My latest column is up at RealMoney.

I think a long Ingram Micro (IM) and short Tech Data paired trade can take advantage of differences in valuation regardless of what happens next in business spending.

While the two companies tend to take turns outperforming one another, over the last five years and since the market peak in early 2000 their cumulative performance is nearly identical. This time around, I’d expect both companies’ P/E multiples to converge, perhaps to 10 times estimated 2009 earnings. To budget in the possibility of further estimate cuts, I am also using the lowest estimate on the Street.

At 10 times the Street-low estimate of $2.38, Tech Data could see a further drop of nearly 30% from current levels. Ingram, meanwhile, could see a 20% share price rise if it were to trade at 10 times the 2009 low estimate of $1.86.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned.

This article is a reprint of my February 8, 2008 RealMoney column

One of my favorite investment themes is engineering and infrastructure software, which I think combines the high margins and cash flow stability of a software investment with the positive long-term trends in global infrastructure development. I think investors can profit handsomely from a potential 64% rise in Autodesk, the leading player in this market.

In November I wrote bullishly about Dassault (DASTY) and Ansys (ANSS), which I bought in January. Since those columns were written the stocks have performed in-line with the market, which is a nicer-sounding euphemism for saying they have gone down. I was more bearish about Parametric (PMTC), which has indeed turned in the worst performance of the three.

Long term, however, I still think the space has tremendous opportunity and think the overall market downturn is providing additional opportunities – most notably that of industry leader Autodesk (ADSK). Autodesk is best known for its AutoCAD software, a customizable and extendable computer aided design (CAD) application for 2D drafting, detailing, functional design documentation and basic 3D model-based design.

A common misperception is that AutoCAD is focused on architectural markets, and that a slowdown in construction activity could be disproportionately harmful. However, the largest end market is manufacturing (product design) and the civil engineering/infrastructure market is nearly as meaningful as construction.

The shares were downgraded by an analyst at Jeffries in January, who cited “anecdotal channel evidence of slowing manufacturing demand in Europe” and a “decent chance” that spending on computer-aided design software and related technologies will slow in both North America and Europe in 2008. Yet his less-than-2% trims to his EPS estimates, which simply brought them in line with the rest of the crowd, are more than reflected in the 25% decline in the share price since the December.

At any rate, Autodesk continues to meet or exceed earnings estimates and has seen modest positive revisions to estimates over the last month. Since its products are used in the early stages of the construction process, if the potential slowdown doesn’t show up soon it likely won’t show up at all.

Furthermore, with more of its customers migrating to a subscription-based model some of the uncertainty surrounding upgrade adoption has been mitigated and revenue growth and stability are more transparent. Subscription revenues are growing at twice the rate of license sales. Deferred revenues have grown 12% in the last nine months, including an 18% increase in long-term deferred revenues. All of this lends to greater confidence in the level of sales and earnings over the next year.

Autodesk generated $640 million in free cash flow over the last 12 months, which amounts to a free cash flow yield approaching 8% of enterprise value. With a 500-basis point advantage over Treasuries and a long-term expected growth rate of 16% (which is more than justified by the company’s high return on equity) the stock looks very attractive here.

If Autodesk grows in line with estimates and narrows the spread between its cash flow yield and the Treasury yield to a still-attractive 100%, its shares could rise to $63, for a potential return of 64%. The shares offered a similar spread to Treasuries as recently as December, when the shares were trading above $51. Meanwhile, short of a considerable decline from the existing level of sales and cash flow it is hard to see significant further downside.

Disclosures: Long Ansys (ANSS)

The following article is a reprint of my February 6, 2008 RealMoney column

Hewitt (HEW) is a leading global provider of human resource benefits, outsourcing and consulting services. On Tuesday the company reported $0.59 in earnings per share, beating analyst estimates by a full $0.20 per share. Given that it currently sports a healthy 9.1% free cash flow yield, I thought it was worth a further look.

Unfortunately, the full year guidance given was that Hewitt is “maintaining our fiscal 2008 guidance despite absorbing what we expect will be about six cents per share in dilution from the divestiture of Cyborg over the balance of the year.” After a $0.20 beat in the first quarter, ideally estimates would be raised by $0.14 (or more) despite absorbing a $0.06 per share dilution.

Hewitt’s surprise was largely driven by the fact that its Human Resources Business Process Outsourcing (HR BPO) business, which accounts for 20% of total revenue, lost less money in the company’s fiscal first quarter 2008 than it did in the prior year. Still, there are contracts that the company is trying to restructure to achieve profitability that are in “sensitive” stages.

