When was the last time you went to Best Buy to buy a computer? People don’t buy PCs in stores anymore. E-commerce is taking the retail industry by storm. Look at Amazon for example; they’ve grown at least 20% every year this decade. As e-commerce continues to grow, the brick and mortar retail industry shrinks. Remember Circuit City? Radio Shack? Tech Data (NYSE:TECD) is the supplier for companies like these failed businesses. E-commerce won’t replace Tech Data, it replaces its customers first. With customers dying off, Tech Data’s revenue has dropped every quarter this year: Q1 -12.5%, Q2 -3.8%, and Q3 -4.9%.
If that wasn’t bad enough, e-commerce cuts into the already narrowing profit margins because it adds new (online) players to the distribution game. For the last decade, industry operating margin has been down 20%. As E-commerce will inevitably grow, we think Tech Data is, at best, the tallest person on a sinking ship.
Europe has always been a deal breaker for Tech Data. The continent is just a tough nut to crack. A large number of small and scattered businesses make it difficult for TECD to utilize economies of scale. Many diverse languages, multiple taxing entities, numerous boarders to cross for shipping, all of these cut into the profit. As Europe has a 5.5% expense ratio vs. Americas 2.8%, it gives IT distributors the lowest profit margins among the world regions (e.g., EU 0.5%, US 2%, Asia 1.5%).
Furthermore, the Return on Invested Capital in Europe (9%) is almost the same as the Cost of Capital (8.75%), which offers little return to TECD shareholders. The company claimed they have been trying to shift to a more quality mix of business towards America to create a 50/50 split. If they were trying, they are not doing it. Year-to-Date, 60% of revenue still comes from Europe.
In contrast, Tech Data’s biggest competitor Ingram Micro (IM) moved away from Europe long ago. Instead of focusing on Europe, IM started operating in Asia, one of best markets for IT distributors. Tech Data, on the other hand, has yet to discover this market. Up to this point, Europe has been a nightmare for Tech Data.
Carl Icahn has warned that low interest rates have created “a new bubble,” that firms borrowed cheap monies to fund their acquisitions and bought back stocks in order to inflate their fundamentals. We think that Tech Data has jumped on the same bandwagon. Under the claim of “maximizing shareholder wealth,” in last 5 years, they have issued over $1 billion debt and bought back over $500 million worth of stock. This is to inflate EPS! The annual 8.5% EPS growth, after adjusted for buyback, dropped to -16%. Actually, Tech Data had a NEGATIVE organic bottom line growth for the last 5 years.
Another clever game that Tech Data is playing is to buy companies to pump up their top line growth. The company had 18 acquisitions, worth $700 million, since 2008. The acquisitions added $2 billion revenue, or 1.5% onto their 2% annual revenue growth. Again, removing the acquisitions would reduce their annual organic top line growth to merely 0.5%.
The real concern here is that all these ploys, as we see it, are “Hail Maries” for a failing business model in an ailing industry. Our estimates for their fundamentals, for the next few years, look grim. For 2016, Tech Data is expected to have a -8% revenue growth and a 4% earnings growth, even lagging industry -5% and 9%, respectively. As a result, the stock is overvalued by 12% and the expected return is -15% for 2016.