Markets

Profit From A Company That Lets Others Do The Work

A business professor once told me that a successful business is 1% idea and 99% execution.

Sure, it helps to have an innovative or useful product, but you absolutely must be able to run the business efficiently and effectively. Lack of a valid business strategy is why nearly 80% of small businesses fail within the first 18 months.

Thinking about this recently, I was struck by a great investment idea: What if I could find a company that let others do the work -- a company that benefited from other companies' research or marketing spending?

A company that helped other companies in exchange for a slice of the pie... a middleman, in other words.

Granted, no company is completely without execution risk, and there will always be operational challenges, but distributors and business service companies are the closest I've found to a risk-reduced middleman.

These companies do not need to spend billions of dollars on research or product development -- the manufacturers do it for them. They also do not need to spend billions on advertising to push products out to retail or enterprise consumers -- the resellers do that job. Some of these companies do not even need to physically touch the product, instead contracting out with delivery companies.

These middleman companies often do not show up on investors' screens because they are not as high-profile as the companies they serve. This means they may not be as broadly covered by the financial community -- and that means the opportunity exists for investors to find a great deal ahead of everyone else.

I think I've found that deal with an industry leader in a segment that is just now starting to rebound.

Synnex Corp. (NYSE: SNX ) is one of the world's leading distributors of IT-related products. The company distributes to large customers like Best Buy (NYSE: BBY ) and CDW Corp. (Nasdaq: CDW ) and to a massive network of 20,000 resellers. On the manufacturer side, Synnex distributes from the biggest names in tech, including Microsoft (Nasdaq: MSFT ) , Intel (Nasdaq: INTC ) and Apple (Nasdaq: AAPL ) .

The company's distribution segment offers a variety of services including integrated supply chain management, assembly, and systems integration. Its model as a middleman means that the company benefits from marketing spent by resellers and manufacturers while still posting higher operating margins than most retailers.

In April, Synnex closed its acquisition of IBM's (NYSE: IBM ) Concentrix global business services unit. In Concentrix's most recent quarter, sales rose 433% from the same period a year ago, to $293 million. In addition, Concentrix posted an operating margin of 9.5% and could improve Synnex's operating results significantly over the next several years.

Synnex easily beat estimates on its second-quarter earnings, reporting $1.52 per share against consensus estimates of $1.36 per share. The beat was largely a result of strength in PC sales due to the end of Microsoft's support for Windows XP in the quarter. Revenue jumped 28% in the first half against last year's results and the company just reported its 108th consecutive quarter of profitability.

Legacy IT companies like Intel, Microsoft and have rallied more than 20% in the last year on a rebound in enterprise IT spending and new products. , and earnings commentary by retailers and manufacturers has been positive, pointing to stronger IT sales this year in both the consumer and enterprise markets.

Legacy IT companies like Intel, Microsoft and Hewlett-Packard (NYSE: HPQ ) have rallied more than 20% in the last year on a rebound in enterprise IT spending and new products. PC sales in the U.S. jumped 7% in this year's second quarter , and earnings commentary by retailers and manufacturers has been positive, pointing to stronger IT sales this year in both the consumer and enterprise markets.

While PC and hardware sales may wane in the third quarter, demand should be relatively strong over the next couple of quarters as companies upgrade their equipment to support new applications and improved functionality.

Earnings are expected to rise 42% this year to $5.95 a share on a 24% increase in sales to $13.5 billion. The company has a strong history of beating expectations, with an average beat of 12% over the past eight quarters.

Risks to Consider: While Synnex benefits from the research and marketing efforts of others, it is also dependent on them to push demand for their products and increase the need for distribution. In a still-recovering global economy, the risk of a slowdown in IT spending at the consumer or enterprise level remains a threat.

Action to Take --> Shares of this little-known distributor are attractively priced and benefiting from the beginning of a rebound in IT spending. Shares are trading at a trailing price-to-earnings (P/E) ratio of just 15.3, lower than the industry average of 26.1 but higher than the company's five-year average of 10.8. My own estimate of $6.10 in earnings this year is slightly above consensus but leads to a price target of $79.30 on an earnings multiple of 13 times. That represents nearly 20% upside from the current price, with possibly even more to come in the years ahead as the hardware refresh cycle continues and business services becomes a larger part of the company.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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