2024-01-11 02:33:57 ET
Summary
- CDW Corporation has seen a shift towards software and services, with a decrease in hardware revenue and growth in complex solutions.
- The company has a strong sales and support team, which has contributed to high-single-digit revenue growth and margin expansion.
- CDW has a solid acquisition record, with recent acquisitions strengthening its capabilities in complex solutions and offering revenue synergies.
CDW Corporation ( CDW ) provides integrated technology solutions and services to over 250,000 businesses, government entities, educational institutions, and healthcare customers. The company's operations are primarily U.S.-centric, with the United States accounting for more than 87% of its group revenue. CDW boasts a robust track record of growth in both topline and bottom line figures, successfully steering its business toward an increased focus on software and services. I recommend initiating a 'Buy' rating, with a fair value of $288 per share.
Mix Shift Towards Software and Services
The hardware business accounted for more than 80% of the total revenue in FY17, and its share dropped to 76.2% in FY22. Concurrently, CDW's software and services segments have experienced growth. The company has been strategically offering more complex solutions to both private and public customers, aiding them in the migration of their workflows to the cloud.
The success of CDW is significantly tied to these complex solutions for several reasons. Firstly, these products and services boast higher profit margins compared to the hardware business. CDW's software offerings encompass application suites, security, virtualization, operating systems, and network management. Notably, many of these services operate on a subscription basis, aligning well with the trends favoring cloud applications.
Secondly, CDW provides advisory and design, software development, implementation, and managed services to its customers. These customized and managed services play a crucial role in enhancing customer loyalty and fostering stronger client relationships.
Lastly, CDW's service delivery engineers collaborate with customers to facilitate the migration of workloads to hybrid and public cloud infrastructures. These services not only contribute to the success of CDW but also open up additional cross-selling opportunities for their hardware and software businesses.
Strong Sales and Support Team
CDW boasts a substantial workforce, with approximately 6,400 technical coworkers and over 10,000 customer-facing employees. The organization strategically organizes its sales team according to specific end markets. Consequently, CDW maintains dedicated sales teams for the private sector, healthcare, education, government, and small businesses. This targeted approach underscores the importance of laser-focused sales teams in contributing to CDW's historical success.
CDW aims to achieve a revenue growth rate surpassing its sales growth over the long term, thereby driving margin expansion for the company. Thanks to their successful sales practices, CDW has consistently achieved high-single-digit revenue growth on average in recent years. Moreover, their margin has expanded impressively from 7.5% in FY17 to 8.6% in FY22, showcasing remarkable financial performance and efficiency improvements.
I anticipate CDW will persist in leveraging its proficient sales force to capture market share. The company exhibits a keen focus on its "sweet spot" of customers with fewer than 5,000 employees. CDW's commitment to offering comprehensive solutions, coupled with a robust sales team, positions them favorably in the integrated technology solutions market, in my opinion.
Financial Review and FY24 Preview
Historically, CDW has maintained a strong track record of revenue growth at a compound annual growth rate of high-single-digit, coupled with robust margin expansion. As previously discussed, this expansion is attributed to their effective sales productivity and the growth of complex solutions. Importantly, the company's balance sheet remains solid, with net debt leverage consistently below 3x.
During Q3 FY23 , CDW experienced a 9.9% decline in revenue in constant currency, while the adjusted EPS demonstrated a growth of 4.6% year over year. On the balance sheet, the net debt leverage improved to 2.4x, a reduction from the 2.6x recorded at the end of the previous year. The company aims to maintain a net debt leverage ratio within the healthy range of 2-3x.
In terms of capital allocation, CDW is targeting a 25% dividend payout ratio. Additionally, they anticipate returning 60%-75% of total free cash flow to investors through a combination of dividends and share repurchases, indicating a commitment to shareholder value.
For FY23, CDW anticipates the IT market to contract at the upper end of high-single digits. Despite this, the company aims to achieve a growth premium of 200-300 basis points above the industry contraction. The guidance for full-year non-GAAP EPS suggests it will be flat to slightly up year-over-year in constant currency. Additionally, the adjusted free cash flow is projected to be 6% of total revenue, exceeding the previous guidance of 5%.
Considering the results from the past three quarters, there's no expectation of significant surprises in their Q4 FY23 results. It's likely that the market will shift its attention to CDW's FY24 guidance upon the release of its Q4 results.
It was a down cycle for CDW in FY23, and I expect their reported revenue to decline by 9% year over year. For FY24, I don't anticipate a significant recovery in the market, especially in hardware demands. Consequently, I expect the company to achieve a 6-7% revenue growth in FY24. During the earnings call, their management's tone was quite conservative regarding next year's growth, and they indicated they haven't seen any signs of demand pickup currently.
According to Gartner's forecast , the device market is expected to grow by 4.8% in 2024. I assume CDW can outperform the market by 2-3%, resulting in a topline growth of around 6-7% in FY24. I continue to believe they can expand their operating margin and free cash margin in FY24 due to their business mix shifting more towards complex solutions with a higher margin profile.
Solid Acquisitions Record
CDW has a robust acquisition record over the past decade, and these tuck-in acquisitions have broadened their solution offerings, accelerating their revenue and profit growth over time.
Notably, on December 1, 2021, the company completed its acquisition of Sirius for $2.5 billion. Sirius is a leading provider of IT solutions for approximately 3,900 large and mid-sized customers. The acquisition has significantly strengthened CDW's capabilities in complex solution areas, and the customer bases of the two companies are highly complementary. Sales cross-selling opportunities are expected to facilitate revenue synergies from the deal. I believe these types of acquisitions are high value accretive for the company.
In June 2023, CDW acquired Enquizit , a service provider of AWS cloud. While the deal is relatively small, Enquizit's cloud consulting business holds the potential to offer additional support for CDW's public sector cloud services. I believe CDW strategically utilizes these tuck-in acquisitions to expand and enhance its solutions.
Valuation
My FY23 assumptions align with their formal guidance, and I anticipate a modest recovery in FY24 with 6% organic revenue growth and 1.1% acquisition growth. As mentioned earlier, I have elaborated on the organic revenue growth. For the normalized revenue growth, my forecast includes 7% organic growth and 1.1% acquisition growth. These assumptions are consistent with their historical trends.
I believe that CDW's growth in complex solutions will be a key driver for margin expansion. Additionally, I expect the company to benefit from operating leverage over the next decade, given that its topline growth is anticipated to outpace its sales force growth. The model employs a 10% discount rate, a 4% terminal growth rate, and a 25% tax rate. The fair value estimated in the model is $288 per share.
Key Risks
Small Business Exposure : Small business customers account for 8.2% of total revenue and contribute 10.8% to operating profits. Generally, the small business market is more volatile compared to enterprise customers and is more sensitive to macroeconomic conditions. Despite this volatility, catering to small businesses remains a highly profitable venture for CDW. This is due to the fact that these customers typically have less negotiation power compared to larger customers, contributing to the overall profitability of CDW's small business segment.
Weak International Market : CDW has a 12% revenue exposure in international markets, including the UK and Canada. They highlighted some weaknesses in these international markets during the recent earnings call. Their business revenue in the UK and Canada declined in the mid-teens in Q3 FY23, falling below their own expectations. CDW is a relatively small player in these international markets, and I don't believe they have similar competitive advantages as they do in their US operations.
Conclusion
The shift in mix towards software and services has the potential to drive margin expansion for CDW over time. Positioned well in the IT transition to the cloud, I am initiating a 'Buy' rating with a fair value of $288 per share.
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CDW Corporation: Mix Shift Towards Software And Services Drive Margin Expansion