Datalink's M&a: Growth By Design

Over the past four years, Minneapolis-based Datalink Corp., a provider of data center infrastructure and services, has made four acquisitions. Together with organic growth, the deals have helped give it a major jolt in size. Revenues jumped from $177 million in 2007 to $294 million in 2010, while net income after taxes just about doubled, to $2.3 million from $1.2 million.

The latest purchase occurred in October, when Datalink spent $17.6 million for the assets of Midwave Corp., a $65 million IT services firm.

It's a fairly common story in industries like value-added reselling, which is characterized by low margins. And Greg Barnum, Datalink's vice president and chief financial officer, explains it well.

"Getting the most from our fixed expenses requires growing the top line as fast as we can," says Barnum. So purchasing a company, he adds, often is a quicker path to bottom-line growth than hiring new sales engineers to open another office -- a strategy that can require several years to turn a profit.

Datalink's recent string of acquisitions began in 2007, when it paid $14 million for Chicago-based Midrange Computer Solution Inc., a storage solutions provider with annual revenues of about $47 million.

Two years later, Datalink paid $8.8 million for Incentra LLC, a data center infrastructure services provider located in Broomfield, Colo., gaining a revenue stream of about $70 million, Barnum says. Also in 2009, Datalink purchased a networking solutions team from Minneapolis-based Cross Telecom for less than $2 million.

The Cost of Displacing Rivals

Analysts in the industries where consolidation is taking place agree on the potential benefits of deal-based growth, rather than by pure competition.

"There's definitely a heavy cost to displace an incumbent (reseller) who has a good relationship with a customer," says Eric Martinuzzi, a senior research analyst who follows Datalink and other companies for investment banking firm Craig-Hallum Capital Group LLC. Many mid-sized businesses rely on established relationships with outside experts when embarking on IT projects.

That's why, when considering potential acquisition targets, Datalink's executive team appears to have concentrated on resellers that either operate in other geographic markets, or that possess an expertise the company lacks, Martinuzzi says.

"They are buying the service engineers; the relationships with the customers," he says. "Datalink is very smart. When they look at prospects, they're looking for a new geography, or a VAR with expertise in an area that Datalink isn't competing in."

Moreover, the acquisitions effectively move the cost of acquiring new customers off the income statement. "We're using our balance sheet to grow," Barnum says. Rather than boost sales expenses, Datalink --- a public company since 1999 -- can use its cash to make an acquisitions. Even after its recent deals, as of Sept. 30 it had more than $30 million in cash and equivalents available.

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