The data storage company Datalink agreed last month to be acquired by an Arizona company called Insight Enterprises for $11.25 per share in cash, about a 19 percent premium to the previous closing price of Datalink’s stock.
Although that kind of a premium seems to be about what investors could expect, the Datalink proxy statement being mailed to shareholders this week explains how just a couple of months before, the Insight deal on the table was for $12 per share.
Unfortunately, Insight and Datalink then got stuck on a technical accounting issue and the deal stalled.
Time passed, Datalink’s business forecast for the rest of year got a little bit worse, another potential buyer’s bid evaporated and Insight decided it would pay only $11 per share. Datalink went ahead with the deal when Insight was talked into $11.25.
Maybe that doesn’t sound like a lot, just 75 cents a share off the price from September, but it works out to be about $17 million. Investors who are grumbling about that, though, need to remember Datalink was forecasting slow revenue growth and a shrinking gross profit margin. And that’s if everything worked out.
That’s not the financial profile of a successful public company. There may be no other explanation necessary for why the Datalink directors correctly saw that this offer was one they had to take.
Datalink executives didn’t take the opportunity to discuss this, given the upcoming shareholder vote on the sale. The situation they found themselves in this year is a common one. Like other small public companies, Datalink is a better business than it is a publicly held corporation.
Datalink, based in Eden Prairie, has about 570 employees and offices in 35 U.S. cities that put together the computer hardware and software that demanding business customers need to securely store computer data. It’s a market the company got into before the go-go years of technology in the 1990s. Datalink was among the many companies that went public just before that dot-com boom turned into a bust.
The price for Datalink stock hasn’t gotten back to its March 2000, dot-com era peak, but that’s true for many technology companies. The frustration for long-term Datalink shareholders has to be that even at the purchase price of $11.25 per share, the share price won’t get back to the peak stock price of two years ago or 10 years ago.
Why has the stock price mostly gone sideways? After all, the company makes money, on revenue of about $550 million for the first nine months of the year. But revenue for the same nine-month period of last year was just a bit more than $550 million. Tech companies that don’t grow rarely have a booming stock price.
The company only decided to sell, though, after CEO Paul Lidsky early this year was invited to a meeting with an unnamed company in Datalink’s industry. There’s nothing particularly unusual about that, and most meetings like this turn out to be nothing more than a pleasant waste of time.
At this one, though, Lidsky was handed a letter that proposed a purchase of Datalink at $10 per share. He couldn’t just slide that letter into a drawer, of course. And so over the course of the next few months talks continued while Lidsky and the other Datalink directors considered what to do.
Even as outlined in the dry language of a public filing, shareholders can read just how concerned the directors were about continuing to go it alone. Particularly worrisome was a steadily eroding gross profit margin.
Eventually, they agreed that selling made sense, and in May asked an investment banker to see if a better deal could be had. Datalink’s investment banker eventually found nearly two-dozen potential buyers, both from the industry as well as so-called financial buyers. Only three followed up with a real proposal. The board selected Insight’s, mostly because it didn’t first need to line up additional financing to close an acquisition.
Insight was talked into raising its bid to $12 per share, and everyone went to work on putting together a deal. The snag they ran into appears to be differing views on how to book revenue from third-party maintenance contracts and how Insight insisted on disclosing it, even though the cash flow and profitability would be exactly the same either way.
That issue was resolved, but not until preliminary results from the third quarter along with a fresh forecast for the fourth quarter were about ready. It wasn’t good news. After looking through the numbers, the runner-up bidder dropped out altogether, and Insight decided it would pay no more than $11 per share.
So now what should Datalink do, wait for business to improve? Why would it? The board already had been discussing how sales growth is hard to come by and how the gross profit margin would continue to contract. That’s not some sort of esoteric financial measure, by the way, as gross profit is the money left over after paying for the products and services Datalink sells. It’s what’s left to pay all of the bills.
Who could be confident in the Datalink boardroom that even if business did improve that all of the bidders from the fall of 2016 would come back to bid again? No one would feel good about a wasted year, either, as a lot of initiatives likely were put on hold. And that’s to say nothing of the lost time of the executive team, including at least 13 management presentations to potential buyers that were mentioned in the proxy statement.
“You are in a tough spot as a board,” said Eric Martinuzzi, analyst with Lake Street Capital Markets of Minneapolis and a longtime Datalink watcher, summarizing the choice to be made. “If the stock’s $7.75 in February 2017 and investors learn you walked from $11.25 in October 2016, they are unlikely to congratulate you for holding out for $12. Instead, you could have a bunch of angry shareholders with torches and pitchforks saying you failed in your fiduciary duty.”