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Steven Chen
Steven Chen
Articles (184)  | Author's Website |

Softcat: An Easy-to-Understand Technology Story

The company has a solid track record of returns on capital, organic growth and cash generation

With the mission to help customers use technology to succeed, U.K.-based Softcat PLC (LSE:SCT) is a leading reseller of a comprehensive range of infrastructure technology solutions. Simply put, the company works with commercial and public sector organizations to identify the right digital infrastructure for their needs from over 200 vendors, procures it for them, implements the software and then delivers a range of ongoing support and managed services.

So Softcat is like a middleman between technology vendors and the end-users, which would probably remind you of Florida-based TechData (NASDAQ:TECD), which Warren Buffett (Trades, Portfolio) and his Berkshire (NYSE:BRK.A)(NYSE:BRK.B) team attempted to acquire late last year. We are in no position to speculate on Buffett’s perspective, but the attractions in this technology distributor and reseller space include 1) a straightforward and easy-to-understand business model; 2) benefit from the digitalization megatrend; 3) less disruption from technological advancement; 4) robust cash flow and little CapEx requirement.

Despite the similarities, Softcat differs with respect to its focus only on the domestic market of its core competency and the high value-add niches (e.g., cloud computing, data management, cybersecurity). This can partially explain the superior margin and return on capital at Softcat, compared with the likes at TechData and Computacenter (LSE:CCC), Softcat’s major competitor.

The growth prospects seem bright for Softcat. Although it is the second-largest player in this space, the business now only shares a little over 3% of the U.K. market, which is expected to grow at an at least mid-single-digit compound annual rate through 2023. The management team believes the industry is fragmented, so there is a lot of room to gain market share.

To achieve organic growth, Softcat employs a simple two-fold strategy – acquire more customers and sell more to existing customers. We notice that the company’s current customer base of 9,500 already accounts for around 20% of the target universe, while the average share of wallet amounts to approximately 15%, compared to the long-term target of 60%. We have seen a steady increase in both customer base and gross profit per customer since the company went public in 2015. Notably, 95% of the gross invoiced income as of fiscal 2019 comes from existing customers at Softcat, signaling strong client stickiness and high predictability into future development.

Thanks to the reseller model, the business is quite asset-light. The most significant investments at Softcat are around people and skills, which do not require capital that accumulates on the balance sheet. As a result, the capital expenditure margin (on sales) never exceeded 1%. Based on our calculation, the company earned an astonishing 270% incremental return on equity over the last three years. As you can see below, the business managed to return most of its free cash flow to shareholders as dividends.

Management believes that clients, especially those small- and medium-sized enterprises (representing the majority of Softcat's total customer base), prefer working with one single provider of IT infrastructure. Therefore, the remarkable breadth and depth of offerings enable Softcat to compete favorably. At the same time, the company feels the quality of services is more important than price in this space. As a result, Softcat’s key differentiator from competitors is its unique culture of “putting employees first.” Looking at the company’s strong track record of gaining market share, customer satisfaction and cash generation, we feel Softcat is on the right track to compound its shareholder value and should be on the watch list for further research.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital).

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website


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