Terms of the all-cash transaction call for ScanSource to pay an initial purchase price of $83.6 million, plus earn-outs based on pre-EBIDTA earnings during the next four years.
Hours after the deal was announced today, ScanSource CEO Mike Baur discussed his firm’s motives and why he thinks the union with Intelisys could have a transformative effect on the channel.
What does this say about the industry that these two powerful organizations are coming together at this time?
At ScanSource we have been looking at how to get the VAR channel into a recurring revenue stream for many years. The relationship with Intelisys actually goes back to 2013, when we struck a relationship that was really more of a vendor-distributor relationship, if you can imagine, trying to test the waters to see if Intelisys could sell through ScanSource to our VARs. Along the way, that effort just kind of bubbled along with nothing really earth-shattering coming out of it. To be honest, I didn’t realize until this past year that we even really had that going on. I probably saw the press release, but it was nothing material for our channel at the time. So go back to October of 2015, last year, I put together a team within ScanSource to find an answer to ‘how could ScanSource develop a services strategy?’ And by that, I meant a recurring revenue services strategy for our partners, and what would it entail.
There’s this $150 billion, today, opportunity in telecom and cloud, but mostly telecom business services, that exists and that is being currently serviced by Intelisys but not by ScanSource and not by many VARs. When we discovered this and looked into it at the beginning of 2016, we decided that a great opportunity for ScanSource would be to enter this market. And what better way than to acquire the industry leader, Intelisys. They, frankly, were not for sale. They were expecting one day for this convergence to happen, but this frankly was something they weren’t necessarily looking for or ready for. But from the time I met the principals in March, until last Friday when we signed the deal, it’s been a remarkable combination of similar strategies and views and cultures toward the channel.
How much of your sales as a value-added distributor were traditionally done on a recurring revenue basis?
Our recurring revenue and services has not been material for the company. We don’t report it as a separate item. But to give you an idea, over the last three or four years – our ‘suppliers,’ as Intelisys calls them, and our ‘vendors,’ as we call them – they’re all used to selling us some services. But it’s primarily maintenance and warranty renewal; stuff like that. (It’s) all around products that need support – are going to break. But not around a recurring-services need. But if you look at all of those products we’re selling: video-conferencing, mobile computing; we’re selling millions of devices over the last 20 years and we’re not selling the connectivity of those devices to the Internet. We’re not selling it.
It’s someone else who’s selling the connectivity to the Internet for all those devices, and many of the companies selling that are these customers that they have at Intelisys.
How big a player does this make you and how would you describe your market?
So today, we’re selling to worldwide 33,000 VARs, and (Intelisys is) selling hardware and software, and some services to be fair, but generally not buying any services through ScanSource. But the VARs are primarily in a declining-margin business. As we all know, the VAR channel is struggling. Certain VARs have changed their stripes and have learned how to get into a recurring revenue business over the years. But in most cases, the VAR channel is still learning how to do that. What Intelisys has figured out is a way to enable a new channel to emerge. The reason we’re interested is we’re trying to help our VARs find this path. Many, many VARs cannot risk doing this on their own without a partner. It’s too risky to switch from a hardware-, maybe even software-centric business model. Selling a solution but, frankly, not the total solution because they’re leaving out the connectivity. Sure, they’re selling the Cisco router, and they’re selling the wireless LAN, but they’re not selling the service – the actual Internet service. That’s something that our customers walk past every day and every one of Jay and Andrew’s carrier partners see this VAR channel as key to their success. Only 10 percent of that $150 billion market today is serviced by some form of the indirect channel.
That’s why this is big news.
Who is your competition?
Today, it doesn’t exist for what we’re creating. This is something new, we believe.
Have you guys just kicked off a wave that others are going to have to respond to to stay competitive?
We certainly don’t know what they have in mind, these other competitors. But we believe we’re creating a unique model; that the convergence of a value added distributor and a master agent is something the industry hasn’t seen. And when I talk to Jay and the other principals at Intelisys, they had seen this for a long time. It’s surprising to me that some of the traditional distributors didn’t get on this path, but it’s almost not surprising. (Intelisys) created a business model that is quite different than the traditional IT distribution model. Number one, there’s no inventory. Number two, there’s no accounts receivables. This requires the value add not to be on a warehouse and the traditional net terms for hardware and passing title on goods and making it work when it breaks. This is much more of a sales machine and this is a development that I think the IT distribution industry has missed. I’ve been in this industry 30 years – 24 with ScanSource – and IT distribution has become, as best we call ourselves “value-added,” we’re still about moving the box. To change that model, frankly, as big as we all are, is daunting. The amount of top line revenue that Intelisys will bring to ScanSource is very small. The profitability is very large. So we’re having to change the financial metrics at which our investors and (the media) will start to evaluate our business. It’s going to look quite different. So that $152 billion of telecom revenue doesn’t translate into revenue for us. We’re going to be getting a commission that we’ll share with our channel on that business. So it’s a much smaller top-line impact but a significant margin impact. That’s what makes this difficult for some of these traditional IT distributors like us to understand. We didn’t understand a business where there’s no working capital.
So what do you call this?
We’ve been talking about this since last year. So, when I put this team together it was October of last year and if you look at our 10Q from October, it’s the first time in the history of our company that we took out the word “distributor.” You won’t find it in that document. We consciously decided that for us to make this pivot for the channel, we had to change our view of what we do. And so we started using the words in October of ’15, technology solutions provider. Not to be confused with what a reseller does. Not to be confused with what a manufacturer does. We’re a technology solutions provider, not a distributor. And it was interesting, when I met the Intelisys guys, their tagline is “…a technology services distributor;” kind of funny. So we’re just now trying to say “well, guys, I don’t like the word distributor anymore but you guys picked it up, so we’ve got to figure this thing out.” We both have shared the words “technology” and “services,” and we both agree that the solution is the key here and if we can create the opportunity for a single VAR to sell the total solution. And I should say “reseller.” It could be an agent selling product now, who has not wanted to or couldn’t in the past. Or, it could be a VAR selling services. We don’t care. Meaning, we’re not going to try to pick the winners. We’re going to make sure both groups have opportunity that is immense. And we think that this opportunity is vast.
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