Datatec — Potential strategic sale of Analysys Mason

Datatec delivered a strong operational performance across all divisions in FY22, with group revenues rising 13% to $4.6bn and adjusted EBITDA (excluding share-based payments and restructuring costs) rising 36% y-o-y to $177m. The FY22 adjusted EBITDA margin was 3.8% (FY21: 3.2%). Exchange rates were less of an issue in FY22 as they have been in recent years, with group revenue growth of 11.8% in constant currency terms.

The FY22 results include a share-based payment charge of $22.5m, double the equivalent charge in FY21 ($11.5m), reflecting the increasing valuations of the divisions’ cash-settled share-based payment plans, particularly for Westcon and Analysys Mason.

The group reported PBT of $51m (FY21: $25m) and paid $11m in tax (FY21: $20m), an effective tax rate of 21% (FY21: 77%), benefiting from UK tax losses. At 28 February 2022, estimated tax loss carry forwards amounted to $231m, a future tax benefit of c $57m, of which $36m has been recognised as a deferred tax asset.

Highlighting the operational gearing of the business, underlying EPS rose 38% to 18.7 US cents per share versus our forecast FY22 EPS of 17.0 US cents. As a result, based on the group’s policy of 3x dividend cover, the board declared a dividend of ZAR1.11 (FY21: ZAR1.00) (a 3.1% dividend yield), in addition to the $70m special dividend paid in November 2021, taking the total dividend paid for the year to $85m in aggregate, or c 39 US cents per share.

Net debt at 28 February 2022 rose to $130m (FY21: $61m), lower than our FY22 forecast of $166m, with net debt typically increasing as the business grows, but with strong cash generation partly mitigating the build-up of inventory. Excluding lease liabilities, net debt was $36m (FY21: net cash of $53m).

For the first time, management provided an analysis of group backlog, highlighting its material growth over the past 12 months as supply chain delays slowed product delivery for both Logicalis and Westcon. Open orders at the end of FY22 were approximately $1.2bn, compared with c $0.5bn for FY21, itself a record level of backlog.

Given the ongoing supply chain issues and the uncertain macroeconomic environment, we do not expect this backlog to unwind in H123, but we do anticipate that it will start to slowly unwind in H223 and in FY24 as the supply-side squeeze steadily eases. These unfulfilled sales orders will then be recognised as additional sales, supplementing and supporting Datatec’s growth in H223 and FY24. Total backlog at FY22 year-end equated to approximately three months of group sales.

Looking at the backlog for the two principal divisions, it becomes apparent that the highest backlog for Logicalis is in Latin America, but the greatest percentage rise in backlog has occurred in North America, with demand outstripping supply. At Westcon, Exhibit 3 shows that backlog growth is centered on hardware fulfilment, although there is also a surprising growth in software backlog, presumably where software fulfilment is dependent on key hardware components.

Management is guiding Datatec to become a global leader in higher-margin, speciality ICT solutions. The group performed strongly in FY22, benefiting in particular from trending demand in networking, cloud usage and cyber security. This positioning enabled all divisions to deliver robust revenue and profit growth in FY22.

Logicalis has the broadest geographical footprint in the group, which meant that although FY22 was a solid year, business was constrained by geopolitical factors. Continuing headwinds from semiconductor shortages, as well as the war in Ukraine, China lockdowns and global inflationary pressures are expected to continue to disrupt global supply chains in FY23 and beyond. This is expected to affect the performance of Logicalis in Latin America for at least H123, increasing uncertainty over Logicalis’s performance in the short and medium term. In FY22, Logicalis revenue increased by 14% to $1.66bn (FY21: $1.45bn), with a 13% increase in EBITDA to $93m (FY21: $82m). EBITDA margins remained broadly stable at 5.6% (FY21: 5.7%), although on an adjusted basis (allowing for the restructuring costs in FY21) they fell from 6.6% to 5.6%.

FY22 was a year of continued improvement for Westcon, despite the uncertain global climate. Westcon remains focused on revenue growth and margin expansion supported by continued investment in process automation and channel investment, coupled with tight cost control. In FY22, revenue increased by 12% to $2.89bn (FY21: $2.59bn) with strong demand for networked infrastructure, remote access solutions, enhanced cyber security for flexible working and unified collaboration tools. Showing the division’s operational gearing, EBITDA lifted by 52% to $68m (FY21: $45m), with margins rising from 1.7% to 2.4%.

