Friday, July 31, 2009

1% Margins, 100% Fun: Why Technology Distribution is Relevant

The “canary in the coal mine,” is what my boss used to say when describing Technology Distributors like Ingram Micro, Tech Data, Avnet and Arrow Electronics. How these players fare can be a leading indicator of what is coming down the pipeline from Technology juggernauts like HP, IBM, Cisco and leading chip manufacturers; all of whom are suppliers into the Channel. But distributors are more than just channel checks, they are the often overlooked and under appreciated engine that powers the supply chain.

Distributors are the middlemen. They do the dirty work of connecting leading OEMs to end-users through a large and fragmented reseller universe. Experts will differentiate between broadline, specialty and component distributors. This classification is not important for us now. The basic facts you need to know are:

  • $35 billion in annual sales (Ingram Micro hit over $35 billion in 2007)

  • 1.0 - 4.0% operating margins (Tech Data and Ingram Micro have gone sub 1% in recent quarters)

  • Each major distributor has issued multiple tranches of straight debt and/or convertible securities

These are big “technology” companies with razor thin margins and high capital requirements. As such, capital structure is important and debt is used often. The capital markets and the banks play a large role in funding operations and covering swings in working capital. This requires true corporate finance advisory work from investment banks; and that makes the industry not only relevant but fun.

Unfortunately for product specialists, when business slow down, these guys are cash machines. Falling revenues lower working capital needs as inventories get worked down and there is no reason to access the capital markets. But when things get going and growth is back, the cash machine will run in reverse and banks will be happy to help. There is also a fair amount of refinancing needed.

On the M&A side, while the industry has already experienced substantial consolidation, there is room for more. And some potential transformational acquisitions could be on the horizon as the industry continues to evolve. More on this to come…

1 comment:

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