PCMI - PCM

[ratiman]

PCM is a tech reseller that competes with PC Connection, CDW, and Insight. It currently trades at about a 7x multiple on this years earnings estimates. CDW and PC Connection trade at around a 13x.

 

Here is some background:

 

PCM has been managed by Frank Khulusi, who started the firm as MacMall, and it's been poorly managed over the years. The last VP of Operations was a former Raymond James stock analyst and PCM regularly missed earnings estimates and was at least 5 years behind schedule in implementing a new ERP system. But two years ago a competitor bought a 5% position and faulted Khulusi's management, and in the last two years Khulusi has made big improvements, hiring a CEO from Ingram Micro and more than doubling revenues through acquisitions. The retail operations in California were shut down and the daily deals site was closed. PCM bought En Pointe, a California software reseller, and adopted En Pointe's SAP system, scrapping a $20M investment in Microsoft's ERP. Most recently PCM acquired what was left of Systemax's tech reseller business, including Tiger Direct. PCM also has three data centers.

 

Scale: PCM vs CDW

 

The key to success in tech reselling is scale. Scale means better terms from vendors and an opportunity to resell the highest margin products. There are some scale advantages in distribution/SG&A but the primary benefit shows up in gross margin. PCM is now up to around $2.2B and 14% gross margins vs. CDW's $13B and 16%. But PCM has a big advantage in services and software, 40% vs. 20% for CDW. Much of that is the recent acquisition of En Pointe, which focuses on software, and PCM has a software training division called Abreon that probably has 50% gross margins. 

 

The bull case

 

The bull case is that the new CEO, Jay Miley, knows what he's doing and Khulusi will stay out of the way and Miley will get the company up to at least 1% in net margins. CDW is closer to 3.5% and PC Connection is around 2%, so there is no reason PCM can't do 1%. PCM has never really had professional management, but Khulusi owns just 20% of the shares, so he has to worry about a takeover attempt, which is motivating much of the recent activity.

 

Balance Sheet

 

PCM's balance sheet is in bad shape. It has just $9M of tangible equity, and PCM relies on $133 in bank borrowing to fund the business. That's worrisome, but by comparison CDW has negative tangible equity of $2.7B, so it could be worse. PC Connection is very conservatively managed and has no borrowing and about $13/share of tangible equity.

 

However, Khulusi appears to be a real estate genius. He bought a retail store in Santa Monica for $2M and recently had a deal to sell it for $25M (deal fell through). Last year he bought a property in Irvine for $7M and recently sold it for around $13. He bought the HQ in El Segundo in the depths of the crisis for around $8M and it is probably worth $20M. So tangible equity is probably closer to $45M.

 

Valuation

 

At $12 or below, PCM is a good deal. There is no reason why PCM couldn't do $2 in earnings next year. At $2.4B of revenue and 1% net margin, that would generate $2 earnings on 12M shares. Considering that PCM is growing faster and has more focus on software, services and data centers than competitors like PC Connection and CDW, it could benefit from a higher multiple. Assuming $2 of earnings and 15x, PCM could be worth $30 on next year's earnings. That's optimistic but $15 is doable.

[ratiman]

The bear case is that Khulusi is still in charge and he will find a way to screw things up. Also big risks from integrating all of the acquisitions at the same time as a new ERP is being rolled out. PCM also relies on distributors like Ingram Micro for much of its inventory, which eats into already thin margins. The DSO is currently approximately 60 days vs 41-45 for competitors. PCM also has a lot of earnouts and debt from the recent acquisitions that could create a cash crunch if results don't improve.

[valuedontlie]

Interesting idea.

 

I have looked at Systemax (SYX) in the past... I'm surprised to hear that PCM expects that NA business to be accretive to earnings given how horrible it had been for SYX in terms of declining revenue and operating losses. Any thoughts there?

[ratiman]

PC Mall (PCM) began as a Mac retail store in Santa Monica. PC Connection was started by two hippies in NH with an ad in a computer magazine. These were originally simple retail and catalog resellers that grew into big companies in the 90s and 00s as technology grew and companies like HP and Microsoft realized that they couldn't profitably market and ship to small businesses and consumers (Dell had a different model, though it now sells through the DMRs). So it started as a fast growing industry with nice margins reselling a commodity product.

