Wayside Technology Group: Expanding the Distribution Network

The 2 most recent deals contribute to the company's inorganic growth and distribution network

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Nicola Guida
Dec 27, 2020
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Introduction

Wayside Technology Group (

WSTG, Financial) is a relatively small IT distributor. The company operates through two different subsidiaries: Climb Channel Solutions, mostly focused on Software distribution, and TechXtend, an IT solution provider specializing in the areas of security, virtualization and datacenter infrastructure.

An IT distributor is basically a company which connects software (or other IT products or services) vendors with a network of resellers, consultants and systems integrators.
Climb Channel Solutions, Wayside´s software distribution business, is currently offering to its clients products from 120 different technology vendors.

As of the writing of this article, the company has a market capitalization of $84.7 million, so it belongs to the so-called micro-cap category (which includes companies having a market cap ranging from $50 to $300 million).

I started researching Wayside as it recently showed up on the Gurufocus Magic Formula Screener, which is based on

Joel Greenblatt (Trades, Portfolio)'s Magic Formula investing strategy..

Wayside's management has recently implemented a strategic plan which is starting to bear its fruits. The plan is focused on the strengthening of marketing and sales divisions and on the expansion of its business through carefully selected acquisitions, consequently adding more vendors and resellers to its network.

Two recent deals

In 2020, the company has announced and completed two acquisitions.

The first deal was announced in April and relates to the acquisition of Interwork Technologies, a Toronto-based distributor focused on cybersecurity, information management and network solutions in both Canada and the U.S. The acquisition was completed at the beginning of June; it added more than 20 new vendors and around 2500 VARs (value added resellers) to Wayside's network. The integration of Interwork is proceeding smoothly and already adding to net sales and gross profit. The acquired company was originally merged to the Lifeboat Distribution business, which was subsequently re-branded as Climb Channel Solutions.

On Nov. 9, the company announced that it had acquired CDF Group Limited (CDF), a UK-based cloud, software and IT distributor and services provider. This deal is strategically aimed at expanding Wayside's presence in the EMEA market. CDF Group is specialized in cloud services products distribution and operates through its Sigma Software Distribution division (which will be merged to Climb Channel Solution's business), the Grey Matter reseller network and Microsoft (

MSFT, Financial) Azure cloud consulting and services specialist CloudKnowHow. The acquisition of CDF Group is, in my opinion, a very smart move, as it contributes to close the company's gap on cloud-related product offerings. Additionally, it offers multiple network-effect advantages to the combined company, as CDF´s vendors products and services relationships can now be "leveraged" in the U.S. (and vice versa).

Here's indeed what Dale Foster, CEO of Climb Channel Solutions, had to say referring to the CDF Group acquisition:

"Integrating these new cloud and services solutions will provide ample cross-sell opportunities for our existing U.S. and Canadian customer base."

The deal will add more than 1,000 new VARs to Wayside's network and strong relationships with Microsoft, Amazon (

AMZN, Financial) Web Services and Adobe (ADBE, Financial), among others. There's little overlap between the two companies, both geographically and on the vendor/VARs side, which is a plus.

Wayside financial situation

Next, let's have a look at Wayside Technology's financial strength. Gurufocus assigns the company a ranking of 8 out of 10 in this regard:

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Moreover, Wayside's cash levels, in relation to its market capitalization, appear to be particularly healthy. As of September, the company holds more than $40 million of cash and equivalents and practically no debt.

If we dig a bit deeper, we notice that in the fiscal second quarter, the cash levels jumped from around $11 to $45 million. This was due to the application of an early-pay discount program with one of their larger customers (an early payment discount is a way for a customer to get a discount on a supplier's product or service related payment in exchange for paying the supplier earlier). In exchange for the early payment, Wayside is currently conceding approximately $400,000 of gross profit per quarter going forward under this program to the above mentioned customer. Usually this is done in order to avoid losing a good (and big) customer, but Wayside's CEO recently declared that they had the option to choose it or not. In any case, the move provided ample liquidity to continue with the planned acquisition strategy.

CDF Group was acquired for a total consideration of approximately $17.4 million, so not only did Wayside complete the acquisition without raising any debt, it still has $22.8 million.

Moreover, for its fiscal year ended June 30, CDF reported approximately $8.9 million in gross profit and $2.0 million in Ebitda, so Wayside acquired CDF at a competitive price with the concrete possibility of leveraging its existing business in the U.S. and Canada. That's very good capital allocation in practice.

The network effect

As we know, a network effect is (potentially) one of the most powerful competitive advantages. While the biggest Software producers already have their own sales and distribution network and don't need a third party distributor, small software vendors can use Wayside's network to gain scale and reach a wide range of resellers and geographically diverse customers in multiple developed markets.

The biggest advantage of a network effect is that, the more elements you add to the network (in this case, mostly vendors and resellers), the bigger the advantage for the newly added ones: a new vendor will have a broader base of resellers/system integrators and a reseller can choose from a wider base of vendors (and, as a consequence, products). Finally, the end customer will also have a benefit as he can get a more tailored solution which can potentially be composed of different dedicated products and tools.

Conclusion

Wayside Technology's inorganic growth strategy is aimed at expanding its IT distribution network in order to gain scale and to spread in different geographies and markets, consequently being able to offer a broader set of products and services.

The company is financially strong, and the CEO has an history of carefully planned capital allocation moves, which I consider to be a real and powerful engine for the company.

As revenues and earnings can be quite bumpy, the company is not easy to value, but this should improve in the future as the network expands and it moves more closer to a subscription-based model.

In a conservative estimation effort, I think that the company can reach a free cash flow level of $10-12 million per year for the next few years (that would correspond to a price of only four times FCF ex-cash), with the possibility of considerable increases if the acquired companies' integration is correctly completed and leveraged.

I plan to continue following the company results in the next quarters to check how this strategy unfolds, but I would not be surprised to see the stock doubling in price in the next three to five years.

Disclosure: The author does not currently hold shares in Wayside Technology (

WSTG, Financial), but is planning to start a small position in the coming weeks.

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