1H) rating on the shares. Current estimates, which we believe are conservative, suggest the potential for an additional 25% upside during the coming twelve months. Moreover, as we have said repeatedly, we believe that there will be further such announcements during the coming 12-18 months which will prompt additional upward revisions to earnings estimates. Finally, we see the potential for significant multiple expansion as investors become aware of the critical role that wholesale distributors play in the IT supply chain (see our 4/8/99 initiation of coverage call note entitled "Initiating Coverage on Tech Data with a Buy (1H) Rating"). UPDATE ON THE APRIL 1999 QUARTER During yesterday's conference call with analysts, CFO Jeff Howells confirmed that Tech Data exceeded our revenue estimate of $3.8 billion for the April, 1999 quarter. Howells also expressed comfort with the consensus estimate of $0.52 (our estimate is $0.53). We remain comfortable with our estimate. Tech Data will report April quarter earnings on June 7 after the market closes. -------------------------------------------------------------------------- # Within the past three years, Salomon Smith Barney, including its parent, subsidiaries and/or affiliates, have acted as manager or co-manager of a public offering of this company. 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