IPO fever

In the late 1990s the European distribution channel was gripped by IPO fever. IT spend was booming across the continent and distributors rushed to capitalise on investors’ seemingly insatiable appetite for tech-related stocks. Is the same distribution IPO fever going to occur in the Middle East during 2006? I wouldn’t bet against it.

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By  Stuart Wilson Published  March 8, 2006

In the late 1990s the European distribution channel was gripped by IPO fever. IT spend was booming across the continent and distributors rushed to capitalise on investors’ seemingly insatiable appetite for tech-related stocks. Is the same distribution IPO fever going to occur in the Middle East during 2006? I wouldn’t bet against it.

The conditions are now ripe for the successful IPO of an indigenous Middle East distribution operation. Demand for IT products continues to climb year-on-year and distributors hoping to capitalise fully on this growth potential understand that there is a real need to ensure that they have sufficient working capital available to match the scale of their ambitions. And investors are lining up to pump capital into indigenous success stories — especially in high growth business sectors.

The financial success or failure of a distributor comes down to a few factors: the ability to create a strong return on capital employed; maximising inventory turns, pumping sufficient credit into the market and achieving the economies of scale that allow competitive pricing while maintaining sustainable margins.

A successful IPO would give major players the working capital required to improve on all these fronts — assuming that the money raised is ploughed back into the business. And that’s a key point in the whole debate concerning the pros and cons of an IPO. The owners of distribution outfits looking at an IPO as an exit strategy are nowhere near as attractive to investors as those companies looking to float to raise capital to fulfil their growth ambitions.

How much?

One of the few thorny issues standing in the way of Middle East distributor IPOs is the question of valuation. In the last two years, there have been persistent rumours that global distribution powerhouses such as Ingram Micro would enter the Middle East market through acquisition. No deals transpired and the perceived wisdom (from vendors as well as global distributors) was that the owners of indigenous distributors were simply valuing their businesses at unreasonably high levels.

How much is a distribution business worth? That’s a tricky question and there is massive variation in valuations in both Europe and the US. One bad quarter has the potential to destroy a distributor’s profits for an entire year and this makes valuations based on price-earnings (P/E) ratios uncertain at best. A few bad debts, mismanagement of the supply chain or a sudden slump in demand for a particular product all have the potential to wipe out the bottom line for a distributor.

In the late 1990s, many distributors in Europe managed to hoodwink the investment community. They didn’t pitch themselves as boxmovers and admit that technology distribution was a highly competitive low margin sector. Far from it. These companies billed themselves as incredibly attractive dotcoms, the architects of the internet and technology revolution and anything else they could think of that would whet investor appetites. It was a smokescreen but it did the job and ensured that many distributors arrived on the stock markets with ridiculously high valuations based on an emotional reaction to their marketing hype as opposed to logical investor sentiment based on solid fundamentals.

Looking at quoted distributors in the US, Synnex is currently trading on a P/E ratio of just 10.6 while Tech Data is currently valued at a trailing P/E ratio of 78.48 — due mainly to a slump in profits. Looking at all the quoted distributors in the US, the industry averages for financial fundamentals make interesting reading — we’re talking about an average net margin of just 1.02%, a PE ratio of 20.91 and a price-sales ratio of 0.21.

Number crunching

We’ve had the calculators out in the Channel Middle East offices on this one. The 2006 Power List, which looked at the sales of 15 of Dubai’s biggest distributors, revealed that they posted combined sales of US$3.176 billion in calendar 2005. There’s still no concrete data available on profit margins for these distributors so we’re forced to crunch numbers from a price-sales perspective. Taking an average price-sales ratio of 0.21, the 15 distributors in the Power List, would have a combined market capitalisation of about US$670m for their operations in the region.

Obviously there are other factors to be taken into consideration. After all, the potential for future growth is much greater in emerging markets than it is in the established markets of the US and Western Europe. You also need to look incredibly carefully at each distributor’s balance of volume and value activities and the impact this has on the bottom line performance.

I’m all for IPOs of the leading distribution houses in the Middle East (and the wider emerging markets). It will usher in an era of greater financial transparency in the region, allow significant investment in the establishment of dedicated in-country distributor operations and provide the capital that the overall IT channel needs to sustain its stellar growth rates.

When the first distributor IPO in the Middle East happens, all eyes will be on the valuation that the company receives. It will act as a yardstick for other players currently mulling over their own IPO plans.

Successful IPOs have the potential to transform regional IT distribution, but they need to be done for the right reasons and everyone involved has to maintain reasonable levels of expectation.

There’s always the potential for a Middle East distributor to get a ridiculously high valuation through an IPO — believe me, it could happen. And that could open up the door to some serious M&A activity — not just in the emerging markets, but also further afield. The investment capital exists in the Middle East, the market dynamics are strong and the global ambition is certainly there.

Does anyone remember CHS?

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