Saloman IM report.....
IM: Raising C1999 and C2000 Estimates; Reiterate Buy
Salomon Smith Barney
Wednesday, May 12, 1999
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--SUMMARY:--Ingram Micro--Wholesale Information Technology Distribution *We are raising our C1999 and C2000 estimates for Ingram Micro to reflect $1.7 billion in incremental revenue from Compaq's Distributor Alliance Program (DAP) which was announced on Monday. *We believe there is an opportunity for Ingram Micro to capture an even bigger portion of the $3.7 billion opportunity based on its experience serving the corporate reseller and systems integrator community. *We also point out that our revised estimates make no attempt to capture "configuration and fulfillment" fees that IM could potentially earn in conjunction with Compaq's non-DAP sales. *Finally, we believe that other major technology suppliers will follow CPQ, SEG and MSFT in dealing more closely with fewer distributors. *We reiterate our Buy rating with a $35 price target. --EARNINGS:----------------------------------------------------------------- FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Actual 12/98 EPS $0.38A $0.37A $0.40A $0.49A $1.64A Previous 12/99 EPS $0.29A $0.33E $0.43E $0.57E $1.62E Current 12/99 EPS $0.29A $0.33E $0.45E $0.60E $1.67E Previous 12/00 EPS $0.45E $0.46E $0.49E $0.59E $2.00E Current 12/00 EPS $0.47E $0.48E $0.51E $0.62E $2.08E Previous 12/01 EPS $N/A $N/A $N/A $N/A $N/A Current 12/01 EPS $N/A $N/A $N/A $N/A $N/A Footnotes: EPS are fully diluted. --FUNDAMENTALS:------------------------------------------------------------- Current Rank........:1-H Price 05/11/99......:$26.62 Prior Rank..........: Target Price........:$35.00 P/E 12/99...........:15.9X 52 Wk Price Range...:54.00 - 16.31 P/E 12/00...........:12.8X Proj. 5yr EPS Grth..:N/A% Return on Equity 98.:22.00% BookValue...........:$N/A LT Debt-to-Capital..:49.69% Dividend............:$N/A Revenue 1999........:$28200.00 mil Yield...............:N/A% Shares Outstanding..:150.00 mil Convertible.........:No Mkt. Capitalization.:$3993.00 mil Hedge Clause(s).....:# Comments............: --OPINION:------------------------------------------------------------------ As expected, Compaq announced on Monday that, as of August 1, 1999, all build-to-order product in North America will pass through just four wholesale distribution partners; Ingram Micro is one of these partners. Thirty-five (35) other North American resellers and distributors who had previously procured product directly from Compaq will now have to procure all BTO products from Ingram Micro and just three other distributors. We emphasize that the DAP program only applies to product sold under Compaq's Build-to-Order (BTO) program; BTO refers to sales of standard SKUs built to reseller order. Compaq also manufactures and fulfills product under two other programs called Configure-to-Order (CTO) and Channel Configuration Program (CCP). However, we believe that CTO and CCP represent a small portion of Compaq's total revenue (less than 15%). DAP also excludes product sold directly from Compaq to the end-user, but again, this is a very small portion of Compaq's revenue (at most 10%). The DAP program therefore applies to at least 75% of Compaq's North American commercial PC sales! All four Distributor Alliance Partners are required to co-locate a light configuration and logistics center at Compaq's Houston manufacturing campus. Ingram Micro and Tech Data have already co-located, Inacom and Merisel will do so between now and Aug 1. RATIONALE FOR THE DAP PROGRAM The DAP program will result in a reduction in the number of reseller warehouses stocking Compaq inventory in North America from 100 to 30; this should allow Compaq to more effectively manage channel inventory levels of its many product lines. Compaq estimates that DAP will also reduce North American channel inventory levels by a full 50%, bringing the company very close to its elusive goal of 2-3 weeks of channel inventory. Ideally, the program should allow Compaq to achieve better product availability with less channel inventory. However, Compaq has not lowered the amount of price protection offered on its products yet; DAPs still get 3 weeks of price protection on desktops and notebooks and 5 weeks on other Compaq products. The DAP program also includes several days of price protection for non-DAP resellers to cover in-transit time. Once Compaq and its four DAPs refine the program, we believe that price protection will come down. Aside from the pure inventory benefits of the DAP program, we believe that this bold move will catalyze certain shifts already underway in the North American PC sales and fulfillment paradigm. It has been our contention for some time that most resellers should not participate in the hardware configuration or fulfillment process, and instead focus on those areas where they truly add value (sales, relationship management and service & support). Shipping product to resellers who then stock several weeks of inventory adds significant cost to the fulfillment process. Why not relegate hardware configuration and fulfillment to a select few co-located distributors who would then have the scale to perform the function much more cost effectively? COMPAQ'S NEAR-TERM RISK... While we believe that Compaq's adoption of the DAP program will turn out to be the right long-term move, we fear that corporate resellers' initial reaction to the program will be negative. The thirty-five resellers who previously procured product directly from Compaq will now have to pay distributor mark-up. While the cost savings generated by dealing with just 4 channel partners may allow Compaq to reduce prices, we believe that non-DAP resellers will still end up paying 2-10% more for Compaq hardware than under the prior regime (the magnitude of the premium will depend on their volumes). Corporate resellers hardware margins are