Wayside Technology Group, Inc. (WSTG) has two operating segments, Lifeboat and TechXtend. Lifeboat operates as a software wholesaler and TechXtend is a value-added reseller (VAR) of software.
In the software market, both wholesalers and VARs earn relatively low margins by reselling software products and adding value through depth of knowledge, breadth of product offerings, and pricing and financing alternatives available to customers. In 2010, according to the Annual Services Survey by the US Census Bureau, software sales in the United States were $145.4 billion. With a current market-cap of just $58 million and revenues of $250 million, Wayside has ample room for future growth and is set to continue to reward shareholders for years to come.
Software wholesalers make money by buying software from publishers (e.g. Microsoft, Oracle, etc.) and reselling it to customers that install and operate the software, such as VARs, consultants, system integrators, and corporate IT departments. The wholesale software distribution business is highly competitive and historically has been a low margin business. Wayside's software wholesaler, Lifeboat, however, does offer several services to both software publishers and customers that help to ensure the company will be part of the software distribution value chain going forward.
Lifeboat generally partners with small, up and coming publishers that lack the resources to market and distribute their own products. In essence, Lifeboat acts as the marketing arm of young software company. This is typically higher margin business for Lifeboat. However, as software companies mature and grow they tend to develop multiple distribution channels-limiting Lifeboat's margin. For larger publishers, Lifeboat can be instrumental in making incremental sales and reducing the risk of losing sales to competitors who are currently selling products through wholesale channels. Further, Lifeboat provides technical assistance to technology resellers of all sizes who may lack the personnel, resources, or time to understand constantly evolving technology. Lifeboat evaluates and compares multiple software solutions in order to help its customers determine the best software to sell and maintain. This allows the service provider to keep a lean staff, remain profitable, and stay ahead of their competition. With Lifeboat's help VARs are able to get it right the first time and successfully implement IT solutions for their customers.
Lifeboat has established numerous long-term customer relationships and its personnel are a valuable asset that can be further levered to produce higher sales in the future. Lifeboat has a network of over 7,000 reseller, consultant, and integrator partners globally. It has distribution partners in the United Kingdom, Germany, France, Russia, Brazil, India, and China. Wayside's sales are concentrated in the United States and they plan to continue to focus on the North American marketplace. In 2011 roughly 84% of Wayside's sales came from the United States, 7.5% came from Canada, and the remaining 8.5% came from elsewhere globally.
Value-added resellers add services to existing software and hardware products, such as selection, installation, and maintenance. VARs usually provide their customers a bespoke solution. TechXtend (Wayside's VAR) has over 30 years of experience helping software developers and information technology costumers integrate software solutions. TechXtend sells software and limited hardware solutions, while providing support level technical services for workstations, servers, storage centers, and data networks. They sell a wide array of solutions from leading publishers of software for uses such as virtualization, application and network infrastructure, application lifecycle management, database modeling, security, and other information technology fields. TechXtend is a vital partner in helping small to medium size businesses, large corporations, and public institutions throughout the United States implement their information technology and manage costs.
Most wholesalers and VARs in the technology field view software as an add-on to a hardware sale. Wayside's businesses strategy focuses on software. They sell minimal hardware. This has several important advantages. First, this model allows both Lifeboat and TechXtend to stay up-to-date on the latest developments in the software world and know the products, licensing, and pricing options in depth. Second, it allows the company to provide outstanding returns to shareholders through increased employee productivity and a strong capital structure.
Comparing Wayside to several of its large competitors allows one to understand the strengths inherent in the company's business model. The following table shows sales per employee, gross margin dollars per employee, and net income dollars per employee for Wayside and three of its largest competitors - Tech Data (TECD), Ingram Micro (IM) and Synnex (SNX). As this table clearly illustrates, Wayside has the highest Gross Margin Dollars per Employee and Net Income Dollars per Employee.
Due to Wayside's focus on software, it is able to generate cash on its existing asset base faster than its competitors. Currently, Wayside carries approximately $1.5 million in inventory, which equates to 1.9 average days of inventory outstanding, or the number of days it takes to turnover inventory. TECD, IM, and SNX have roughly 29, 31, and 35 average days of inventory outstanding. This means Wayside, unlike its competitors, does not have to finance and carry a large capital investment in inventory, thus providing greater operating profit margins.
Wayside has a strong balance sheet and substantial cash reserves (roughly 22 percent of its current market capitalization) and zero debt. Whereas, TECD, IM, SNX have debt-to-equity ratios of 5%, 14%, and 23% respectively.
Wayside has an average days of payables outstanding ratio of 65; whereas, TECD, IM, and SNX have average days payable outstanding ratios of 46, 50, and 36. This indicates that Wayside is more effectively able to manage its working capital by delaying payments to vendors than are its competitors.
On the other hand, Wayside's average days of sales outstanding are 65; whereas TECD, IM, and SNX averages are 40, 43, and 38 days. This indicates that Wayside takes longer to collect on receivables than its competitors (a negative). Nevertheless, Wayside has the shortest cash conversion cycle (days of inventory outstanding + days of receivables outstanding - days of payables outstanding) a measure of how long the business is deprived of cash that is need to complete a sale. Since Wayside's cash conversion cycle is 2 days compared to 23, 24, and 37 days for TECD, IM, and SNX, Wayside can better use its capital base to both grow sales and reward shareholders through such actions as dividend payouts and share buybacks.
Additionally, Wayside has zero interest expense; instead it generates positive interest income. TECD, IM, and SNX all have net interest expense to operating income of more than 8 percent. When interest rates begin to rise, Wayside will be in a better financial position to defend its net income margin.
All of these advantages help Wayside outperform its competitors when measured against net income margin, return on equity (ROE), and return on assets (ROA). Last year Wayside's net income margin was 2.1% compared to TECD's 0.8%, IM's 0.7%, and SNX's 1.4%. Wayside's ROE and ROA were 19.9% and 8.1%. TECD had an ROE and ROA of 10.5% and 3.6%, IM had an ROE and ROA of 8.2% and 3.3%, and SNX had an ROE and ROA of 13.9% and 5.9%.
Wayside has generated outstanding returns on invested capital over the last decade. Measured since 2005, Wayside has had an average ROE of 15.8% and an average ROA of 6.6%. If one were to exclude Wayside's balance sheet cash, the ROE and ROA over this time period would have been 49.0% and 9.9%. The company's balance sheet consists of $14.8 million of cash and they carry no debt. Current cash represents 42.0% of stockholders' equity. Wayside's only significant liability is $42.5 million in accounts payable; however, this is offset by $50.4 million of current accounts receivable and an additional $9 million of long-term accounts receivable.
Since 2005, Wayside has grown its sales from $138 million to $250 million, an 8.9% compounded annual growth rate (CAGR). Net income has grown from $2.7 million to $5.5 million, an 11.1% CAGR. During this seven year period, Wayside has $23.6 million of dividend payouts and treasury stock purchases - with cumulative net income of $25.6 million. This is a good indication that Directors and Officers think like owners, as they should since they own 26.8% of the common shares outstanding. The current dividend yield is nearly 5%.
Software is a fundamental part of everyday life and an integral piece of driving business 'productivity and improvement' throughout the world. Wayside Technology Group, Inc. should be a leader in the software distribution channel for many years to come.
Disclosure: I am long WSTG.
Additional disclosure: The security described in this article is owned by the contributor and clients of Milwaukee Private Wealth Management, Inc., an investment management firm owned by the contributor. Thus, the contributor has a financial interest in any future price increase of the security.