Investors might want to sit down for this one. Over five years, the total return to technology conglomerate Datatec shareholders is a ridiculous 570%. The share price is responsible for 234% of that return, with the rest coming from ordinary and special dividends.
Over the past 12 months, shareholders have enjoyed a total return of 46%. This has been boosted by a strong move of nearly 6% in response to the company flagging yet another special dividend in the works.
This payday for investors will be thanks to an investor coming on board in Westcon International, leading to a flow of cash to the holding company and a potential special dividend of more than R7bn to shareholders, or about a third of the market cap!
Westcon is one of the two major business models in the Datatec group. The other is Logicalis (split into Latin America and international), a managed services house that has a higher-touch model with clients vs the distribution-focused model found at Westcon.
Recurring revenue is one of the easiest ways to see this difference, contributing 68% of Westcon’s sales vs just 35% at Logicalis international. Businesses with a more services-led, project-driven model tend to have less predictable repeat revenue than distribution businesses built around products.
Despite the incredible performance of Datatec’s shares, the tech distribution sector hasn’t been easy in recent years. Before digging into the details of the Westcon deal, it’s worth understanding more about the pressure points in the sector.
An important nuance greets investors right at the top of Datatec’s income statement in the form of “gross invoiced income”, an unusual line distinct from revenue. This is a function of the agency model common in this sector, with technology distributors acting on behalf of global tech giants (such as Microsoft) and earning a commission. If you think the poultry industry has thin margins, then try tech distribution!
This is very much a volumes game, where distributors build relationships in a particular market and then benefit from customers regularly hitting the renew button for software and hardware needs. Hardware is a very low-margin business, so distributors have focused on increasing the exposure to software and services in gross invoiced income (where margins are at least slightly better).
The software exposure used to be far more appealing before Microsoft put the squeeze on distributors by reducing commissions. You only need to look at Bytes Technology Group (down 34% in the past 12 months) to see where an overreliance on Microsoft can lead you.
The right strategy for distributors has been to pivot to where the money is. Players such as Microsoft can try to disintermediate the market, but that’s certainly not the case for all technology houses. By focusing on working with vendors who value the role channel partners play in the route-to-market strategy, the likes of Datatec have been able to keep their margins at reasonable levels.
Cybersecurity is also top of mind for corporate executives trying to manage expanded networks with numerous additional endpoints
Recent developments in the technology space have been extremely helpful to Datatec’s business.
Widespread adoption of AI has increased complexity across IT environments. This boosts the value to end users of trusted channel partners who can help them navigate this environment, bringing some of the economics back into this part of the value chain. Demand for devices that can handle AI use cases is increasing, with the replacement cycle of hardware creating additional revenue opportunities.
Cybersecurity is also top of mind for corporate executives trying to manage expanded networks with numerous additional endpoints. At Westcon, cybersecurity was 52% of gross invoiced income in the latest financial year.
This underlying thesis has attracted General Atlantic Service Company as an investor in Westcon. It is providing $375m in debt to partially refinance shareholder loans. It is also acquiring 5% in Westcon from shareholders for $25m. The use of share warrants will take General Atlantic up to an 8.7% stake after the transaction closes, with further warrants to increase that stake over time.
As mentioned earlier, this flow of cash to Datatec will unlock a special dividend of more than R7bn. This is another excellent example of Datatec trying to address the conglomerate discount that has plagued the group (and many other names on the JSE), where holding companies trade at a discount to the value of the underlying assets.
Founder and CEO Jens Montanana holds about 19% of the company’s shares. This much alignment between the CEO and other shareholders tends to lead to smart decisions around capital allocation.
You can contrast this to scenarios where CEOs are getting rich through salaries and bonuses, rather than appreciation in the value of shares. In such misaligned structures, holding company discounts are a feature rather than a bug. This is why alignment with management is such a critical part of the Datatec bull case.
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