Insight Enterprises: Around 47% Upward Potential By 2020

Summary

• Insight Enterprises' acquisition of PCM is a major win for shareholders.
• In the last quarterly report, the software segment has seen significant drops in sales.
• In the long term, Insight Enterprises is expected to benefit from several technological trends, such as Software as a Service, Internet of Things, Big Data, Cloud solutions and growth in industrial automation.
• Based on our calculations, we expect the stock to be worth 47% more by 2020.

Investment Thesis

Insight Enterprises (NASDAQ:NSIT) delivered a mixed Q2 2019 earnings results with limited growth in the services segment and declining and flat growth in the software and hardware segments respectively. However, we believe that in the long term NSIT will deliver strong top and bottom line growth. The following catalysts will contribute to this growth:

• The company is well-positioned to benefit from several long-term trends in the technology sector;
• Strong track record of acquisitions that enhance NSIT product and service portfolio;
• Acquisition of PCM could contribute $530-560 million in net sales in 4Q19;
• By 2020, PCM can contribute up to 0.70 EPS;
• The recent decline in the share price presents an excellent buying opportunity;
• Based on my calculations, NSIT has an upward potential of 47% by the end of 2020.

All in all, we think NSIT is a good holding for investors with a long-term investment horizon.

Rating	Strong Buy
Current Price	$48.51
Target Price (2020)	$71.53
Dividend/Yield	None
Total Return	47%
Market Capitalization	$1.682 billion
Average Volume (90 days)	227,985
52-Week Range	$37.77-60.10

Source: Created by author

Investment Highlights and Risks

The biggest opportunity for investors is the strategic acquisition of PCM. With this, NSIT will greatly expand its scale and reach with new clients in North America and EMEA. Expectations are that this acquisition will add $530-560 million in net sales for Q4 2019, and for the whole of 2020, we expect that the acquisition will add more than $0.70 in adjusted EPS to the company's consolidated results.

Currently, NSIT stock has taken a severe beating, with the share price down by almost 13% since August 8. We believe that this decline is unfair:

• Gross profit in North America was up 4% year over year;
• NSIT showed impressive improvements in its gross margin, which is up by 60 basis points, or 15% year over year.

However, expenses increased mainly because of extra costs related to the acquisition of Cardinal. We believe that in 3Q19 and Q419, expenses will remain fairly high because of the acquisition of PCM, which will affect the earnings in the short term. Besides additional costs, one other major risk we see is that the net sales figure has seen no growth and is even declining.

Furthermore, NSIT is facing fierce competition, and the acquisition of PCM is still pending regulatory and shareholder approval.

Looking ahead to 2020, when the largest chunk of one-time acquisitions costs have been made and the synergies will start to bear fruit, we expect significant returns to shareholders.

Key Charts

Source: Created by author

NSIT delivered revenue of $1840 million in Q2 2019. This represented a growth rate of only 1% year over year. Its gross profit increased by 4% year over year to 275.4 million.

Source: 2Q2019 Investor presentation

Source: Form 10-Q

The company has seen declining growth in its software segment and flat growth in its hardware segment. The only segment that experienced growth was its services segment, which delivered 9% growth year on year.

Key Financial Estimates

Source: Created by author

We are estimating that the sales to grow from 2018’s $7,180.10 to at least $8,282.19 by 2020, thanks to its PCM acquisition and not accounting for any organic growth. This represents a growth rate of nearly 17%.

We also accounted for a slightly higher gross margin in 2020. PCM has products and services with margins of around 15%. Furthermore, NSIT has been improving its margins, which are up by 60 basis points.

Company and Industry Overview

Insight Enterprises is a Fortune 500 global IT provider helping businesses such as governments, schools and health care organizations define, architect, implement and manage technological solutions. This industry is set to grow rapidly in the next decade, thanks to several technological trends such as the advent of SaaS, artificial intelligence, cloud business, growth in data centres, and Big Data. Its products and services are playing a key role in these trends.

The table below summarizes the services and products that NSIT offers:

Source: 2018 Annual Report

The software segment of the company is facing a declining trend in sales. As NSIT noted in its 2018 annual report:

The decrease in the software category was primarily the result of lower volume of sales with public sector clients. Software product net sales have also been affected by clients migrating software applications to cloud solution offering.

But this was partly offset by increases in the services segment, where sales were higher due to sales in cloud solutions offerings.

The market in which NSIT operates is quite fragmented and highly competitive. In this market, the company faces competition from different companies, such as CDW, Zones, Connection, SHI, Softchoice, Systemax, Computacenter, Bechtle, SoftwareONE, Comparex, and Crayon.

Long-Term Growth Outlook

NSIT is poised to benefit from several important technological trends:

Software as a Service (SaaS)

NSIT is currently working with several small-to-medium sized businesses to supply help them implement or set up SaaS. If NSIT manages to grow its services segment by the same growth rate as the broad market, this could mean that its sales could grow at a CAGR of more then 10% a year.

Source: Statista

Internet of Things

Simply put, the IoT connects any device with an on/off switch to the internet and/or each other. For NSIT, potential benefits for growing businesses include everything from remote monitoring and inventory management to improving mobility, security, and overall efficiency.

A clear example is the development of automated oil drills in Texas, where all the sensors are being remotely monitored, and with the combination of artificial intelligence (also offered by NSIT), the drills are automated.

Industrial automation

Automation is a key ingredient in the so-called "Industry 4.0". This industry is expected to see a compound annual growth rate of 9% through 2024. NSIT is in a good position to capture these growth opportunities, as it offers that help and supports industrial automation.

Source: MarketsandMarkets

Management Strategy

Management knows the importance of capturing new businesses that have arisen from these trends and is applying a long-term investment approach, and if required, is not shy to acquire companies that enhance NSIT. This is illustrated in the by the acquisitions of Cardinal Solutions Group in 2018 and Datalink Corporation in 2017.

Operating activities generated $292.6 million in cash in 2018. NSIT's primary uses of this cash during 2018 were to fund working capital requirements, pay down its debt balances, fund capital expenditures, repurchase shares of its common stock, and to fund the acquisition of Cardinal Solutions Group. Capital expenditures were $17.3 million in 2018, reflecting continued investment in the company's core ERP systems and e-commerce and digital marketing platforms.

We understand management's inclination to keep investing and not pay dividends. The sector the company operates in is highly competitive. If you are not keeping up with the recent technological innovations, you will get left behind in the market. Therefore, investors should not be concerned about the lack of dividend, and should instead focus on capital gains and share repurchases.

Valuation Analysis

We expect NSIT to generate EPS of at least (worst case) $5.26 per share in 2020. Historically, the company has been trading at a P/E ratio of about 10.0x. Using this ratio, we derived our price target of $70.48 per share in 2020. This price target is about 47% higher than the company's current share price. If we use the current P/E ratio of around 10x, the price target will be $52.26, or around 7.75% higher.

Note that our sales estimate for 2020 does not include any organic growth and only includes the expected net sales coming for the acquisition for PCM.

Source: Created by author

Key Risks to the Price Target

(1) Macroeconomic risks, such as an economic recession, will likely result in lower revenues.

(2) The acquisition of PCM is still subject to approval by regulators and PCM shareholders.

(3) NSIT's organic growth has been limited this quarter. The organic growth might be lacking in the short term.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NSIT over 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.