KUHN CAPITAL Wednesday, December 13, 2017
Dispatches from the front

A Tour of VAR-land
(3/7/2005)

Itís been some time since we looked at the computer VAR business and the sight isnít pretty.

The industry, partly captured in the wholesaling SIC 5045, has been struggling against steady disintermediation at the hands of its own manufacturing suppliers as well as the Internet. These pressures are heightened by regularly declining hardware prices and market saturation.

Itís tough to make a profit when clients are free to shop dozens or even hundreds of suppliers, when prices for the same functionality are in perpetual free-fall, and when most users are engaged in piecemeal upgrades rather than buying whole new systems.

Of about 15 public companies in the SIC, four have either bankrupted or staged distress sales in the last several years. The group as a whole shows breakeven profitability and in the last year or two has partially reversed a long run of annual sales declines. While some sales growth may continue given a strong economy, the marginal profitability appears likely to hold.

Even industry giants like Ingram Micro with $25 billion in sales donít look robust: the company has been generating an operating margin of about 1% for a return on equity of about 11% on flat sales.

Of course, VARs arenít alone in feeling the heat of IT commoditization. Also struggling is the related industry of computer systems design and integration businesses (SIC 7373), but in general these players enjoy better margins. Their market caps also show stronger multiples: the public sectorís median market cap/EBITDA multiple is nearly 15x versus 9x for VARs. In a word, the integration business appears to be more attractive in direct proportion to its ability to bring human expertise to bear on the IT problems of its clients.

In both industries, we see examples of salvation through specialization. Three VAR examples are:
* By market (like GTSI serving government clients);
* By technology (like ScanSource reselling POS devices), and;
* By service (like Pomeroy, leasing equipment).

Successful computer integration competitors also frequently specialize by market (government, healthcare and financial services being most visible); by technology (networked resources, telecom, embedded systems); or by end-user function (HR or A/R management).

So the message seems clear and commonsensical: exit the rough waters of commoditization by sailing into the protected harbors of specialization. What we do here at Kuhn Capital is help our clients use M&A to make this transition.

Ryan Kuhn


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