pitch date: 2024-06-05

Author: Anthony Spencer

Long: Climb Global Solutions (NASDAQ: CLMB)
Market Cap: $260 million | 4.4 million shares outstanding
Current Price: $57 (6/5/24) | 2025 base case year-end price target: $77 (35% upside)

Company Overview:

Climb Global Solutions (CLMB) is a specialty IT distributor focused on data center technology, software, and cybersecurity, distributing products to 7,000+ customers and vendors globally. With the new company focus, they operate as an outsourced sales team for their software vendors, connecting companies with their clients, who include end users and software resellers. They get paid off commission. The Company primarily operates through its Distribution segment, which distributes emerging technologies to corporate resellers, value-added resellers (VARs), consultants, and systems integrators. This segment distributes technology products from software developers, vendors, or OEMs to resellers and system integrators worldwide. The Company's Solutions segment is a cloud solutions provider and value-added reseller of software, hardware, and services for customers worldwide. Distribution accounted for ~92% of sales and ~83% of gross profits as of FY’23.

What makes this company attractive relative to its competitors is that hardware sales only account for 5-6% of adjusted gross billings. The vast majority of their sales are software, which has a positive working capital and ROIC effect. The majority of products are digital products such as license authorizations, 3rd party maintenance contracts, or hardware that is dropped shipped to the end customer directly by the vendor. The company looks to establish deep relationships with its vendors and reseller partners by providing specialized products and having an efficient ordering process in place for its customers. CLMB’s relationships with key vendor partners are long-term in nature despite the absence of long-term contracts, with a significant portion of sales derived from annually recurring renewals of software maintenance and subscription agreements related to their partners' embedded base of customers utilizing their software products

The company had a change in leadership in 2020 with the new CEO, Dale Foster, and he brought in an executive management team with decades of IT distribution experience. They enacted a sales culture to scale partners in the IT channel through purpose-driven strategies and expertise. Additionally, they implemented a new vendor recruitment plan that freed up cash on the balance sheet to improve capital allocation opportunities. Since 2020, adjusted gross billings have compounded at ~20%, and gross profit has compounded at ~25%.

Company Focus:

CLMB focuses on finding disruptive technology vendors and partnering with them early, enabling strong organic growth for years ahead. They are highly focused on core vendors and can actively sell their products, in comparison to volume distributors that focus on products that sell themselves like HP, MSFT, and DELL do. These large vendors can sell directly to their end users due to their size, scale, and product awareness. Smaller vendors rely on the expertise of distributors to bring their products to market. This is where CLMB fits in as an outsourced sales team for its software vendors. CLMB was recognized by CDW as a Channel Partner of the Year in 2023, highlighting the symbiotic relationship between these two parts of the IT distribution market. The growing complexity of the IT landscape benefits the company as more vendors look to specialty distributor partners like CLMB as a go-to-market solution, and VARs require this specialty expertise as part of the integration of their solutions. CLMB’s top vendor relationships include SolarWinds and Sophos. CLMB has a tremendous opportunity going forward, given the size of the Global IT Market ($650B+) with a growth rate of 6%-10% per year. The emerging vendors, where CLMB sits, are projected to grow 10%- 16% yearly with a TAM of $22B+ for software distribution as a whole.

Arrow, TD Synnex, and Ingram Micro are the three largest companies within the software distribution industry, each occupying about ~1/3rd of the $22B+ market. Arrow and TD Synnex have ~$90B in sales, but a large portion comes from hardware. With CLMB’s software focus and smaller number of vendors compared to the larger players, they have the ability to provide better service to their clients. This enables them to have a virtual monopoly on the smaller growth companies (growing at 10% -15%). CLMB’s larger competitors do not care about these smaller businesses. Regarding the advantage of focusing on smaller companies, Dale Foster stated in the most recent earnings call (5/02/24), “What we're seeing though, is the larger they get in some of their vendors, because if you look at their top 10 vendors are bringing in 90% of their revenues. As soon as you get down the Line Card, those vendors are not getting the care and targeted approach that we provide. So, we're seeing a share shift from our competitors to us in a pretty big way. If I look at just the ones, we talked about that we won awards for, if you take a look at those vendors, the share shift that they're pushing to us because they're just getting a much higher touch white glove service to sell their products out to the market.” Additionally, their size enables them to be nimble and get their products to market faster. On this, in an interview done in February of 2024, Mr. Foster stated, “But it’s really about how fast we can get in front of customers, how fast we can transact, and how fast we get quotes out. That’s what people come to us for, and that’s what’s going to make us continue to grow.” In the past two quarters, six of CLMB’s clients have named them either “partner” or “distributor” of the year.

Financials:

CLMB is an asset-light business, and they carry very little inventory as their license delivery does not require physical possession like a traditional hardware distributor. Unlike its competition, CLMB does not have the working capital burden and does not require investment in a physical distribution network, leaving little risk for obsolescence. The company operates a negative net working capital cycle and 20% ROIC. This leads to limited capex requirements. With CLMB’s focus on high-growth vendors and the growing demand for cybersecurity and data center technology, organic revenue is forecasted to grow at a 10%+ CAGR over that time. Management is expecting adjusted gross billings to double to $2.6B by 2026. Organic growth will be supplemented by M&A, which CLMB can do due to its $42.5mm net cash position as of the LTM.

CLMB has a 5-year revenue CAGR of 14%+ versus Arrow with a 5-year revenue CAGR of 2.2%. TD Synnex has seen impressive revenue growth but has recently seen a slowing of growth, with its revenue contracting 8% y/y for FY’23 vs. CLMB growing revenue ~16% y/y for FY’23.

