Don't write off the middlemen yet.
Inundated with the hype of Web commerce slogans like "Be Direct" and plagued by fears about plummeting margins for computers and parts, investors have shunned hardware distributor stocks in recent weeks. Shares of distribution giants Ingram Micro Inc. (NYSE: IM) and Tech Data Corp. (Nasdaq: TECD) dropped more than 15 percent since the end of July, when Banc of America analyst Kurt King warned that Ingram's margins could take a hit from price wars related to Compaq's new distributor program.
Today King is telling investors to stop punishing Tech Data, the world's second largest distributor of PCs and related hardware. King upgraded Tech Data to "strong buy" from a "buy" rating and kept his price target at $52. The latest advisory boosted Tech Data shares as much as 17 percent; larger rival Ingram also got a jolt, rising almost 6 percent at one point.
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When Compaq recently decided to trim its distributor base, the remaining four -- Inacom, Tech Data, Merisel and Inacom -- became suppliers for the 35 companies no longer dealing with Compaq directly. As expected, price wars spawned as the Compaq Quartet dueled each other for the smaller players' business; but industry observers worried the price cutting would spread to Ingram's and Tech Data's non-Compaq business.
But that didn't happen, meaning no more than 10 percent of Tech Data's revenue and 15 percent of Ingram Micro's will be affected by the new Compaq program, King says. The rest of the business remains the same, which is good, since it happens to be strong at the moment. After a rocky period earlier this year when Tech Data felt the effects of Y2K-induced spending cuts, the company has regained momentum; it beat First Call's consensus estimate in the latest quarterly report, with net income of $28 million and revenue of $3.8 billion.
Even the Compaq brouhaha -- which only started this month -- should settle down once the initial frenzy of bidding exhausts itself and companies align themselves with one Compaq distributor or another. The Big Four still have to resolve details with Compaq itself, but that should happen by the end of the quarter.
In any case, the long term trend clearly favors big distributors gaining market share. Consolidation is afoot for the non-direct channel and as with any mature industry, the ones already on top are the ones best positioned to dictate the the pace. Compaq's decision to go with its Distributor Alliance Program merely accelerates a growing trend. "We remain convinced that margins will improve over time and that the program will ultimately shift billions in sales to Ingram and Tech Data, significantly increasing these companies' earnings power," King writes.
Going into today, Tech Data was trading at just 11 times First Call's consensus estimate for fiscal 2001. That's a multiple normally reserved for true dogs, not a company poised to benefit at the expense of smaller rivals.
Of course, the Web was supposed to destroy the traditional distribution channels. But as long as there are retailers of any sort, you need least a few distributors in the PC market, unless the world of PC manufacturers suddenly shrinks to three or four players. And that's not going to happen any time soon.
"We see the company as an emerging eBusiness franchise with a valuation that does not reflect its ability to leverage its loyal and growing customer base," Robbie Stephens analyst Keith Benjamin wrote last month.
The stock closed at 15 7/16 the session before that note was released. It's now trading at 14 and change, so if you're on the side of the analyst bulls, you might find it worth your while to peek in on this afternoon's Fatbrain conference call.
Yesterday shares of the media and cable system giant slid 6 percent after Merrill Lynch's Jessica Reif Cohen cited weakness in Time Warner's music division as reason to cut full-year EPS estimates. Today Fred Moran of ING Barings and Edward T. Hatch of SG Cowen upgraded the stock to "strong buy". PaineWebber's Christopher Dixon reiterated a "buy" rating.
Music generates just 10 percent of Time Warner's cash flow, Moran notes. "One would have to argue that the (music) division is practically worthless to justify such a violent reaction in the stock," Moran writes in a research note. " "Overall outlook for Time Warner remains favorable, with strong fundamentals across the core operating segments fueling sustainable double-digit EBITA growth into the new millennium."
Broad indices were mixed in the afternoon.