Revenue at Analysys Mason increased by 24% to $90m (FY21: $73m), with EBITDA rising by 9% to $11.1m (FY21: $10.2m). Excluding share-based payments, adjusted EBITDA rose 27% to $18.1m (FY21: $14.3m), with margins ticking up from 19.5% to 20%. Analysys Mason then completed the acquisition of Northern Sky Research on 30 April 2022 (post year-end), a US-based research and consultancy business focused on the space and satellite sector. Finally, in parallel with the release of the group’s FY22 results, management confirmed that, as a result of the strategic review, Datatec was in discussions with an unnamed buyer over a potential sale of Analysys Mason. Analysys Mason has c 300 employees.

FY22 annuity revenues, despite growing in absolute terms, fell back slightly year-on-year to represent 9% of group revenues (FY21: 10%). Despite this, when taken together with software and services, the proportion of non-hardware revenues rose marginally to 47% of overall revenues (FY21: 46%). We expect the proportion of non-hardware revenues to continue to increase in the medium term.

Even with management’s understandably cautious tone for H123, particularly for Logicalis Latin America (given the challenging macro-economic situation in Latin America), Datatec remains a defensive player, despite continuing economic and geopolitical uncertainties (growing price and wage inflation, the war in Ukraine, lockdowns). Management expects the technology trends that benefited the business in FY21 and FY22 - ongoing digitalisation driving demand for software-as-a-service solutions, investment in hybrid working and cybersecurity - to continue in FY23.

As we have noted, supply chain issues and semiconductor shortages have constrained Datatec’s ability to meet demand in FY22, leading to a growing backlog of pending orders. Although we expect supply chain issues to continue into FY23, we then expect the backlog to start steadily to unwind, providing additional demand to support sales in H223 and FY24. Management has noted that it expects a weak performance from Logicalis in Latin America in H123 as macroeconomic challenges and supply chain constraints continue to affect the region.

Software & services (FY22: 47% of revenues) is expected to continue to grow as a proportion of sales, with the group continuing to focus on networking, security and cloud infrastructure. This means the business is becoming progressively less asset intensive, benefiting from structural working capital improvements.

With FY22 net debt of $130m and leverage of 20%, the group has a strong balance sheet to support future growth. Although, Westcon absorbs cash as it grows, limiting cash generation in FY23 and FY24.

We have made some changes to our FY23 and FY24 estimates following Datatec’s FY22 results, increasing net revenue growth in FY23 to 6%, slowing to 4% in FY24. Given the wide economic uncertainties, we have softened gross margins by 0.2% to 16.9% in FY23 and 17.0% in FY24, although both are still higher than the 16.6% in FY22. Adjusted EBITDA margins in FY23 and FY24 soften slightly to 3.9% (FY22: 3.8%), with share-based payments in FY23 at a similar level to FY22 ($22.5m), falling to $13.5m in FY24 once the current Westcon incentive scheme expires. We have also assumed an increase in net finance costs (FY22: 5.9%), raising these to 7.0% for FY23 and subsequent years to reflect rising interest rates (particularly in Latin America) and higher utilisation of facilities. With the anticipated growth of Westcon, coupled with high inventory levels and backlog in FY23, we assume an increase in net debt in FY23, to $154m, remaining at a similar level of $161m in FY24. We have also introduced forecasts for FY25, with revenues of $5.3bn and adjusted EBITDA of $218m.

Off the back of FY22, all three of Datatec’s divisions can now point to a track record of solid profitability. Following the group’s strong performance in FY22, we have raised our revenue estimates, but softened margins to reflect increasing uncertainties. Datatec’s shares still trade on only 3.5x FY23e EV/adjusted EBITDA and 12.5x FY23e P/E. The shares also offer a 2.7% prospective dividend yield, as well as incremental upside from any uplift following the conclusion of the group strategic review, with a sale of Analysys Mason looking like the most likely initial outcome.

As we have stated before, we believe Datatec’s valuation is backward looking and does not reflect the positive transformation of the business and its improved operational performance. From peer analysis, a blended multiple of 9x FY23 EV/EBITDA or 14x FY23 P/E would appear justifiable.

Given the announcement of negotiations around the potential sale of Analysys Mason, we include an updated estimate of the potential value of the divisions on a standalone basis using the peer group multiples (Exhibit 15).