ScanSource (SCSC): The Distributor That Just Bought Its Own Services Business

Disclosure: I own shares. This is my personal research, not investment advice.

ScanSource is a two-tier distributor. It buys barcode scanners, networking gear and security cameras from about 500 vendors (Zebra and Cisco are each more than 10% of sales) and sells them to roughly 25,000 resellers and integrators. The market prices it like that: at ~$60 it trades around 7.9x forward EBITDA, and every buyback in its history has been below $45.

My thesis is that the company is in the middle of changing what it is, and the first evidence shows up in early November.

Two businesses, and a third one nobody has numbers for

Hardware distribution is healthy. Its five-year sales track Zebra's almost exactly, so there is no sign of share loss to the broadline distributors. But it is a 13% gross margin, working-capital-heavy business, and the market will not pay much for it.

Intelisys, the telecom and cloud agency, is the opposite: $101M of revenue at a 99% gross margin and 28% operating margin, about a quarter of operating income. It is also slowing every year, from 12.5% billings growth to 3.2%, because private-equity-backed rivals bought partners with better commission splits and ScanSource chose margin over share.

On September 1 ScanSource closed the largest deal in its history: $220M in cash for MicroAge, a Phoenix IT integrator and managed service provider with its own security operations center. The idea, in the CEO's words, is that "none of our partners, except the very largest, have their own NOC or SOC," so ScanSource will sell that monitoring to its channel on a wholesale basis, bundled with the hardware, connectivity and cloud it already sells. No distributor has done this. ScanSource has not disclosed MicroAge's revenue, margin or the multiple it paid.

Why I think it can work

• Management has talked about this since 2016 and could only afford it after exiting its international businesses and paying down debt.
• Every US channel acquisition in the company's history (Intelisys, POS Portal, KBZ) was kept and worked. Everything foreign was impaired or sold.
• Recurring revenue is already 34% of gross profit. The stated goal is 50%, which cannot be reached by tuck-ins; this is the check that implies.
• Hardware refresh has legs: Zebra guides double-digit growth and Cisco calls campus networking a multi-year cycle. Juniper is added in the second half.

What could make me wrong

• Every MicroAge number in my model is an assumption. If it is mostly product resale, the recurring mix barely moves.
• The one prior services deal (Canpango, 2018) was shut inside two years.
• Resellers can already rent a SOC from CrowdStrike, Huntress or Microsoft. The bundle has to be sticky, and that is a hypothesis.
• No earn-out retains MicroAge's management; ScanSource has not named who runs it.
• Net debt went from near zero to ~1.6x EBITDA. Buybacks slow.
• Intelisys could keep melting faster than the margin can absorb.

Bottom line

I underwrote this as fairly priced for a 20% return and took a half-size position because the business analysis is sound but the odds on the deal are not. I do not need MicroAge to transform the company. I need it to show that resellers will buy monitoring from their distributor, and November is the first time anyone outside the company can see whether they do.