Datatec — On track for better performance in FY24

Exhibit 1 summarises Datatec’s performance at a group level in H124. Revenue grew 15% y-o-y (16% constant currency (cc)) while gross profit increased 24% over the same period. With a significantly lower level of share-based payments and one-off costs in H124 compared to H123, EBITDA was 39% higher y-o-y. Operating costs included FX gains totalling $29.5m ($18.9m unrealised) in H123 compared to FX losses of $13.3m ($9.2m unrealised) in H124, resulting in a 2% increase in adjusted EBITDA year-on-year. Reversing the effect of the unrealised gains/losses, adjusted EBITDA would have been 44% higher at $99m. Net income from continuing operations increased 140% y-o-y and headline EPS from continuing operations increased 88% y-o-y. Underlying EPS from continuing operations increased 336% y-o-y – adjustments include amortisation of acquired intangibles, unrealised FX gains/losses, restructuring costs, one-off tax items affecting EBITDA and other one-off costs.

Net debt increased 58% y-o-y, reflecting higher working capital requirements as the company increased shipments from the backlog (which declined 35% y-o-y and 21% h-o-h to $932m). The company also made the final $59m payment to settle the Westcon International Equity Appreciation Plan, which has now been replaced with a divisional ownership scheme (more detail below).

Exhibit 2 summarises performance at a divisional level and Exhibits 3 and 4 show the progression of recurring revenue. At a group level, recurring revenue made up 40% of total revenue in H124 compared to 43% in H123 (see Exhibits 3 and 4). As supply chain issues during FY22 and FY23 made it more difficult to get hold of hardware products, this element had grown in backlog. Product lead times have reduced over the last 12 months, allowing the group to ship more hardware as a percentage of total revenue, resulting in a lower contribution from recurring revenue.

Westcon saw revenue growth of 15% y-o-y (16% cc), with particularly strong demand for cyber security and networking solutions (see Exhibit 5 for revenue split). As supply chain issues started to recede, product supply lead times improved and the business was able to increase the amount shipped from backlog (see Exhibit 6). Westcon gross profit increased 33% y-o-y and gross margin expanded 1.5pp to 11.0%. The increase was mainly due to stabilisation of exchange rates compared to H123 when the US dollar strengthened significantly versus sterling and the euro. In H123, the negative effect of currency on gross margin was partially offset by hedging gains reported in operating expenses. In H124 Westcon reported FX losses of $4.6m (including $2.7m unrealised) compared to FX gains of $32.1m (including $19.3m unrealised) in H123.

Reported EBITDA increased 16% y-o-y and adjusted EBITDA declined by 4% y-o-y, with the adjusted EBITDA margin declining 0.6pp to 3.4%. In H123, adjusted EBITDA excluded share-based payments of $12.0m and other one-offs totalling $1m, whereas in H124, adjusted EBITDA only excluded share-based payments of $2.5m. Excluding foreign exchange and share-based payment charges, operating expenses increased 12.9% y-o-y.

44% of revenue was generated from the Comstor business unit, up from 41% in H123, with the remainder from the Westcon business unit. Exhibit 7 shows the increase in the reseller contribution to revenue in H124 versus H123.

Inventory turns improved, partially offset by slightly higher DSOs and lower DPOs, resulting in a reduction of net working capital days by one to 15 compared to H123. This in turn drove a $10.6m y-o-y reduction in divisional net debt to $67.7m.

Logicalis International reported revenue growth of 12% (12% cc), with the strongest growth from the EMEA region (Exhibit 10). Hardware revenue increased as a proportion of total revenue (Exhibit 9) as product lead times reduced. Cloud revenue increased 58% y-o-y to $155m to make up 24% of divisional revenue. Gross profit was 15% higher y-o-y resulting in a gross margin improvement of 0.7pp to 24.4%. EBITDA increased 41% y-o-y and adjusted EBITDA 7%. Adjustments to EBITDA in H124 were $0.8m for share-based payments and $1.8m in one-off tax costs and in H123 were $0.3m for share-based payments, $5.2m for restructuring and $2.6m for one-off tax costs.

