Datatec — Resilient performance despite challenges

As Analysys Mason was sold post-period end, it has been accounted for in discontinued operations, with H122 and FY22 results restated to reflect this. The table below summarises Datatec’s performance in H123, with results down to profit after tax for continuing operations only.

The company reported year-on-year revenue growth of 9% (15% in constant currency). As a large proportion of Westcon, and to a lesser extent, Logicalis International sales are denominated in euro or sterling while the majority of cost of goods sold are in US dollars, the strength of the US dollar during the reporting period reduced gross margin in H123 at a group level by 2pp. Included within operating expenses were $7.8m in restructuring charges within Logicalis (combined) and $16.0m of share-based payments, mainly relating to the Westcon incentive scheme. This resulted in an EBITDA decline of 15% y-o-y and an EBITDA margin decline of 0.7pp. The gains on forward contracts taken out to hedge currency exposure are reported within operating expenditure, mitigating the currency effect seen at the gross profit level. Adjusted EBITDA, which excludes share-based payments, restructuring costs, one-off tax items impacting EBITDA, and acquisition, integration and corporate actions costs, increased 16% y-o-y and the adjusted EBITDA margin increased 0.2pp y-o-y.

Due to the mix of losses in Latin America, profits in other geographies and the removal of the Analysys Mason contribution (which attracted a lower tax rate than the group average), the effective tax rate in H123 was 46.7%. Reported net income for continuing operations, after minority interest deductions, declined 39% y-o-y. After adjusting for restructuring charges and other one-off items, but still including $16.0m of share-based payments (vs $7.3m in H122), underlying earnings for continuing operations declined 64% y-o-y and uEPS declined 67% y-o-y.

Net debt declined 31% y-o-y to $111m for continuing operations. We discuss the reasons for this in the divisional performance section.

With Analysys Mason now accounted for in discontinued operations, Datatec now reports three segments: Westcon, Logicalis International and Logicalis Latin America. At the EBITDA level, it also reports central costs separately. We discuss below the performance on the new divisional basis.

Westcon generated strong revenue growth of 16% y-o-y in H123 (constant currency growth 23%). The business saw strong demand for cyber security and network infrastructure (up 22% and 16% respectively). Reflecting the currency impact of the strong US dollar versus sterling and the euro, gross profit declined 1% y-o-y resulting in a 1.7pp decline in gross margin to 9.5%. Foreign exchange hedging gains reported within operating expenses ($12.8m realised gains, $19.3m unrealised gains) meant that EBITDA increased 66% y-o-y, with the EBITDA margin increasing 1pp to 3.2%. Adjusted EBITDA (the main adjustment was for $12m in share-based payments) increased 84% y-o-y and the adjusted EBITDA margin increased by 1.5pp to 4.0%.

Semiconductor shortages and supply chain issues continued to constrain the division’s ability to deliver orders, resulting in another increase in the backlog (+95% y-o-y, +18% h-o-h) as per Exhibit 3. Software in the backlog tends to be part of a larger order that also includes hardware and cannot be installed until the hardware is available. Semiconductor availability has started improving and freight costs have fallen, and management believes that the backlog is likely to start to unwind through the course of H223. The division managed working capital well during the period (see Exhibit 4), with net working capital days reducing to 16 days from 22 days in H122 and divisional net debt reducing by $63m y-o-y. The main benefit came from suppliers, particularly Cisco, extending payment days.

The $12m in share-based payments recorded in H123 related to the Westcon International Equity Appreciation Plan (WI EAP), which is linked to the valuation of the Westcon business. Based on a starting valuation of $125m, 10% of the value of WI above the starting valuation will be paid to the EAP pool. If WI is not sold within five years of the start of the scheme (ie March 2023), it will be valued by an independent valuer. At the end of H123, the group recorded a $33.5m short-term payable for cash-settled share-based payments. We understand that more than $20m of this relates to the WI EAP. Adding a further $12m to this balance (our estimate for share-based payment charges in Westcon in H223), this implies a total of $32m is owed to participants in the Westcon scheme and that Westcon is currently valued at c $445m.

Logicalis International, which operates across North America, EMEA and Asia Pacific, grew revenue by 6% y-o-y. Revenue from North America and Asia Pacific saw strong growth (up 24% and 23% respectively), while EMEA revenues declined 21%, partly due to currency translation and partly due to supply chain disruption. Demand for public cloud services was lower but remained strong for private or hybrid cloud services, with cloud revenue increasing 41% y-o-y to make up 17% of divisional revenue (H122: 13%).

