Why would CVC invest in IT distribution?

Why would CVC invest in IT distribution?

News that a venture capital company outlayed close to $200 million for a 58.5 per cent stake in the Tech Pacific Group has drawn a mixed response from competitors, vendors and analysts in the channel.

Competitors expressed a degree of surprise that in the post tech-wreck era such a large investment would be directed into what they described as a high-volume-low-margin business such as Tech Pacific.

One large competitor, who preferred to remain anonymous, said he was astonished that CVC wanted to be involved in the cut-throat IT distribution game which Tech Pacific dominates.

Duplicated costs

According to the distributor, CVC “must have a bigger game plan” because margins in large parts of the IT wholesaling game were some of the “lowest on offer of just about any industry” that could be named.

“I would suspect that the return on investment in Tech Pacific would not be huge at the moment,” the competitor said. “Their money would be better off in the bank unless they have a strategy to inject additional capital and grow the business.

“One possibility is that they would look at acquiring some complementary distribution companies to aggregate business and then rip out some of the duplicated costs. There is no doubt that Tech Pacific has great systems and processes, so it could be that the VC company has some plan to utilise those systems to move into other areas of the IT business or other areas of logistic services.”

Managing director of Synnex, Frank Sheu, said that “it is not very often that you see a VC company investing in distribution” as they are usually interested in start-ups. He was surprised and not sure how long CVC would remain interested in the distribution giant.

“In the end VC companies are all looking for return on investment (ROI),” Sheu said. “The ROI on most IT distribution companies is very poor at the moment. It all depends on the performance of Tech Pacific. If it provides reasonable ROI and a stable income, they will keep the investment. If they do not get a return, I would expect them to dump it.”

Sheu said that he was also expecting CVC to face some challenges as “acquisition has not been an easy thing” in the IT channel.

“I haven’t seen any acquistions or mergers in the last 5-10 years [in the IT channel] that have delivered good ROI,” he said.

Managing director of LAN Systems, Nick Verykios, said it was not entirely unprecedented for venture capitalists to acquire distribution companies.

He reminded ARN that his first company 1World was bought by a VC company although he did qualify this by saying that “there were big fat balance sheets and big fat profits” in those days.

“I am not sure those conditions still exist today,” Verykios said.

It must be remembered that it was a “regional play” that CVC made, “not just Australia”, he said.

While admitting he did not have access to the distributor’s Australian balance sheet, Verykios thought that operations elsewhere in the region were perhaps performing better than locally.

The bubble part

“Tech Pacific’s expertise is as a commodity based distributor,” Verykios said. “In Australia they have strong market shares in the commodity based products where margins are low. They don’t have any major market share in complex technologies.

“Venture capital companies invest where a they see a business that is either making good money and will continue to do so or where they can see potential to turn around a business that isn’t quite so strong. I don’t know which scenario is happening here but I do know is that there is no reason why Tech Pacific should not be a strong and profitable organisation.”

General manager of Toshiba’s information systems division in Australia, Ralph Stadus, did not think it was unusual for CVC to invest in Tech Pacific.

He also noted that Hagemeyer retained around 30 per cent of Tech Pacific which indicated the Dutch company still saw some value in it.

“There are two elements to the IT industry,” Stadus said. “There is the bubble part which VCs are all avoiding then there is the fairly mature business part of the industry that Tech Pacific are well and truly in. It is a model based on moving a high volume of gear and that is a fairly stable business.

“I think there is still an opportunity for growth in distribution and I think Tech Pacific still has an opportunity to drive that growth.”

Stadus said he didn’t see how the change of majority ownership would have any negative impact on Toshiba’s relationship with Tech Pacific.

“If anything, I think it just gives it access to funding to grow the business where there are those opportunities,” he said. “We certainly see it as a good thing for our relationship. There have been some opportunities for growth that Tech Pacific hasn’t actually been able to take up which now they can so we see it as a good thing.”

Research director at channel research organisation Inform, Chris Herbert, agreed that it was a bit odd for a VC company to be investing in a broad-based distributor where there is “knife-edge margins”.

However, Herbert said that in some ways he saw it as a bit of an “endorsement of Tech Pacific’s potential”.

He suggested that perhaps the investors saw an opportunity to leverage the distributor’s customer relationships to move towards higher value distribution.

“CVC must have something up its sleeve that made the investment seem like a good one,” Herbert said. “There’s the age-old adage in distribution that says you have to get big, get niche or get out. [The investors] are either planning to make Tech Pacific bigger or they are looking to getting into more niche areas where it is not already operating.”

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