Order intake in H124 was strong albeit slightly lower than in H123. Combined with improving supplier lead times, the backlog declined 17% y-o-y and 10% h-o-h (Exhibit 11).

Net working capital decreased to $41m from $77m at the end of FY23 but increased from $16m at the end of H123. Working capital metrics per Exhibit 12 show that DSOs were relatively flat y-o-y while DIOs and DPOs both reduced. Net debt increased to $113m from $88m a year ago due to the increase in working capital.

Logicalis Latin America saw revenue growth of 20% y-o-y (31% cc) with growth from all regions, despite challenges in Argentina (Exhibit 13), benefiting from strong order intake in H223 and improving product lead times. As with Logicalis International, hardware sales increased as a proportion of total revenue (Exhibit 14). Cloud revenue increased 21% y-o-y to make up 22% of divisional revenue.

Order intake in H124 was lower than in H123 and backlog reduced by 28% y-o-y and 16% h-o-h to $118m (Exhibit 15). Gross profit increased 17% and gross margin reduced by 0.6pp to 21.6%. Despite the impact of hyperinflation in Argentina and FX losses, EBITDA increased from a loss of $1.0m to a profit of $5.8m. Adjusted EBITDA increased 50% with an adjusted EBITDA margin of 2.3%, up 0.5pp. Adjustments in H124 included share-based payments of $0.2m; adjustments in H123 included share-based payments of $0.3m and restructuring and other one-off costs of $4.7m.

Divisional net debt was essentially flat year-on-year at $25.5m despite strong revenue growth over the period. Net working capital improved from $98m in H123 to $67m in H124 as the reduction in DSOs and DIOs more than offset the reduction in DPOs (Exhibit 16).

With the completion of the Westcon International Equity Appreciation Plan in FY23, the company decided to change the way it incentivises divisional management by offering them the chance to own stakes in their respective divisions rather than incentive schemes based on Datatec shares. A scheme was launched for Logicalis International in March with a holding company set up between Datatec PLC and the division. Datatec PLC owns 94.7% of the ordinary equity of the holding company and the remaining 5.3% is held by divisional management, who will be able to monetise their stakes if the division is sold. A further 0.9% will be available for purchase by management to allow for changes to the management team. A fixed return investment was also issued to Datatec PLC.

In September, a similar plan was implemented for Westcon International with an intermediate holding company called Westcon International Group Holdings Ltd (WIGHL) inserted in the group structure owned by Westcon International Ltd (WIL). Management purchased 5% of the shares in WIGHL and WIL holds the remaining 95%, with 1% earmarked for potential management participation in the future. WIGHL also issued a fixed return instrument to WIL.

There are still some incentive schemes operating at the group level as well as share appreciation rights at divisional level, thus Datatec will continue to report share-based payment charges, albeit at a significantly lower level than in FY22 and FY23. The new divisional share ownership schemes will not attract any IFRS2 share-based payment charges.

The company expects improved performance in all divisions in FY24. By division:

We have revised our forecasts to reflect H124 performance. We have raised our Westcon revenue and adjusted EBITDA forecasts on the back of strong performance in H1 and we have trimmed our Logicalis Latin America forecasts to reflect continued uncertainty in the region. At a group level, our FY24 adjusted EBITDA forecast increase offsets higher interest costs and our uEPS forecast is broadly unchanged. We have increased our net debt forecast, reflecting higher working capital requirements, particularly as suppliers start to reduce their previously extended payment terms.

On a group basis, Datatec is valued on a minority-adjusted EV/adjusted EBITDA multiple of 3.8x FY24e and 3.3x FY25eand on a normalised P/E basis of 10.1x FY24e and 7.6x FY25. 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. Using the EV/EBITDA peer multiples in Exhibit 18, average of end-FY23 and FY24e net debt (we add $100m to this as the group typically operates at a higher 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 ZAR70.95. This implies 84% upside from the current share price.

Through the ongoing strategic review, management has started to unlock some of this value with the sale of Analysys Mason and the subsequent return of cash to shareholders. We believe further transactions may take place in the medium term when market conditions start to improve. In the meantime, the company continues to work on operational improvements across the three divisions.

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