Gross profit declined 5% y-o-y and gross margin declined 2.5pp to 23.7%, mainly due to product mix and the strong dollar versus sterling and euro, which reduced the translated value of European services. EBITDA declined 35% y-o-y and the EBITDA margin declined 2pp to 3.2%, due to the lower gross profit, $5.2m in restructuring costs to split out Logicalis International and Logicalis Latin America and $2.6m in tax-related charges at the EBITDA level. Adjusted EBITDA declined 9% y-o-y and the adjusted EBITDA margin declined 0.8pp to 4.6%.

Similar challenges as in Westcon resulted in further growth in the backlog during the period (+38% y-o-y, +7% h-o-h), although management believes the peak in the size of the backlog is fast approaching (see Exhibit 5). This division reduced net working capital days (see Exhibit 6), also benefiting from longer payment periods from suppliers, resulting in a decrease in net working capital of $75m y-o-y.

The division saw challenging trading conditions during H123 and revenue declined 21% y-o-y, with particular weakness in Brazil (down 31% y-o-y) and southern Latin America (SOLA, down 16% due to Chile and Argentina), while northern Latin America (NOLA) grew 22% due to good demand from Mexico and Colombia. Cloud revenue grew 36% y-o-y to make up 21% of revenue (H122: 12%). Hardware and software sales were held back by supply chain issues and this division saw the fastest growth in backlog since the end of FY22 (+84% y-o-y, +21% h-o-h) – see Exhibit 7.

Gross profit declined 14% y-o-y but gross margin increased 2pp to 22.2% helped by a higher proportion of services in the mix. EBITDA declined 106% y-o-y and the EBITDA margin declined 7pp y-o-y to -0.5%. This included $2.6m in restructuring costs and $2.2m in costs related to the aborted Brazilian IPO. Adjusted EBITDA declined 78% y-o-y and the adjusted EBITDA margin declined 4.8pp to 1.8%. The division has a relatively high fixed cost base, but management is loath to reduce the size of the workforce while there is a large backlog that needs to be delivered once supply chain issues recede. While DSOs and inventory days increased, extended payment periods from suppliers meant that net working capital reduced slightly year-on-year (Exhibit 8).

On a group basis, recurring revenue grew 13% y-o-y to make up 43% of total revenue (H122: 41%). On a divisional basis, growth in recurring revenue varied widely (see Exhibit 9). Notably, recurring revenue made up more than half of Logicalis Latin America revenue in H123, reflecting the weaker sales of hardware and software due to supply chain constraints.

Datatec sold its effective 71.2% shareholding in management consulting firm, Analysys Mason, on 27 September (see Management buyout of Analysys Mason for further discussion). It received cash of £128m and will receive a deferred payment of £7.1m three years after the completion date; the deal also includes an earnout of up to £7.1m based on an EBITDA target for FY23, payable on 28 February 2025. The company will pay a special dividend totalling £135m (equivalent to 1,250 ZAR cents per share), with a cash or scrip alternative, to shareholders as at 2 December. The company will bear the costs of the disposal.

The division that was previously called Corporate and Management Consulting now only includes central costs. On a reported basis, central costs increased 15% y-o-y, while on an adjusted basis (mainly excluding share-based payments), they increased only 1% y-o-y.

The uncertain macroeconomic environment and supply chain disruption are likely to present challenges for Datatec for the remainder of the year. However, the accelerating use of digital technologies and the ongoing shift to the cloud and hybrid working provide ongoing demand drivers for the company. As supply chain issues improve, the company should be able to start delivering more of its backlog.

We have revised our forecasts to reflect the sale of Analysys Mason (previous forecasts contained the business in the revenue and profit lines), the new divisional structure and H123 performance. We have made the following changes:

On a group basis, Datatec is valued on an EV/adjusted EBITDA of 3.9x FY23e and 3.6x FY24e and on a normalised P/E basis of 12.9x FY23e and 11.2x FY24. To more accurately reflect the dynamics of the different divisions, we continue to value Datatec on a sum-of-the-parts basis. Although Logicalis is now reported through two divisions (International and Latin America), we continue to combine them in the valuation as their business models are similar. We have stripped out the value of Analysys Mason as the cash receipt from the disposal will be paid out as a special dividend. We note that the current share price (until 2 December) includes the benefit of this special dividend, at ZAR12.50 per share. Using the EV/EBITDA peer multiples in Exhibit 12, average net debt for FY23 (we add c $100m to our year-end forecast as the group typically operates at this level of net debt across the year), and a 30% discount (South Africa sovereign risk and holding company discount), we arrive at a per share valuation of ZAR54.74. This implies 22% upside from the current share price, and stripping out the special dividend, 69% upside from the ex-div share price.