Given how much most companies hate the human resources function, one would think that those willing to take on others’ headaches would be able to earn high profits. Unfortunately, there are a surprisingly large number of companies willing to take on those headaches. In the latest 10K, management says that “The principal competitors in our HR BPO segment are technology consultants and integrators such as Accenture (ACN), Affiliated Computer Services (ACS - Annual Report, EDS/ExcellerateHRO (EDS) and IBM (IBM - Annual Report) and; companies that have extended their services into human resources outsourcing such as Automatic Data Processing (ADP) and Convergys (CVG).

On the conference call, management indicated that the outsourcing business was counter-cyclical, with customers outsourcing more in downturns in order to reduce costs. Yet they seemed to contradict this statement by saying that the current market environment was causing their new contract signing pace to be behind schedule. Hewitt’s Zacks rank declined last week from 1 (best) to 2. Although the current rank still puts Hewitt in the top 20% of companies measured for earnings momentum, the cautious guidance and talk of a light pipeline are likely to result in some estimate reductions for the remainder of the year.

Despite the lower sales pipeline and ongoing restructuring of unprofitable contracts, Hewitt paid higher performance-based compensation in the fourth quarter. This resulted in first quarter free cash flow being $4 million lower than last year. The company also expects to spend more on capital expenditures this year, which will dampen free cash flow generation.

Furthermore, while earnings are improving the quality of those earnings is not. To gauge earnings quality, I measured the accrual ratio (change in net operating assets as a percentage of net operating assets) over the past several years. The accrual ratio gives an indication of the extent that earnings are driven by cash flows versus accounting choices. The closer the ratio is to zero, the better. Hewitt’s has been declining.

Source: Zacks Research Wizard, compiled by William A. Trent

So, after looking under the hood, I see a company with falling earnings momentum, falling free cash flow yield and falling earnings quality. The only thing rising in recent quarters has been the share price. As a value oriented investor, I’d rather it was the other way around.

Disclosures: None

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

This article was originally published at RealMoney on November 19, 2007.

With shares of Ansys (ANSS) up 100% over the last two years and more than 1,200% over the last seven, it hardly qualifies as undiscovered. However, with only four analysts covering the stock – and none from bulge bracket investment firms, the stock may remain under-appreciated.

Earnings have exceeded estimates by a wide margin for several consecutive quarters (including a significant earnings beat just two weeks ago), which is further evidence that the current consensus may not fully reflect the company’s earnings power. The shares soared on that news but have since come back down to their prior levels due to the overall stock market weakness. I think this baby is wrongfully being thrown out with the market’s bath water.

Ansys (ANSS) designs engineering simulation software used in such industries as aerospace, automotive, manufacturing, electronics, biomedical and defense. Simulation software reduces the time it takes to move products from the design stage into manufacturing because it allows for much of the necessary product testing to be simulated rather than tested on prototypes. Ansys licenses its technology to businesses, educational institutions, and governmental agencies.

On May 1, 2006 Ansys acquired one of its largest competitors, Fluent. The acquisition depressed trailing earnings and elevated trailing valuation multiples, possibly keeping Ansys off the radar screen of some investors.

Despite a fairly hefty multiple of 28x next year’s earnings, the company generates a strong free cash flow yield of 3.5%, which is nearly as high as the current yield on five-year treasuries. Unlike Treasuries, Ansys also offers significant growth that should more than compensate for accepting the related risk. Based on my calculations, the stock has an intrinsic value of $46 per share based on that ability to generate excess cash.

An Eye on the Risks

With the possibility of a recession rising, it is worth considering a possible demand slowdown. The company’s largest end markets are aerospace and autos. Aerospace is booming but major projects like the A-380 and Boeing Dreamliner are past the design stage, so arguably demand could slow until the next major product cycle is under way. Autos face the opposite risk – slowing demand due to the overall industry’s distress.

The long sales cycle and potential for large license sales can lead to lumpy sales patterns, a risk reduced by the Fluent acquisition since Fluent sells a higher proportion of lease-based licenses rather than perpetual licenses. Ansys has been a leader for many years, and even if it were to fall behind technologically its customers would be unwilling to migrate to a new platform immediately. This lag could allow them to catch up or buy the necessary technology.

The company could fail to successfully integrate a future acquisition. However, its acquisition of Fluent, and Dassault’s (DASTY) purchase of ABAQUS, has reduced the pool of potentially large acquisition candidates significantly.