 

Over the years, margins shrank and growth slowed, and the companies responded in different ways. PC Connection is very well run and has a good customer reputation and stuck with the core reselling strategy. PC Connection is also very efficient at sales, so sales rep turnover is low (it helps being in NH) and sales per rep is very high. By contrast, PC Mall was very poorly run and sales rep efficiency is very low. Khulusi treated his sales reps so poorly that they sued him for running a sweatshop operation and in fact won the lawsuit. After that, he realized that there was no future in the call center/sweatshop business model and within weeks he acquired Sarcom, a tech services firm in Ohio, and then he started acquiring other higher-end tech resellers with better margins, things like Cisco and Sun resellers (he acquired a Sun reseller right before Sun was acquired by Oracle). So he moved up market and into more of a consultative sales strategy. Systemax was probably stuck selling commodity products, the same products sold in the consumer stores and website, that's probably why it had trouble competing, especially once the retail stores were shut down and competition from Amazon intensified. Of course, there is no reason to believe that PCM will succeed where Systemax failed, but scale is important, and simply increasing scale and leverage with vendors will help PCM. That's the strategy.

 

Anyway, that's a long winded way of saying that Systemax was probably stuck at the commodity/hardware end of the reselling market. PCM has done a pretty good job of getting the certifications and selling at the higher end of the market and focusing on services more than its competition. You can see that emphasis in the product mix, PCM has a higher mix of software and services than either CDW or PC Connection.

[kab60]

This is just very quick and dirty, so don't take it for more than it is, but isn't it an incredibly bad business?

 

I see ROIC from -6.21 to a max of 12.47% in the last ten years (even PC Connection, which sounds like the gold standard (and I know nothing about it) has pretty bad returns). If it was trading below NCAV or something like that it might warrant a look, but poor business and shitty management at like 10 times tangible equity? I think there are much easier hurdles to clear out there, but thanks for the idea anyway.

 

[ratiman]

This is just very quick and dirty, so don't take it for more than it is, but isn't it an incredibly bad business?

 

I see ROIC from -6.21 to a max of 12.47% in the last ten years (even PC Connection, which sounds like the gold standard (and I know nothing about it) has pretty bad returns). If it was trading below NCAV or something like that it might warrant a look, but poor business and shitty management at like 10 times tangible equity? I think there are much easier hurdles to clear out there, but thanks for the idea anyway.

 

  CDW uses about $1B of capital and generates about $1B of ebitda. That's why PE firms keep taking it private. PC Connection is probably overcapitalized. Annualizing the last quarter, PC Connection uses about $290M of capital and generates about $72M of ebitda, so that's about 25%. With a little bit of leverage PC Connection could easily generate a 50% ROE. 

[valuedontlie]

Good results today... Earnings for 2016 going from $1.27-1.40 to $1.51-1.64... Pretty big jump there, seems market underestimated (possibly still underestimating?) earnings potential of these combined businesses... Market still has this at 9x earnings or so...

 

Earnings of $1.60/sh implies ~90bps or so of net margin which is a full 60-90bps lower than NSIT/PCCC... Even if they were to achieve half the difference in peer profitability (i.e. 1.2-1.3% net margins) would imply earnings potential of $2.20-2.40/share...

 

Still some hair on it (leverage, management, etc etc) but risk/reward still looks decent after near 30% move today...

[ratiman]

some bearish arguments:

 

a) $20M of hidden debt in the form of earnouts

 

b) net margins are a little misleading, PCMI has much more debt than NSIT/PCCC, hence will have lower margins

 

c) revenues for a company like this can be misleading - very easy to generate revenues, just put on website and sell at cost

 

d) gross margins are misleading because PCMI can include unprofitable services revenue with higher margins. Have to look at each

business separately, which PCMI does not break out. Look at Ciber for an example of unprofitable services revenue

 

e) very easy to generate profits through acquisition. Here is how:

 

1. Acquire business

2. Cut sales expense: Fire 10% of junior salespeople, shift their business to senior staff. Voila: lower sales expense, higher sales efficiency

3. Profit! (but revenues decline on proforma basis. PCM barely made lower end of revenue guidance, reduced full year revenue) Khulusi has a history of doing this, look at PCM after Sarcom acquisition

 

PCMI is hiring 220 sales reps in New Mexico, that will depress earnings going forward.

 

TBH,  this is sour grapes, I sold before the earnings report. However, I sold because if you compare PCCC and PCMI and back out the cash, you'll find that at this point PCCC is actually cheaper than PCMI, though PCCC is much more conservatively run and can generate growth without acquisitions. Khulusi has never grown profitably without acquisitions.