Shares in Data#3 (ASX:DTL) have recovered well from their January lows, which were triggered by changes to Microsoft’s partner incentive program announced late last year.

We recently researched the Company in The Dynamic Investor to assess the prospect for a further recovery in the share price.

About Data#3

Data#3 provides IT products and services to almost exclusively Australian-domiciled clients. Data#3 partners with leading global tech firms (e.g. Microsoft) to procure, deploy and manage complex IT systems to its clients. Its clients are predominantly in the Government, education, healthcare and resources sectors.

The Company is the #1 partner to Microsoft, Cisco and HP in Australia and a top-5 partner to Dell Technologies in Australia.

Key Fundamental Drivers

Impact From Changes Microsoft Incentive Program Less Than Feared

On 16 December 2024, DTL issued an ASX release stating the impact from changes announced by Microsoft to its partner incentive program. The changes, which came into effect on 1 January 2025, reduce the incentives earned by DTL on its Microsoft Enterprise Agreements (EAs).

As part of these changes, Microsoft will increase its focus on Small, Medium and Corporate (SMC) initiatives. Microsoft has also increased incentives for its Co-pilot, Security, Azure Migrations and Cloud Solutions Provider (CSP) programs.

At the 1H25 results release in February, the Company was confident of mitigating the impact to have less than a 3% hit to PBT, via:

• Increasing focus on small, medium and corporate customer segments, along with CSPs, Copilot, Security Solutions, and Azure.
• Leveraging their investment through a CSP platform, which will support the increased administration from higher transaction volumes from a larger amount of small-to-medium and midmarket customers.
• Benefiting from higher margins for FMC vs larger enterprise customers.
• Growing business with other vendor partners.

Potential for Operating Leverage

The Internal Cost Ratio increases by ~70 basis points to 82.2%, compared to 81.5% in 1H24. The increase reflects redundancy costs, headcount growth (+1%) and investment in new systems and processes (e.g. payroll). There is scope for the Internal Cost Ratio to decline below 80% by FY27 given that redundancies undertaken in 1H25 are expected to benefit in 2H25 and FY26.

Aside from a lower Internal Cost Ratio, there is potential upside to Gross Profit Margin (GPM) from the mix shift towards Services and away from Product. In context, Services generates a GPM of ~36%, compared to ~5.7% for Product. FY25 is expected to be the first year that Services Gross Profit will exceed Product Gross Profit in dollar terms. We note that this will be a continuation of 1H25 where Services Gross Profit ($74m) exceeded Product Gross Profit ($69m).

Balance Sheet Remains in Strong Position

The Company has a strong balance sheet (net cash and no debt). The FY-end cash balance typically varies due to factors such as higher customer spend in the 4th quarter and timing of customer billing. The above-mentioned decline in the cash balance at 31 December 2024 reflected payments made relating to the May/June peak selling period.

However, despite seasonal fluctuations at period end, DTL typically have a stable net working capital position. In addition, the working capital model is efficient in the sense that short or negative working capital cycles underpin a self-funding business model.

Given the strong net cash balance, interest income is a significant contributor to Profit Before Tax. The latter highlights DTL’s cash generative business model and ongoing improvements in working capital management.

Fundamental View

DTL shares are currently trading on a 1-year forward P/E multiple of ~23.5x. This multiple is well below the post-COVID average of 27x over the past five years and at the bottom end of the trading range over that timeframe. The current multiple is also undemanding in the context of an EPS growth profile of ~10.5% over FY25-27 on a CAGR basis.

The recent emergence of stronger tailwinds – in the form of the PC refresh cycle, demand pull-forward in PCs and higher GenAI bookings – is expected to drive revenue growth and mitigate the (reducing) impact of the Microsoft incentive changes on profit.

There is also potential upside to EPS forecasts from: i) DTL using its net cash balance sheet position to undertake capital management and/or EPS-accretive acquisitions and ii) Upward revisions to consensus estimates for GPM from the mix shift towards Services and away from Product.

The FY25 results release (due mid-to-late August) is likely to be a key upcoming catalyst.

Charting View

After the large reversal in February 2024, DTL then continued to trend lower for the next year, finding some support near $6. The stock then rallied up towards $8 before easing back again. This area near $8 now appears to be a level of strong resistance. DTL appears to be recovering and is therefore a tentative buy here. More conservative investors may wish to wait for a break above $8 before stepping in.

 

Michael Gable is managing director of Fairmont Equities.

 

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