Valuation

Ansys has generated more than $103 million of free cash flow in the last 12 months. Based on its current enterprise value of $2.9 billion, Ansys is generating a free cash flow yield of 3.5%, slightly less than the yield on five-year treasury securities.

According to Zacks Investment Research, the consensus five-year earnings growth estimate is 18% per year, which compares to 11% actual historic market growth and a 13% theoretical sustainable growth rate (equal to the average ROE since there is no dividend.)

I think sales can grow 15.7% in 2008 and 15% in 2009, which should generate nearly $130 million of free cash flow in 2008 ($1.60 per share) and $160 million in 2009 ($2.00 per share). At that time, assuming a 100% required return premium to treasuries and a 4% terminal growth rate the company could be worth $3.7 billion, or approximately $46 per share. I further believe they would have $4 per share in net cash by that time for a total potential value of $50 per share and total potential cash on cash return over the 2+ years of 30%. Discounting the cash flows to the present at a required return of 8.5% generates an estimated current intrinsic value of $46.00 per share, from which the current price represents a 20% discount.

Note: Find the best business credit cards for your small business and get the most out of your credit.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

This article was originally published at RealMoney on November 6, 2007.

Parametric Technology (PMTC) develops software used for Product Lifecycle Management (PLM) and Enterprise Content Management (ECM). At a P/E of approximately 15x and a 5.3% free cash flow yield, Parametric appears cheap relative to other technical software developers. However, its earnings quality has historically been low and it faces more severe competition than some of its peers. With earnings quality improving and the valuation favorable, PMTC certainly bears watching. But for now I think Dassault Systemes (DASTY) and Ansys (ANSS) have sufficiently better prospects to justify their higher valuations.

Compared to companies like Ansys, which develops highly technical products and has relatively few competitors, Parametric has significant competition in each of its business segments.

PLM competitors include Dassault Systemes SA, Siemens (SI) subsidiary UGS, Autodesk (ADSK) and Agile Software (AGIL). They also compete with larger enterprise-solution companies such as SAP (SAP - Annual Report) that have entered the PLM market and offer solutions integrated with their other enterprise software applications.

ECM competitors include EMC (EMC - Annual Report) Documentum, IBM’s (IBM - Annual Report) FileNet, OpenText, Adobe (ADBE) Framemaker, and the Microsoft (MSFT - Annual Report) Office suite.

Parametric suffered mightily during the tech downturn, but since 2004 the company has been engineering a turnaround based on improved profitability and a return to growth. Current consensus growth estimates for the next five years are just 7%, or half the rate expected for the industry. The lower growth estimates are part of the reason for the cheaper valuation. However, they also make for a lower bar to clear, and the recent reversals of its deferred tax valuation allowance are a signal that the company is now “more likely than not” to earn sufficient income in future years to utilize tax losses from prior periods.

There are a few other issues that cause me to think Parametric’s low valuation is justified. For example, 58% of revenues are derived in North America, which faces an uncertain near-term economic outlook.

Another issue is earnings quality. Gross margins have been declining due to a higher percentage of revenue being derived from consulting and training rather than license and maintenance revenue. A bad debt charge-off in 2006 and increased customer financing activity are other signals that earnings quality may be low.

To get a feel for overall earnings quality, I calculated the accrual ratio, or the change in net operating assets divided by average net operating assets. This ratio describes the percentage of earnings contributed by discretionary accounting items rather than actual cash flows. An ideal accrual ratio would fluctuate around zero. Parametric’s has been all over the map, though it has been improving for several quarters.

Sources: Zacks Research Wizard, William A. Trent

If Parametric continues to improve its earnings quality, or if it gives back some of the stock gains it enjoyed post-earnings (or preferably both!) it could become an attractive buy candidate.  In the meantime, interested investors may find an option play worthwhile.

The January 17.50 puts were trading recently at $0.50/$0.75. If you could write the option for $0.60 it would offer a 3.1% 2.5-month return on the money at risk, which annualizes to nearly 15%. You’d be forced to pay $17.50 for the shares if they drop between now and then, but the option premium would give you an effective price of just $16.90. At that price, the 6.0% free cash flow yield would probably be enticing enough to justify a buy anyway.

Disclosure: Short naked put options on Ansys (ANSS)

William Trent currently has a short position in put options related to Office Depot (ODP).

This article was originally published at RealMoney on November 5, 2007.