already under a great deal of pressure due to Dell's direct model--they may initially try to shore up margins by switching to IBM and HWP product. Longer-term, we believe that corporate resellers' options are as follows: 1) learn to live with lower hardware margins which more truly reflect their value add; or, 2) lose hardware market share to Dell, CPQ, HWP and IBM. We believe that Compaq's adoption of DAP will serve as an ice-breaker which prompts other suppliers to announce similar programs. ...INGRAM MICRO'S NEAR-TERM (AND LONG-TERM) GAIN Compaq's DAP program obviously represents a significant incremental revenue opportunity for Ingram Micro. We had previously estimated that Ingram would sell slightly more than $2.5 Billion in Compaq product in North American during C2000--we believe the DAP program will increase this amount by $1.7 Billion. The table below presents our analysis of the incremental revenue accruing to Ingram Micro from this new arrangement with Compaq. We assume that Ingram Micro will capture 45% of the total incremental Compaq revenue opportunity per quarter. There is potential upside to our current estimates from 1) the possibility that Ingram might capture more than 45% of the incremental revenue opportunity, and 2) fees accruing to Ingram for performing final configuration and fulfillment on "Direct" and Configure-to-Order (CTO) sales. -------------------------------------------------------------------------- $Billions 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 Total -------------------------------------------------------------------------- CPQ Comm PC Rev $5.5B $6.5B $5.6B $5.8B $6.3B $7.5B $25.4B N.Am. Comm PC Rev $2.8B $3.3B $2.8B $2.9B $3.2B $3.8B $12.7B - Direct sales .3 .4 .4 .5 .6 .8 2.1 - CTO Sales .3 .3 .3 .3 .3 .4 1.3 - CCP Sales .1 .2 .1 .1 .2 .2 .6 -------------------------------------------------------------------------- Total DAP Rev Opp $2.1B $2.4B $2.0B $2.0B $2.1B $2.5B $8.6B - Existing Rev 1.0 1.0 1.1 1.1 1.2 1.4 4.8 -------------------------------------------------------------------------- Increm DAP Rev $1.1B $1.4B $0.9B $0.9B $0.9B $1.1B $3.8B -------------------------------------------------------------------------- IM Portion $0.3B $0.6B $0.4B $0.4B $0.4B $0.5B $1.7B -------------------------------------------------------------------------- CTO = Configure-to-Order CCP = Channel Configuration Program DAP = Distributor Alliance Partner Rev = Revenue OTHER POSITIVES OF THE DAP PROGRAM *According to Compaq executives, DAP participants were chosen on the basis of their 1) financial stability, 2) global coverage, and 3) the quality of their logistical and information systems infrastructures. The fact that Ingram Micro was chosen as one of only four DAPs for the North American phase of the program is an indication of the company's superior position along all three of these parameters. It also demonstrates that wholesale distributors with these qualities will be the long-term winners in the wholesale IT distribution industry. *While the current DAP program is limited to PC products in North America, we believe that the program will eventually be extended to other products (mid-range Digital and Tandem systems) and other geographies (Europe, etc.). Comments by Ingram Micro management suggest that such discussions are already underway. Such expansions of the DAP program will provide more incremental revenue to Ingram. *We believe that more and more IT vendors will follow Compaq, Seagate and Microsoft's lead in reducing the number of channel partners with whom they maintain direct sales relationships. This will reignite the consolidation trend in the industry, freeing up billions of dollars of revenue opportunity for the survivors. We believe that Ingram Micro, by virtue of the advantages listed above, will not only participate in the majority of these programs but will also benefit from the ensuing consolidation. *Performing final configuration and fulfillment for corporate resellers will provide a more predictable revenue stream for Ingram Micro because corporate resellers' sales tend to be project-based. Moreover, superior configuration capability may result in a DAP's being rewarded a "primary sourcing" relationship by certain resellers. On the flip side, if Ingram fails to win the large reseller business initially, these accounts may be tougher to penetrate later for very same reasons. RAISING F99 AND F00 ESTIMATES; MAINTAIN $40 TARGET We are raising our C1999 and C2000 estimates for reflect the incremental revenue accruing to Ingram from the DAP program. Our C1999 revenue estimate has increased from $29.3B (up 33% yr/yr) to $30.2B (up 37% yr/yr). Our C2000 revenue estimate has increased from $34.1B (up 17% yr/yr) to $35.9B (up 22% yr/yr). Our C1999 earnings estimate has increased from $1.62 to $1.67 and our C2000 estimate has increased from $2.00 to $2.08. As we remarked earlier, these upward revisions assume that Ingram Micro will capture 45% of the incremental revenue freed up by the DAP program. This is Ingram's proportion of the total Compaq revenue currently sold by the four DAP partners. Obviously, Ingram has the opportunity to capture an even higher share of the incremental revenue based on its proven track record in providing final configuration and fulfillment services for large corporate resellers and systems integrators. We also note that our upward revisions fail to capture fees that Ingram could potentially earn for performing final configuration and fulfillment in conjunction with Compaq's CTO and "Direct" initiatives. It will be some time before Compaq is able to perform all final configuration on CTO product itself; in the meantime, Compaq will leverage the configuration capabilities of co-located DAPs such as Ingram. Net, net, we believe that our upward revisions may prove conservative. We maintain our Buy (1H) rating on Ingram Micro shares with a $35 price target. |
