Ingram Micro Warning Rattles Distributor Sector

By Richard McCaffery, Staff WriterDistributor stocks tanked in March after market leader Ingram Micro Inc. warned investors of weak first quarter earnings, and analysts see no end to the misery in the short term.Many pointed to the need for further consolidation among industry players, and for distributors to adjust to changes in the sales channel. "You're just going to see more confirmation of bad news," said Steve Ashley, an analyst at Robert W. Baird & Co. of Milwaukee.The March 11 news that Ingram slashed earnings expectations for the quarter led three of the country's largest distributors and one reseller to new market lows — where the entire industry has been hovering since similar announcements in the fourth quarter of 1998.Ingram Micro of Santa Ana, Calif.; Tech Data Corp. of Clearwater, Fla.; Merisel Inc. of El Segundo, Calif.; and Inacom Corp. of Omaha, Neb., all hit 52-week lows in the wake of Ingram's decision this month to cut 1,400 jobs and reorganize to save money and increase efficiency.It was the latest slip on a painful slide. Ingram and Tech Data, the world's largest and second largest distributors of computer products, respectively, have lost more than half their stock value since October 1998 when both traded at more than $50 a share. Analysts blame the downturn on price wars sparked by the need for consolidation in the U.S. market, falling computer product prices and other uncertainties in the sales channel.Phil Ellett, president of Ingram Micro North America, said the company organized a task force over a month ago to address issues such as price pressures and customer relationships and is confident it has made the right moves. "We have seen changes in the marketplace, and we responded," he said. Ingram is closing its consolidation center in Fremont, Calif., and realigning its sales force to get workers closer to customers, he said.Ellett would not disclose how much money the plan saves, nor speculate whether the company's weak earnings will continue beyond the first quarter. "I think, obviously, we continue to enjoy great top-line growth," he said. "The gross margins, of course, are under pressure."Ingram Micro intends to maintain market share growth, Ellett said. At the same time, "we have to realign ourselves in recognition of gross margin deterioration and streamline our operations," he said.Like many distributors, Ingram had a strong year up until the fourth quarter. Sales for 1998 grew 33 percent to $22 billion, and net income jumped 27 percent to $245 million.Some analysts expect the number of large U.S. distributors will drop from more than six to perhaps three or four, though they declined to speculate when it might occur or who will be left standing."I don't think all the players in the U.S. have the financial strength to bear the price pressure," said Kristi Thiese, research analyst at Raymond James & Associates, St. Petersburg, Fla. "I just don't see the market bearing it without some of the companies waving the white flag." "What you need is fewer competitors, " said Ashley of Robert Baird & Co. So severe is the competition and plunging market values that Ashley does not expect to see a wave of mergers and acquisitions. "No one is going to buy anyone," he said. "People are just going to leave the business.""We're in a free fall," said Steven Fortuna, a technology analyst at Deutsche Bank Securities in Boston. "Ingram Micro and Tech Data have been high fliers for a couple of years. There was a lot of luster around those companies. That luster is gone."Tough times for distributors go back further than the fourth quarter of 1998. The distribution industry has been rocked by competition from companies like Dell Computer Corp. of Round Rock, Texas, which skips the sales channel and sells directly to end users. Michael Dell, Dell's chairman and chief executive, has built an $18 billion company by selling directly and building computers to order.In response, manufacturers have started selling some products directly and reducing the amount of unsold products distributors can return. It has hit distributors hard.Neal Johnson, an analyst at Robinson-Humphrey Co. LLC of Atlanta, said price pressures are forcing a natural change in the industry as distributors adjust to become more efficient. "The question is how long will it take to make the transition," he said. Falling prices for PCs and computer products are behind the most recent crunch, analysts said. Last year alone, the average selling price for commercial computers fell 15 percent, from $2,054 in the first quarter to $1,742 in the fourth quarter, said Roger Kay, research manager at International Data Corp., Framingham, Mass. In the consumer market, computers for less than $1,000 are now common, making it even harder for distributors to eke out a profit. Resellers introduced three new price points for consumer PCs in 1998: $800, $600 and $400."It was a real rough year, probably the worst in terms of price decline in the history of the industry," Kay said. "There are more units moving and more people hooking up, but it has an unhealthy effect on the industry because the margins are moving out of hardware."Many analysts are betting that Ingram and Tech Data are strong enough to weather the storm. Combined, the two giants posted sales of $34 billion in 1998. Whichever companies survive, the winners will emerge stronger players. "I would equate it to a forest fire that looks terrible, but three years later it looks great," Ashley said. "You've burned off all the underbrush."Ashley has a buy rating on Tech Data. He does not formally cover any other distributors. Thiese has buy ratings on the world's top three distributors: Ingram, Tech Data and CHS Electronics Inc. of Miami. "Now is the time to be buying these companies," she said.Distributors are taking the storm in stride. Tech Data set the tone for this year in February when it pared expectations. After the announcement, analysts cut their 1999 earnings expectations for Tech Data from more than $2.70 a share to about $2.35.Jeff Howells, Tech Data's chief financial officer, said the company saw price wars on the horizon last year and prepared by not hiring additional people to support U.S. operations. Despite this, the 8,000-employee company grew U.S. sales 17 percent in 1998. Overall, sales jumped from $7 billion in 1997 to about $11.5 billion last year. Income jumped from $89 million to $126 million, not counting one-time acquisitions costs. "I think we're going to be fine," Howells said. "We have plenty of capital for the entire year."Bob O'Malley, chief executive officer of Pinacor Inc., dismissed the idea there are too many competitors in the U.S. market. "There are four," he said, referring to Ingram, Tech Data, Merisel and Pinacor, a subsidiary of MicroAge Inc. of Tempe, Ariz. "Is that too many? The little ones are never a factor." O'Malley said the distribution industry has grown more than 30 percent annually during the last two years, as integrators and retailers started buying more from distributors. Now the growth curve is slowing. O'Malley expects industry growth in the 10 percent to 15 percent range for 1999.One way Pinacor is adjusting to the decline is by getting tighter control of its inventory, O'Malley said. This is an issue all distributors must address as companies like Intel Corp. of Santa Clara, Calif., constantly lower prices, making inventory more of a liability than an asset, he said.O'Malley's plan is to cut Pinacor's inventory from 35 days down to about 25 days by thinning out the most price-sensitive items, such as computer processors.Regarding Pinacor's future, executives are still deciding whether to keep the company a MicroAge subsidiary, spin it off, or merge it with another distributor. Recent turmoil in the market has delayed action and made spinning off the company impossible at this time, executives said. Meanwhile, Pinacor's balance sheet is strong, O'Malley said. For the quarter ended Jan. 31, Pinacor had sales of $1.3 billion, up 24 percent from a year ago. Income nearly tripled to $17 million.Jim Illson, Merisel's president and chief operating officer, agreed weak demand is responsible for the recent crunch. Illson identified several areas to focus on in 1999 to drive revenue and profits, including investment in automation, new partnerships and programs to drive business to resellers. "Overall, I'm very pleased with the progress we've made," he said.The company is implementing a full suite of SAP software to improve operations and efficiency, teaming with manufacturers to assemble and configure products faster and stepping up electronic commerce efforts though a partnership with ECWerks, an e-commerce consulting company in Tampa, Fla. Since a major restructuring effort in 1997, Merisel has paid off most of its long-term debt and built up $36 million in cash, Illson said. Merisel reported income of $18.5 million on sales of $4.5 billion for 1998. Sales grew 18 percent for the year. Despite the progress, Merisel's stock languishes around $1.50 a share. It has traded in the $1 to $3 range for the last year.