Dassault Systemes (DASTY) is trading down nearly 6% after the company trimmed its earnings outlook by five Eurocents last week. The company now expects to earn between €1.96 and €2.00 in 2007, compared with earlier guidance of €2.00 - €2.05. With a solid overall business and a valuation that I believe looks reasonable, I think investors will ultimately find today’s price to have been an excellent entry point.

Dassault designs engineering software used for Product Lifecycle Management (PLM) (81% of 2006 revenue) and Mainstream 3-D design (19%). It has grown through organic growth and a series of acquisitions, including Abaqus in 2005 and MatrixOne in 2006 – each of which was in the order of $500 million consideration. It is 44.5% owned and effectively controlled by France’s Groupe Industriel Marcel Dassault.

Dassault offers software under several brands, including Solidworks for Mainstream 3D design and CATIA, DELMIA, SIMULIA and ENOVIA for PLM. However, a key aspect of its growth strategy is to combine the strengths of its various programs and allow customers to customize solutions using the company’s V5 platform.

The company generates 47% of its revenue in Europe, 31% in the Americas and the remainder in Asia. Although it blamed the lowered outlook on the weak dollar, the company’s latest annual report said its greatest currency exposures are between the Euro (its reporting currency) and the Yen, Pound and Korean Won.

More than half of the company’s sales are on a recurring (software rental or maintenance contract) basis rather than through perpetual license fees. With a largely industrial customer base, revenue growth drivers include business investment and industrial production in its end markets.

Competition

Dassault lists its primary PLM competitors as Parametric (PMTC) and Unigraphics, which was recently acquired by Siemens (SI). Its main competitor in Mainstream 3D is Autodesk (ADSK). The company also competes with Ansys (ANSS), Agile (AGIL), MSC Software (a href="http://stockmarketbeat.com/blog1/category/msc-software-mscs/">MSCS - Annual Report) and to a lesser extent Oracle (ORCL - Annual Report) and SAP (SAP - Annual Report).

The combined revenue of the nearest competitors and comparables, which I believe to be Dassault, Ansys, MSC and Parametric, has been approximately 11% annually over the last decade. Dassault has used its acquisitions and the opportunities provided by the V5 platform to grow at a faster rate than its peers.

In 2006 Dassault grew 24%, much of which was contributed by the Abaqus and MatrixOne acquisitions. On an organic basis sales grew 10% (12% assuming constant currency exchange rates.)

Risks

As I see it, the greatest risk Dassault faces is loss of a major customer. Although the company cites a customer base of 100,000 just 20 of those account for 25% of sales, with the largest customer accounting for 5%.

A potentially greater, though probably less likely risk is the company’s long-standing relationship with International Business Machines (IBM - Annual Report). IBM has a non-exclusive distribution relationship with Dassault and accounted for 45% of sales in 2006, so a rift between the companies could have a serious impact. The companies renegotiated the partnership earlier this year such that Dassault is taking responsibility for mid-market customers and IBM will serve enterprise customers. However, this adds a new risk related to maintaining a larger sales force.

Valuation

Dassault current market cap is approximately $7.3 billion, and with net cash on hand of nearly half a billion its enterprise value is about $6.8 billion. Given that it is on track to exceed its 2006 free cash flow generation of $300 million, the free cash flow yield of 4.4% compares favorably to the yield on five-year treasuries, and the 10% growth rate of recent years looks like a nice inducement for taking on the added risk.

By some common measures (5x book value and a P/E in the mid-20’s) the stock doesn’t exactly look like a bargain. But these measures overlook the cash flow generating power available to software companies. With essentially fixed costs and high margins, each dollar of sales contributes mightily to cash.

Although a recession or slowdown in Dassault’s key end markets or further dollar weakening could delay investor rewards, Dassault’s current valuation and long-term prospects appear to justify the wait.

Disclosure: Short naked put options on Ansys (ANSS)

Note: Set up high growth savings accounts and plan for your financial future today!

This article was originally published at RealMoney on September 26, 2007.

My article last week about mining the PPI report for stock ideas was so well received I thought I’d share another of my favorite taxpayer-provided idea generators, the durable goods report. Published by the U.S. Census Bureau, the report has a similar breakdown by industry of durable goods orders, shipments, inventories and backlog.  I came away with 28 potential ideas for further research.

In line with much of the recent economic data, the headline durable goods number was weaker than expected. To quote from the report, “New orders for manufactured durable goods in August decreased $11.3 billion or 4.9 percent to $219.5 billion, the U.S. Census Bureau announced today…. Shipments of manufactured durable goods in August, down two of the last three months, decreased $3.4 billion or 1.6 percent to $216.7 billion.”