Opportunities:

As stated, Dale Foster has been CEO since 2020. He has over 20 years of industry experience and served as the President of Promark Technology before it was sold to Ingram Micro in 2012, where he became Executive Director and General Manager overseeing the growth strategies of the Promark emerging vendor division. Given Mr. Foster’s history with M&A, he hired Andrew Clark as CFO due to his experience with acquisitions in his previous roles. It is a possibility that in a few years, CLMB will look to sell the company. Their software focus and deep relationships with newer vendors are an attractive proposition to any broadline players or specialty distributors. Moreover, CLMB’s strong net cash position (~17% of market cap) and growing FCF ($37.1mm as of FY’23) could attract private equity buyers, as P.E. has had interest in this space historically. Exclusive Networks, a European competitor, has significant ownership by global private equity firm Permira, and according to a report by Reuters in March 2024, Permira is considering taking Exclusive Networks private.

CLMB has a history of M&A, as does management. The company generates enough cash to acquire smaller competitors and has completed one acquisition per year since 2020. Their most recent acquisition was Ireland-based DataSolutions for 5x EBITDA, a company with 14 clients, 90%+ recurring revenue, and double- digit growth. The company will continue to do M&A especially as they expand more into their European business which has quietly grown from 14% of net sales in 2019 to 19% of net sales in 2023.

Valuation/Price Target:

CLMB does not have any pure-play public comps in the U.S., which is part of what makes CLMB so unique. The closest comparable is Exclusive Networks (EXN.PA), a French company that trades at ~10.5x EV/EBITDA. EXN.PA is a distributor of cybersecurity products and has a concentration on legacy cybersecurity vendors like CrowdStrike, Fortinet, and Palo Alto Networks. Although the companies are similar, ~25% of EXN.PA sales are hardware, which deserves a lower multiple than a predominate software business due to the working capital requirements and obsolescence risk associated with having physical inventory, which could lead to significant inventory markdowns and a hit to net income. Moreover, CLMB is more exposed to the U.S. and North America, which should command a premium multiple when compared to its non-U.S. competitors.

CLMB currently trades at ~8x EV/EBITDA. I believe they trade at a discount to peers because of their revenue concentration. Given they are diversifying their revenue base methodically, I expect this to be less of a problem that should cause a multiple re-rating. As they diversify their revenue across customers, they will trade in line with EXN.PA, and eventually trade at a premium due to their capital-light business model, far higher revenue, EBITDA, and EPS growth rates, and their 20% ROIC vs. EXN.PA’s 5.4%. CLMB’s exposure to fast-growing sectors like cybersecurity and data centers should provide them with a long growth run rate and be supportive of management’s expectations of a doubling in adjusted gross billings by 2026. Assuming they reach this AGB target in 2026, this would mean an EBITDA number of ~$45mm. Assuming a 10x EV/EBITDA multiple, this suggests a stock price of $92/share for a 22%+ CAGR, assuming they maintain their net cash position of $42.5mm over that time. A 12x multiple suggests a price of $113/share, 32.5%+ CAGR.

I believe CLMB can achieve these share price levels through business execution, or through a sale of the company which is a possibility due to the history management has with M&A.

Risks:

CLMB’s has customer concentration risk. According to their last 10-K “For the year ended December 31, 2023, we had one vendor that accounted for 14% of our consolidated purchases and our largest five vendors generated approximately 40% of our consolidated purchases. For the year ended December 31, 2022, this same vendor accounted for 17% of our consolidated purchases. The loss of a key vendor or group of vendors could disrupt our product availability and otherwise have an adverse effect on the Company.”

However, I do not however believe this is a major risk. CLMB aims to bring on high-growth vendors and remove vendors where growth is slowing by offloading them to its sister company Climb Elevate. CLMB has repeatedly said they only want to work with vendors that grow at 10-15% per year, matching CLMB’s own growth rate. Climb can sustain this by reevaluating vendors and keeping only those with higher growth. In the company’s most recent earnings call, management stated, “So when we look back three years, we've if you look at our top 70 vendors, they make up 96% of our overall sales. Of those top 70 vendors, 36 of them have been brought on since 2020. So, you can see we have a very robust way to bring vendors in. They get into our top group. The 70th vendor with us transact about $4 million. So that's kind of our limited threshold, because we'd love to be able -- I'd love to have 50 vendors doing 90% and really have more of a focus on our team and have our Climb Elevate team do the rest of it as far as the Clutter piece of it goes.” Out of CLMB’s approximately 100 vendors, 70 constitute the majority of sales. Climb has been bringing in about 12 new vendors per year, which implies an average working relationship duration of 8-10 years and recurring revenue of about 80%. I believe CLMB can sustain 10-15% growth because they have many potential vendors who want to work with them, so they can be selective and choose the best ones. According to earnings calls, Climb evaluated 98 potential vendors in 2023 and signed only 15.

Conclusion:

This is a unique company and a more subtle way to play broader technology trends with an attractive valuation and growth prospects. The company can do very well as a stand-alone enterprise while being a potential M&A target for a larger player like Ingram, Synnex, or Arrow. Despite having lower gross margins and net income margins than other pure-play SaaS companies, they leverage an efficient and scalable business model with low capital investment requirements. Due to high returns on capital, as the company becomes more profitable, they are left with more cash to reinvest in its business, driving further growth.

Catalysts:

Continued growth in cybersecurity and data centers. Their recent expanded partnership with JAMF, the leading provider of Apple device management and security software, should provide a strong tailwind to growth, leading to a potential multiple re-rate and higher operating metrics. Any M&A activity as rates come down and larger software companies look to expand.