Arrow Buys Agilysys' IT Distribution Business for $485 Million

Published: January 11, 2007

by Timothy Prickett Morgan

The consolidation in the server and storage distribution business continues apace in 2007 as Arrow Electronics announced last week that it would pay $485 million in cash to buy the KeyLink Systems Group distribution business from rival Agilysys. With this deal, Arrow positions itself to better compete against Avnet, its remaining big rival in the enterprise server, storage, and software distribution business. Both Arrow and Avnet have been doing acquisitions in recent months to build up their IT distributorships.

Both Arrow and Avnet also have strong partnerships with the two biggest server makers, IBM and Hewlett-Packard, and the acquisition of the KeyLink unit from Agilysys will give Arrow a bigger footprint in X64-based servers as well as more business in proprietary machines from Big Blue. Back in November, Avnet diversified a bit from Arrow when it acquired General Electric's Access Distribution business for $412.5 million.

GE Access was the largest distributor of servers and storage created by Sun Microsystems, and will probably have more than $2 billion in sales for calendar 2006. When added to Avnet's Technology Solutions unit, Avnet's IT distribution business will account for about $7 billion in sales annually, and comprise about 40 percent of its overall $17 billion in annual sales.

The Agilysys deal does not add as much to the top line for Arrow as the GE Access deal did for Avnet, but it will nonetheless significantly bolster Arrow's position in the cut-throat IT distribution business. Pro forma sales for the KeyLink unit are expected to be in the range $1.6 billion for calendar 2006. Some of that dough will include sales related to a five-year procurement agreement that another Agilysys unit, its Enterprise Solutions Group, signed. This unit sells solutions to customers, as opposed to what KeyLink did, which was sell boxes to value-added resellers who in turn sold them to customers. Arrow did not disclose the value of that five-year procurement agreement.

The KeyLink deal not only brings 500 employees and 800 reseller partners into the Arrow fold who were formerly under the umbrella of a competitor. Perhaps more importantly, the acquisition of the KeyLink unit also eliminates yet another competitor in the server distribution business. For all intents and purposes, there are only two master distributors left--Arrow and Avnet. And with Agilysys now sourcing its IT products for resale as part of solutions for end users from Arrow, that locks up another revenue stream that cannot be taken over by Avnet.

The acquisition of the KeyLink distribution business follows fast on the heels of another deal that Arrow did in late 2006, acquiring InTechnology, a British distributor of servers and storage with about 200 employees and about $400 million in sales in 2006. The KeyLink and InTechnology businesses are being folded into Arrow's Enterprise Computing Solutions group, which is headed up by president Cathy Morris. Like Avnet, Arrow has an immense electronics component distribution business as well as IT distribution businesses.

After divesting itself of KeyLink, Agilysys will focus on selling complete hardware, software, and services stacks to customers as many other VARs do. While the hardware distribution business has been disappointing for Agilysys in recent quarters--particularly as it relates to IBM's System i5 proprietary server business--the solutions side of the house has grown from $276.7 million in sales in the fiscal year ended March 2003 to $469 million in the fiscal year ended March 2006. (Agilysys got out of the electronics distribution business in 2003 because Arrow and Avnet were too big to compete with, incidentally.)

Agilysys says that it will book about $340 million in net cash on the sale of KeyLink, but will have restructuring costs in the neighborhood of $2 million after restructuring. The company's board of directors authorized Agilysys to buy up as much as 20 percent of its outstanding shares, which could burn through as much as $100 million. The remaining cash will be used to grow its Enterprise Solutions Group, which sells complete IT setups to government, retail, hospitality, and a few other vertical sectors. And for the first time in its 30-year history, Agilysys says it will be debt free, and therefore better able to invest in a future where it will try to directly serve--rather than indirectly serve--IT shops. The company says that it hopes to grow its sales to $1 billion in two years and to $1.5 billion in three years, to have gross margins in the range of 20 percent, and return on invested capital of 15 percent.

Ironically, according to Paul Reilly, Arrow's chief financial officer, the KeyLink business already has a return on invested capital of 15 percent--about Arrow's own long-term goal of 12.5 percent, which it has stated frequently throughout 2006. Given this, it might seem surprising that Agilysys would want to get out of the business. But dealing with IBM, HP, and a reseller channel is a big hassle--presumably worse than dealing with customers.

For Arrow's part, the KeyLink acquisition increases its VAR channel from 500 resellers to about 1,300 resellers, and gives it good presence in both North America and Europe, when you add in InTechnology. The deal also gives Arrow a much bigger presence in the X64 server market. According to Reilly, servers and storage accounted for about half of the hardware revenues at the KeyLink unit, with about 30 percent of that coming from proprietary servers (mainly IBM's System i5 but also some mainframes) and about 70 percent coming from X64 machines in tower, rack, and blade form factors. After the deal is done--it is expected to close by the end of March--the Enterprise Computing Solutions group will account for about 30 percent of Arrow's overall business. If Arrow can hit the high end of its targets for the fourth quarter of 2006, then it will post $13.7 billion in sales for all of last year without KeyLink, which will add another $1.6 billion plus whatever the reseller agreement with the remaining parts of Agilysys is worth. In other words, Arrow and Avnet will be of roughly the same size.

Arrow's chairman and chief executive officer, Bill Mitchell, said in a conference call with Wall Street analysts that scale is a weapon that Arrow intended to use to its advantage in the IT market. "What we can bring to the VAR base is a much broader and deeper line card," he explained, using the IT distribution lingo for product catalog. "We also have scale, and scale does count in this business. We intend to invest in this business, and we have the financial clout to do it." In particular, Mitchell said that Arrow would focus on small and medium businesses, companies that have sophisticated IT problems like large enterprises, but do not have the staff, money, or skills to handle them and therefore need a total solution from VARs. "This is a lot more than selling boxes," he said. "This about selling solutions to a large and growing set of customers. We think that the SMB market is a sweet spot that we can serve very well."

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