Datatec — Positive outlook for FY25

Exhibit 1 summarises the FY24 results.

Datatec reported revenue growth of 6% for FY24, 2% below our forecast. We discuss divisional performance below. Despite lower-than-expected revenue growth, gross profit increased 16% y-o-y and was 2% ahead of our forecast. EBITDA increased 81% y-o-y and was 4% below our forecast. Adjusted EBITDA increased 7% y-o-y, resulting in an unchanged margin of 3.5%. Adjusted EBITDA excludes share-based payments of $8.3m (FY23: $52.6m) and restructuring and other one-off charges totalling $6.2m (FY23: $29.3m). Net finance costs increased from $38.1m in FY23 to $55.0m in FY24, reflecting higher interest rates on higher debt. Reported EPS includes a $14.9m gain relating to the Mason Advisory acquisition (see below), which we had not forecast. Headline EPS from continuing operations, which excludes the post-tax gains and losses from the disposal of fixed assets, increased from -10.8 cents in FY23 to 14.2 cents in FY24. Underlying EPS from continuing operations (adjusts headline EPS by excluding impairment of intangible assets, amortisation of acquired intangibles, unrealised FX movements, acquisition-related adjustments and fair value movements, restructuring costs, one-off tax items affecting EBITDA, and costs relating to acquisitions, integrations and corporate actions), increased 230% y-o-y, reflecting a better trading performance and a significantly lower level of share-based payments than in FY23.

Net debt at year-end was $123.1m, up from $106.6m at the end of FY23 but well below our $205.2m forecast due to better-than-expected management of working capital.

The company declared a final dividend of ZAR1.3/US$0.07 for FY24, based on its policy of paying out one-third of underlying EPS. This is available as cash or with a scrip alternative.

In December 2023, the company increased its shareholding in Mason Advisory Limited from 42.5% to 80% for a consideration of $18.2m. It is now accounted for as a subsidiary rather than an associate and this resulted in a fair value adjustment of $14.9m. Mason Advisory is included within the Corporate and Management Consulting division.

In September 2023, Logicalis Latin America acquired 5% of its shares held by Promon for $8.6m and cancelled the shares. This reduced the minority interest in Logicalis Latin America from 35% to 31.58%.

In January 2024, Westcon acquired 100% of Rebura Holdings Limited for $7.6m, of which $6.5m was paid in cash on completion, with the remaining $1.1m due one year after completion subject to certain conditions.

During FY24, the company put in place two new incentive schemes for the management teams of Westcon International and Logicalis International. Post year-end, the company set up a similar scheme for Mason Advisory. Exhibit 2 shows the key features of each scheme. Management will only be able to realise their shareholdings on the sale of the relevant business or similar exit event.

Exhibits 3 and 4 show recurring revenue by division.

Exhibit 5 summarises divisional revenue and profitability.

Westcon reported revenue growth of 7.7% for FY24 (H124: +14.9% y-o-y; H224: +1.3%), with revenue slightly below our forecast. Revenues grew in every region as supply chain constraints eased and hardware availability improved, and the business worked its way through the backlog that had developed over previous years (Exhibit 6). Recurring revenue grew 24% y-o-y to 44% of total revenue, reflecting stronger growth in software sales. The business saw strong demand for cyber security, which grew 16% y-o-y to 42% of revenue (Exhibit 7). Software grew as a proportion of revenue, from 38% in FY23 to 43% in FY24 (Exhibit 8).

Gross profit grew 23% y-o-y and the gross margin expanded 1.3pp to 11.0%, helped by more stable exchange rates than in FY23. Adjusted EBITDA grew 26% y-o-y and was 5% ahead of our forecast, with the adjusted EBITDA margin expanding 0.5pp to 3.3%.

We have previously written about the extended payment terms offered by Cisco in recognition of the delays to delivery caused by supply chain constraints. These terms have now been reversed, which was the main reason for the $21m increase in Westcon net debt in FY24 to $88.9m. Partially offsetting this, the business saw an inventory reduction and faster inventory turns (from 8.8x in FY23 to 9.6x in FY24).

LI grew revenue 1.5% y-o-y in FY24 (0.9% in constant currency) with 12.1% y-o-y growth in H124 and a 7.8% decline in H224. Recurring revenue increased 2% y-o-y to make up 38% of revenue. An increase in net revenue-accounted software sales, mainly in North America, dampened reported revenue growth, with North American revenue down 8% y-o-y, EMEA revenue up 11% and Asia-Pacific revenue flat, and software declining from 15% to 13% of sales. As for Westcon, the backlog continued to unwind (Exhibit 9) as delivery lead times have become more predictable. Asia-Pacific backlog often relates to long-term infrastructure-related projects and it can take longer to ship. Cloud revenue increased 53% y-o-y, making up 27% of revenue compared to 18% in FY23.

