Presidio (PSDO) is an Apollo-backed IT solution provider which recently has gone public. Demand for the IPO has been tepid, as I see few reasons to own the shares at these valuations for a variety of reasons. This includes an elevated leverage position, continued selling pressure from Apollo, modest growth, narrowing margins and fierce competition.
A modest discount from the preliminary offering range and lack of returns on the IPO date do not change this cautious stance. I believe that Presidio has a lot to prove in order to create value for investors going forward.
Who Is Presidio?
Presidio provides IT solutions to the middle market in North America. Offered services focus on three areas: digital infrastructure, cloud and security. Each of these segments representS growth opportunities in my eyes, as over 7,000 organizations use Presidio´s services, creating a well-diversified customer base. Note that the company is nearly entirely focused on the US, with foreign sales making up just 2% of total sales.
While the company reports its sales across three segments, the company relies heavily on the digital infrastructure segment which makes up three quarters of sales. Cloud makes up 15% of revenues and security is responsible for the remaining ten percent. The key digital infrastructure offerings comprise networking, collaboration, internet of things and data analytics, really focusing on flexibility, mobility and insights to be gained.
The company aims to differentiate itself from other competitors by specifically focusing on the middle market. These customers are large enough to have real IT needs, which requires them to move along with industry trends, yet they often lack sophisticated internal IT departments. As many of Presidio´s peers, including pure re-sellers, focus on larger companies, the company believes that it operates in a very attractive niche of the overall market.
The company was previously known as Aegis Holdings, but changed is name late in 2014 when it was acquired by Apollo Global Management. Dealmaking has played an important role in the growth trajectory of the company throughout its history.
Ahead of the Apollo deal, the company bought INX in 2011 and BlueWater in 2012. Following the Apollo deal, the company acquired Sequoia in 2015 to focus more on the cloud and Netech in 2016. The deal tag of the two latest deals run in the hundreds of millions of dollar on a combined basis, although the definitive transaction amounts have not been disclosed.
Presidio sold 16.7 million shares at $14 per share in its IPO, thereby raising $232 million in gross proceeds. It should be said that demand was not very strong as the offering took place at the lower end of the preliminary price range of $14-$16.
The company has 88.6 million shares outstanding which ever since have risen modestly towards $14.50 per share. This gives the company a market valuation of $1.28 billion. The issue is that Presidio ended 2016 with a steep net debt load of $963 million, as this number could fall towards $760 million in the aftermath of the IPO.
That gives the company a $2.04 billion enterprise valuation which implies that Apollo made a great deal late in 2014. The purchase of Presidio reportedly took place at a $1.3 billion valuation based on the enterprise value of the firm.
The company posted sales of $2.71 billion in the fiscal year which ended on June 30 of 2016, while posting an operating profit of $102 million. The company posted revenue growth of 6% year-over-year in the six months period which ended on December of 2016. While that looks solid, margins were actually down, as the 6% growth number includes the unspecified revenue contribution of both the Netech and Sequoia deal, in part offset by the disposition of Atlantix Global Systems.
Unfortunately enough, in terms of organic growth numbers, operating profits were down 13% in actual dollar terms. Operating margins were down 80 basis points to just 4.0% of sales.
With adjusted EBITDA having come in at $211 million over the past fiscal year, leverage ratios stand around 3.6 times which is a bit high. This is certainly the case as margins are contracting in what can easily be regarded as a very competitive environment.
If these trends continue, the company will only post operating profits of roughly $100 million per year going forward. If we assume a 6% cost of debt on the $760 million net debt load (after refinancing some existing debt), interest costs come in at $45 million a year. After incorporating a 30% tax rate, after-tax earnings come in at $38 million, equivalent to roughly $0.43 per share.
With such earnings potential we can hardly call shares appealing at current levels.
I would be very hesitant with Presidio as the company faces a lot of challenges. Leverage is a minor concern. The premium valuation is a much bigger one. Other risks relate to the business model as changes in the industry occur rapidly, even as the positioning of the company to certain growth areas seems good.
That said, the company relies heavily on partnerships with OEMs and faces stiff competition from Accenture (NYSE:ACN), CSC (CSC) and Dimension Data, all resellers and integrators as well. The real risk is if OEMs start selling directly to end customers, a strategy employed by Amazon´s (NASDAQ:AMZN) AWS for instance. This tactic is furthermore employed by many emerging cloud players as well as traditional companies like HP (NYSE:HPQ), Dell and Apple (NASDAQ:AAPL).
The truth is that Apollo made a quick and impressive return on their money. With leverage high, changes potentially threatening the business model, organic growth unimpressive and valuations elevated, I see no reason to initiate a position at these levels.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.