Description

Summary

TD Synnex is the largest IT distributor in the world, with >$60b in gross sales, connecting >150k customers with >1,500 vendors.  The company has a long history of steady growth and margin expansion at attractive returns, value-creating and consolidating M&A, and accelerating cash generation in economic downturns.  The company trades at <8x this year’s earnings, with 2.2x net leverage and cash generation set to accelerate meaningfully in the next twelve months.

It's hard to argue that SNX isn’t optically cheap, so the thesis really revolves more around identifying and addressing the main concerns, and then laying out a path forward that could catalyze the valuation of the company.

Concern #1 – business model losing relevancy

I think the main overarching concern re: SNX is anxiety around whether or not the traditional IT distribution model is losing relevancy as the tech world shifts towards more software vs hardware, and more cloud vs on-premise.  I think the best way to address this concern is through both a micro lens and a macro lens.

On a micro level, I found that speaking with software companies about this issue to be particularly helpful.  For example, I spoke to a former high-level executive at Facebook Workplace who articulated two main areas re: the importance of the IT distribution channel to enterprise software; the buy vs build of go-to-market, and the importance of speed to market in a competitive software environment.  For what it’s worth, this exec also spoke about SNX’s reputation for “hustle” and their strength in SMB as things that set them apart from other distribution channels.  On the buy vs build, the exec talked about the economies of scale gained from outsourcing go-to-market to the distribution channel.  On the speed issue, he spoke about how in today’s very competitive and dynamic software marketplace, getting to market at scale quickly is invaluable, and the distribution channel allows for that.

From a macro perspective, the numbers just don’t seem to fit the “losing relevance” narrative.  SNX has grown ~6% annually over the past ~15yrs, growing in-line with the IT market last year, and this year tracking to MSD-HSD vs Gartner’s LSD expectation for the IT market.  That performance is despite a substantial revenue recognition headwind; for hardware SNX recognizes the entire value as revenue, but ASC 606 requires them to basically only recognize their gross profit as revenue on the software side.  So basically, as software grows faster than hardware, revenue growth is going to be understated vs gross billings growth, making SNX’s revenue growth comp look even more favorable vs total market growth stats.

Concern #2 – PC exposure / risk

A second, and more topical concern re: SNX is around the company’s exposure to PCs and whether this represents a risk that the company has been over-earning and is set for a period of declining growth.

First, I believe the company’s exposure to PCs is often overstated; some casual observers believe it to be the bulk of the company’s Endpoint Solutions (~45% of total revenue), whereas it is more like 20 of those 45ppts.  Second, whereas the bulk of the recent PC cycle has been in consumer & Chromebooks, these are not only low/no margin for SNX, but the bulk of SNX’s PC exposure is commercial.  We have seen several quarters now of negative consumer PC market growth, vs resilient SNX Endpoint Solutions growth because of these differences.  Furthermore, on the most recent conference call, while management said that their Endpoint Solutions backlog has finally begun to decline, the majority of the impact was due to supply chain improvements at a major OEM who has very strong ongoing demand; i.e. growth in PCs should continue to be more resilient but with a better cash cycle.

At a higher level, and similar to the previous concern, I think it’s useful to go back and look at the last PC cycle, and SNX’s ability to growth through a decline in the PC market.  In summary, not only is SNX’s PC exposure much smaller than feared, but SNX growth is determined more by direction and pace of overall IT spend, rather than the PC subsegment.

Concern #3 – quality of earnings / lack of FCF

The last main concern that I see, and another topical one, is SNX’s poor recent quality of earnings / cash generation.  It’s hard to find any company that hasn’t been impacted by supply chain issues over the last several years, and SNX is no different.  While the company is on track to generate ~$12/share in earnings this year, OCF for the first 9mos of the year has been a ~$350m use.  The main driver of this dynamic has been a nearly $3.4b inventory build since the start of the year.  While lead times have extended (until only recently in Endpoint Solutions), they’ve been most pronounced in Advanced Solutions, and the company’s Hyve business.  In Advanced Solutions the company has a significant amount of inventory in the form of solutions that are nearly complete but might be missing one or two critical components.  In the Hyve business that is not only the case, but the company also has racks of completed equipment that is awaiting the final construction of customer data centers.  There has been some A/P offset, with suppliers amending terms to partly compensate for these issues, but the payables benefit YTD of ~$2.2b has only been a partial offset.  In total, the company’s cash conversion cycle has blown out from ~15 days to ~23 days.  Prior to supply chain issues, both SNX and TECD had strong working capital performance.  I expect the business to generate >$1b in FCF next year, with minimal working capital progress, and then grow earnings and have W/C release after that.

Catalysts to fair value

I think that three things will catalyze SNX’s valuation: 1) OEM share gains as a result of the TD/Synnex merger, 2) cash performance, and 2) more aggressive share repurchases.

SNX has a strong history of M&A where not only do they over-deliver on cost synergies, but they have delivered impressive OEM market share gains through acquiring a relationship and then leveraging it through their channel.  For example, when the company bought Westcon, they nearly doubled their market share with Cisco from ~8% to ~15%.  With the Tech Data merger, the company should be able to leverage the individual legacy strengths through the combined distribution channel; for example, Tech Data has had a very strong data center portfolio historically, and legacy Synnex has had a very strong security portfolio historically.  One gating factor to this opportunity has been getting the two companies onto one ERP system in the Americas; the legacy Synnex CIS system which is agile and purpose-built for distribution.  The company just finished migrating the bulk of its Canadian operations, which went well, and expects to complete the bulk of the U.S. next year.

On cash performance, I’ve discussed above, but needless to say the impact on earnings quality, leverage and share count, should all be positive for the stock.

On share repurchases, the company has committed to getting to 50% of FCF towards share repurchase as leverage from the TD merger comes down.  With leverage at only 2.2x, and supply chain issues peaking, both FCF and share repurchases should accelerate meaningfully over the next 12-24mos.

Valuation

I expect the business to generate on average, about $1.25b of FCF per year or greater over the next few years.  With a 10x multiple, the stock should be >$130 over the next 12-24mos, vs <$90 today.

Catalyst

1) OEM share gains from TD/Synnex merger

2) Better cash performance

3 More aggressive share repurchases