Gross profit increased 11% y-o-y with gross margin expanding 2.2pp to 27.1%, helped by the increased contribution from annuity services. Adjusted EBITDA increased 12% y-o-y with the adjusted EBITDA margin increasing 0.5pp to 5.9%. Adjusted EBITDA excluded share-based payments of $2.4m (FY23: $0.4m) and one-off tax items and M&A integration costs of $5.2m (FY23: $15.1m). Management noted that EBITDA growth was driven by strong performances in the US, the Asia-Pacific region and Spain, whereas the UK was at break-even and South Africa was lossmaking.

The absolute level of inventory declined and days of inventory outstanding reduced from 14 in FY23 to 11 in FY24. Net working capital was reduced by $38m year-on-year, helping lower divisional net debt by $8.7m to $79.3m.

Logicalis Latin America grew revenue 4.5% in FY24 (15.7% in constant currency) with 20.2% y-o-y growth in H124 and an 8.2% decline in H224. Revenue was 5% below our forecast due to lower-than-expected demand from Brazil and Mexico, with revenue from Brazil down 2% y-o-y, northern Latin America up 9% and southern Latin America up by 14%, despite the difficult economic situation in Argentina. The product backlog continued to reduce (Exhibit 11), although Brazil is taking longer than other countries to unwind. Recurring revenue declined by 7% y-o-y to 44% of revenue (FY23: 49%) mainly due to the reduction in scope or cancellation of some annuity contracts, particularly in Brazil. Cloud revenue increased 1% y-o-y making up 18% of revenue.

Gross profit increased 8% y-o-y and the gross margin increased 0.7pp to 23.0%, helped by professional services and better product margins. Adjusted EBITDA declined by 49% y-o-y and was 54% below our forecast. Adjusted EBITDA includes a large proportion of the group’s $15.9m unrealised FX losses (which relate to the devaluation of the Argentine peso vs the US dollar) and excludes share-based payments of $0.3m (FY23: $0.5m) and restructuring and other one-off charges totalling $0.7m (FY23: $3.2m). The business saw a $30m improvement from net debt of $25.2m at the end of FY23 to net cash of $5.2m at the end of FY24, helped by an improvement in net working capital days resulting from higher days’ purchases outstanding (FY24: 166 days, vs FY23: 147 days) and lower days’ sales outstanding (FY24: 56 days, vs FY23: 65 days).

Overall, the group continues to benefit from secular technology growth trends, including strong demand for cyber security and hybrid working, and the adoption of GenAI. As companies look to integrate GenAI into their internal and customer-facing processes, they will need help to build adequate hardware infrastructure and to integrate ChatGPT (or alternative) solutions into their existing IT estate, driving demand for both Westcon and Logicalis.

Management confirmed that it maintains its mid-term adjusted EBITDA margin targets. For Westcon, it is targeting a margin of 3.5–4.0% and, as it achieved a margin of 3.3% in FY24, management believes there is scope to exceed 4.0% in the medium term.

For both Logicalis businesses, it believes that the mid-term margin should be in the range of 6–7%. Logicalis International is very close to the bottom of the range at 5.9% in FY24. Logicalis Latin America’s profitability clearly declined significantly in FY24 to 2.5%, but achieved 5.1% in FY23 and 5.3% in FY22. Management noted that interest rates have been declining in Brazil (from 13.75% in July 2023 to 10.75% currently), which could help stimulate demand. In Argentina, the new government is working to stabilise the economy and currency controls have been relaxed somewhat, allowing Argentina operations to start paying their dollar-based suppliers.

We have revised our forecasts to reflect FY24 results and introduce forecasts for FY27.

Overall, our adjusted EBITDA forecasts increase marginally in FY25 but are 4% lower in FY26. Factoring in higher net debt as working capital requirements increase, we have increased net finance costs and reduced the tax rate slightly from 35% to 33%, resulting in uEPS 2% lower than our previous forecast in FY25 and 10% lower in FY26. This flows through to the dividend, which is based on one-third of uEPS.

On a group basis, Datatec is valued on a minority-adjusted EV/adjusted EBITDA multiple of 3.0x FY25e and 2.8x FY26e and on a normalised P/E basis of 7.7x FY25e and 6.6x FY26. To more accurately reflect the dynamics of the different divisions, we continue to value Datatec on a SOTP basis. We have rolled forward our forecasts by one year. We note that peer multiples are broadly unchanged since we last published our valuation in November 2023 and we have adjusted our minority interest percentages to reflect the new management incentive schemes and the buy-back of a small amount of minority interest in Logicalis Latin America.

Using the EV/EBITDA peer multiples in Exhibit 13, FY25e net debt (we add $150m 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 ZAR70.46. This implies 88% 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.