By Craig Martin*
Datacentrix Holdings Ltd (DCT), which is trading on a market cap of R837m, compared to Pinnacle Holdings Ltd (PNC) market-cap just shy of R2bn, released its interim results to the end of August earlier this week (7 Oct). Growth in operating profit of 18% off revenue growth of 9% certainly looked a lot better than Pinnacle’s drop in profit of around 19% off similar revenue growth.
Pinnacle Holdings Ltd (PNC) was historically a distributor of hardware and software on the African continent. As the slowdown in desktops occurred, they transitioned from moving laptops and notebooks and as that began to slowdown, Pinnacle moved tablets. The problem with the tablet market it that software or application sales no longer take place through a distributor like Pinnacle, but happen though Google and Apple stores online. The sale of servers to the corporate market is also something that has slowed down in recent years as companies migrate to the cloud and virtual solutions.
The kind of technology that Pinnacle offer has experienced declining technology prices as hardware became a commodity. The group is heavily exposed to foreign exchange movements which add a level of volatility to its earnings. To an extent, Pinnacle relies on imports and so a weaker Rand does not always bode well for the company.
Datacentrix recognised these challenges in the market place and so they transformed from making product-based revenue through moving boxes, into delivering complex technology infrastructure solutions.
Unfortunately Pinnacle have been slow in transitioning and so are still exposed to competition pressure, they could also be affected by constrained consumer spending and if interest rates climb higher, not only will Pinnacle feel the brunt of having to service its own debts, but it also faces new dynamics with the CentraFin loans book, which is now heading for R400m.
The past few financial results clearly show that the company has been feeling margin pressure, cash flow has been slightly strained and debt has been on the increase. The cash flow pressure and higher debt levels have been partly as a result of the demands from the CentraFin lease book, as well as the purchase of 34,99% equity in Datacentrix Holdings Ltd (DCT) in 2013 for R284m.
However, it also this purchase into Datacentrix that could ultimately be Pinnacle’s saving grace. When the hostile stake in Datacentrix was made,Pinnacles CEO, Arnold Fourie indicated that “services will become a more and more critical part of the total IT solution, and Datacentrix have all the skills to offer these very complex solutions.Pinnacle Holdings (PNC) shares were still trading in the 2400-2500c range when the company took its 34,99% stake in Datacentrix. Earlier this year news broke of Takalani Tshivhase bribery charges, the Board was criticised for not warning the market of his arrest via SENS and frowns were cast over the fact that Directors were significant sellers of Pinnacle shares over this period. These incidents along with the aforementioned financial pressures have pushed the share price down to the 1150-1200c range.
It is our view that Pinnacle were intending to acquire Datacentrix in its entirety, but the only way that they would have been able to do that would have been through an exchange of paper. At that stage, the company could have possibly gotten away with a ratio of one Pinnacle share for every 4.5 or 5 Datacentrix shares held. Today with Pinnacle trading on a PE of under 7, the purchase of any company with paper just doesn’t look viable.
Soon after the announcement of Pinnacle’s hostile acquisition of Datacentrix, the Chairman of the company, Gary Morolo, immediately stepped down. The current CEO, Ahmed Mahomed, was previously MD of Pinnacle Micro and so has a long-standing relationship with Arnold Fourie, who also sits as a Non-Executive on the Board of Datacentrix.
After acquiring its 34.99% in Datacentrix, Pinnacle approached the competition authorities for approval to acquire a controlling stake. This was granted, subject to certain conditions. However at present Pinnacle cannot purchase any more shares, as this would mean breaching the magical 35% mark which implies a change in “de facto control”, which will force Pinnacle to have to make an offer to minorities.
The option of waiting for Pinnacle’s share price to recover to the levels it was at the start of the year, and to complete the acquisition with paper, is looking more and more unlikely as the year progresses. So, if Pinnacle are going to go ahead and complete their purchase of Datacentrix, they will need to do so with cash.
Pinnacle has already considered their investment in Datacentrix to be an associated company and the results are equity accounted. Essentially this means that the interim results that Datacentrix just released will add around 18.5cps to Pinnacles interims to December 2014.  Assuming that Datacentrix was absorbed into Pinnacle, its full year earnings for 2015 could add between 120-130cps to HEPS.
Datacentrix has managed to maintain its Level Two B-BBEE status with 125% procurement recognition. Pinnacle is a Level Three contributor with 110% procurement recognition, but they arguably have some added work to do on their reputation.
The two business models fit together very well, with Pinnacle looking to increase its projects and services part of the business and Datacentrix benefiting from some of Pinnacles access to a wide range of hardware and software solutions. While Pinnacle manage revenue in excess of R7bn and Datacentrix only just north of R2bn, the margins in Datacentrix’ business is substantially better.
The other alternative, which may be the only option available to Pinnacle at the moment, is to find a buyer for their CentraFin business. This should fetch in excess of R400m and allow Pinnacle to make a cash purchase of Datacentrix. The additional cash flow received from Datacentrix will allow the group to repay the additional debt required to complete the purchase.
Whatever move Arnold Fourie and the Board now make, it will come at a higher cost than it would have if done a year ago.
* Craig Martin is an entrepreneur with investments in information technology and financial services. He has experience as a discretionary Portfolio Manager, and has worked for ABN-Amro, Aurica Asset Management and Guardbank in the past. He currently investments for his own account and operates as an independent equity analyst.Â