But in this case, I think focusing on the forest means you could miss out on some of the more attractive trees. I gathered the data from the Census Bureau and created charts showing the year/year change in durable goods statistics for a variety of industries hoping to find some areas worth further consideration. Keep in mind, this is an initial screen for idea generation, not a full-fledged analysis of any of the names. You wouldn’t want to buy the stocks listed here without further research. That caveat aside, let’s look at some of the better performing industries.

First up is technology – computers and electronic products. Although 3.3% order growth year/year and essentially flat shipments may not be the type of growth investors typically look for from tech, it is a clear improvement from recent months. Inventories are starting to be drawn down and backlog remains strong.

But there are areas of strength and weakness within tech. Specifically, computers (and related products) themselves are starting to look strong, with backlog headed through the roof and inventories in check.

The fairly obvious stock ideas from this industry include Apple (AAPL), IBM (IBM - Annual Report) and Hewlett Packard (HPQ - Annual Report). If things keep getting better (and the company figures out how to file its required regulatory reports) Dell (DELL) might even look interesting again. Stretching a bit further, Sun Microsystems (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report) and Lexmark (LXK) come to mind. And don’t forget the storage plays, which also showed up on the PPI hotlist. The names I mentioned then were Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), SanDisk (SNDK - Annual Report), Seagate (STX - Annual Report) and Western Digital (WDC).

Communications equipment is also showing some signs of strength. Though the latest month was down, the trend seems to be up.

I have actually analyzed Motorola (MOT - Annual Report), so that would be a play to include here. Cisco (CSCO), Research in Motion (RIMM), 3Com (COMS), Nokia (NOK) and Corning (GLW - Annual Report) also come to mind.

And finally, turning away from technology, I hope you didn’t think the aircraft boom was over. If anything, it looks to be picking up steam.

Ways to play this include Boeing (BA - Annual Report), Embraer (ERJ), General Dynamics (GD - Annual Report), United Industrial (UIC) and Cessna parent Textron (TXT). Parts suppliers include Rockwell Collins (COL), Curtiss Wright (CW - Annual Report), and LMI Aerospace (LMIA).

So there you have it: 28 potential stock ideas from what looked at first glance to be a negative report on durable goods.

Disclosure: Long RIMM put options at time of publication.

I am taking a look at a couple of the engineering software stocks, and a review of recent conference call transcripts can frequently be a good place to start.

Ansys (ANSS) provides software that simulates physical forces such as turbulence, heat and pressure. Seldom was heard a discouraging word on that call, and for good reason. The closest I could come to was:

So even as we increase our outlook this will also be tempered of course by our short term engineers’ paranoia which I have to say has also served us well.”

(Excerpt from full ANSS conference call transcript)

Dassault Systemes (DASTY) has simulation and 3D design, plus software to help companies manage the product life cycle. It, too, has been on a tear for the past few years, and is showing no signs of stopping.

One of our most visible initiatives is the successful transformation of our PLM channel. Looking at the quarter, we had good progress in the PLM value channel and with IBM in large accounts. Our results today demonstrate that we are well in line with our plans, driving growth for CATIA and ENOVIA.

CATIA performed well with both large accounts and mid-market. We continue to invest in strengthening and broadening the CATIA product line. In mid-June, we completed the acquisition of ICEM, expanding our presence at the front-end of design. ENOVIA’s strong results demonstrate that our products form a powerful combination and are clearly complementary.

In total, we have had a dynamic product release schedule during the 2007 first half. We continue to advance our technology and strategic roadmap. During the second quarter, we launched our newest brand, 3DVIA, whose goal is to enable 3D to become a universal media for online product experiences.

(Excerpt from full DASTY conference call transcript)

Parametric (PMTC) has much in common with Dassault. Except for the being on a tear and showing no signs of stopping, that is.

We are disappointed with our performance in other areas. Most of the revenue shortfall was in license revenue. Our Desktop Solutions revenue declined year-over-year, which is counter to our recent trend of strong growth in this line of business.

The performance was spread across Pro/ENGINEER new seats, modules, and upgrades, with the most significant change from recent quarters in upgrade and module sales. By geography the revenue weakness was concentrated in North America and Japan.

(Excerpt from full PMTC conference call transcript)

The next question, of course, is to determine whether the successes at Ansys and Dassault are priced in, or whether Parametric has taken enough of a beating to be worth taking the risk.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Earlier today I said “Other signs are pointing to the consumer slowdown extending beyond just housing-related stores. The consumer was the last leg in the economy’s stool, so businesses had better take up the slack or we could be in for more of a slowdown than we already have.”

Right on cue, I learn that CDW’s Average Daily Sales Increase 25.3 Percent in June 2007 and 24.4 Percent in the Second Quarter of 2007:

Excluding Berbee sales in June 2007, and therefore on a non-GAAP basis, CDW’s average daily sales for June 2007 were $31.641 million, an increase of 15.9 percent compared to average daily sales for June 2006 of $27.293 million and total sales for June 2007 were $664.5 million, an increase of 10.7 percent compared to total sales of $600.4 million for June 2006.

That is a pretty darned good number. If it is happening across the board, and not as a result of CDW gaining market share, the GDP chart for tech equipment and software spending won’t look like this for long.

If it is an industry-wide phenomenon, there are positive implications for Tech Data (TECD), Ingram Micro (IM) and Mid Cap Watch List (Track at Marketocracy) member Synnex (SNX) as well as for their suppliers, primarily Hewlett Packard (HPQ - Annual Report).

Mid Cap Watch List (Track at Marketocracy) member Synnex (SNX) reported strong earnings just before it was added to the Watch List. It just filed its 10Q, so I decided to take a quick look. This post was featured at the Festival of Stocks.
Synnex is a Business Process Outsourcing (BPO) company. Other companies hire Synnex to manage business functions such as distribution, assembly and logistics. Nearly all of the company’s sales are to North American customers. Hewlett Packard products account for 28% of the company’s distribution sales.

The first thing I noticed was a large increase in accounts receivable, which rose more than 50% since November compared to a 9% increase in sales and resulted in negative cash flow from operating activities for the first six months of the year. It turns out the company changed the way it accounts for certain receivables:

The Company has established a revolving securitization arrangement (the “U.S. Arrangement”) through a consolidated wholly-owned subsidiary to sell up to $350,000 U.S. trade accounts receivable based upon eligible trade receivables (“U.S. Receivables”). The U.S. Arrangement expires in February 2011. The Company’s effective borrowing cost under the U.S. Arrangement is a blend of the prevailing dealer commercial paper rate and LIBOR plus 0.55% per annum. Prior to amending the U.S. Arrangement in February 2007, the Company recorded the previous U.S. Arrangement as an off-balance sheet transaction because the Company funded its advances by selling undivided ownership interests in the U.S. Receivables. The amended U.S. Arrangement requires the Company to account for this transaction as an on-balance sheet transaction because the Company funds its borrowings by pledging all of its rights, title and interest in and to the U.S. Receivables as security.

Including more of the receivables on the balance sheet will improve comparability in the future, and earnings will be of higher quality. Still, however, the company’s Canadian division can continue to carry as much as $125 million in receivables off balance sheet. The fact that such a large percentage of receivables was carried off-balance sheet in the past should encourage investors to be especially vigilant when it comes to earnings quality issues.

Synnex operates on thin profit margins (net profit margins are less than 1% of sales.) Given the potential for fixed cost leverage, minor increases in revenue could lead to very large earnings gains. However, the leverage also works the other way and the company could quickly experience losses should there be a revenue setback. Revenues are highly dependent on the end-market demand for IT products and services.

During the first six months of the fiscal year Synnex paid total consideration of approximately $115 million to acquire four companies. Despite the fact that this amount represents approximately 18% of the company’s market capitalization, the company claims that “The above acquisitions, individually and in the aggregate, did not meet the conditions of a material business combination and they were not subject to the disclosure requirements of SFAS No. 141, “Business Combinations.” The acquisitions were:

• Link2Support, a technical support and contact center based in the Philippines
• PC Wholesale, an IT distributor focused on refurbished and end-of-life equipment
• China Civilink, a China-based domain registration and web hosting provider
• Redmond Group, a consumer electronics distributor

Synnex also has a complicated relationship with MiTAC International, which owns 46% of the company’s shares. Matthew Miau serves as Chairman for both companies. MiTac is a major supplier to Synnex but supply agreements have been informal and there are no contracts or other assurances the relationship will continue. MiTAC introduced the company to several customers, including Sun Microsystems (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report), with whom the company’s account requires a continued relationship with MiTAC.

Due to the thin profit margins and concentrated ownership, Synnex is not the type of name I would hold for a long-term investment. To me, it seems better suited for trading opportunities when demand for IT products and services is growing rapidly.