Black Box

Revenue Focused M&A:  Does it Build Long-Term Business Value?

Black Box Corporation Case Study                                                                                12/21/2011


Black Box Corporation (“Black Box”) is a public company that trades under the symbol BBOX.
Neither I, nor any entity in which I hold an economic interest, has any financial position directly related to Black Box, nor do I intend to initiate a position in the next 30 days following this papers publication date on 12/21/2011. 
This paper is based on both my opinions and Black Box’s SEC filings and other public documents. A complete reference list has been provided for readers at the conclusion of the paper.  Every effort has been made to be thorough and accurate at all times.  If, however, there are any errors, or any readers have additional facts that have not been considered, I would welcome hearing from you.  As to the opinions expressed here, others may disagree with some or all of them.  
This paper is not intended as investment advice to anyone.

Paper Overview

In the continuation of a series of papers focused on telecom, and in particular telecom value-added resellers or VARs, it makes sense to profile Black Box, the biggest telecom VAR in the country.  Black Box is unique because of its revenue size, several competitive advantages it enjoys over other smaller telecom VARs and the ease of which access to its business and financial history can be found via its SEC filings and various public documents.  However, like its competition, Black Box currently faces several challenges to its business model that threaten to displace the value it provides to its clients in the future, especially small and medium sized businesses (SMB).  The evolution of cloud-based technology is changing the way these firms procure telephony services and will result in a substantial decrease in the amount of equipment, hardware and on-site services they require in the future.   Black Box also faces company specific challenges including its dependence on the government for approximately 25% of revenues as well as a long-term capital allocation strategy that has used more than $700 million over the past decade for acquisitions and produced little in the way of increased earning power of the business or stock price appreciation.  In this paper we will explore the past history, present condition and future potential of Black Box Corporation.

Black Box Overview

Black Box Corporation (BBOX) is one of the leading dedicated network infrastructure service providers in the world.  In its fiscal year 2011, Black Box generated over $1 billion in global revenues from its three primary service offerings; voice services, data services (collectively “on-site services”) and hotline products which includes the sale of 118,000 network infrastructure products sold through a catalog and  As of October 1, 2011, its global telecommunications footprint encompassed approximately 4,500 team members, 198 offices and serviced more than 175,000 clients in 141 countries throughout the world including 85 of the Fortune 100 companies. (1).  Black Box today earns the majority of its revenue through the sale, installation, support and maintenance of voice and data networks and systems to new and existing clients.  It has a physical presence throughout in North America and Europe, operating brick and mortar branch offices and several network operations centers (NOCs) around the country.

Over the last ten years, Black Box has undergone a massive transition and shift in strategy, moving away from solely providing data networking products through a catalog business to becoming a company that now earns most of its revenue by performing voice and data on-site services for business clients.  The transition took place over roughly a ten year period from 1998, when the company’s split of revenue between catalog and on-site services was 100%/0% respectively and 2008, when the same split was approximately 23%/77%. (2)  The same split stands at about 18%/82% today. (3)  The migration of its business model from essentially a distributor to a large voice and data value-added reseller (VAR) and system integrator has changed both the company’s business and financial profile, as well as exposed it to new opportunities and competitive threats.  

Its transformation and revenue growth has almost exclusively come through merger and acquisitions (M&A) by way of “rolling-up” mostly small voice and data VARs across the county and interweaving them  into its business fabric*.  These small VARs had characteristics Black Box deemed desirable such as client lists, maintenance agreements, physical offices in key markets, sales and technical staff, and other competitive advantages the company could integrate and leverage post acquisition.  When leveraged properly, many of these attributes do provide Black Box with unique advantages over smaller VARs in a highly fragmented and competitive landscape for telecom services.  Before further examining its current position and future potential, let’s take a closer look at exactly how Black Box got to where it is today.

 *A request for clarification on exact revenue contributed by acquired companies for the period of FY 2000-2011, submitted to Black Box investor relations on 12/7/2011, was never returned.   

Company History

Catalog/Distribution Company

Like most big corporations, Black Box’s history began modestly.  The company started out as Expandor, Inc. and in 1976, began selling connectivity devices; “little black boxes” clients could use to connect their primary data communication products.  The concept and technology caught on and in 1977, the company expanded by introducing its first product catalog that was six pages long and generated $170,000 in sales in its first year. Continuing to grow and evolve, Expandor would change its name in 1982 to Black Box, symbolizing its marquee product.  As its catalog business grew, Black Box decided it was time to raise additional capital and in 1992, officially became a publicly traded company. (4)

From inception to 1998, Black Box’s primary focus was on running a successful technology catalog company.  In its fiscal 1997 10-K SEC filing, Black Box described itself as a “leading worldwide direct marketer of computer communications and networking equipment and services”.   That same year, it mailed 8.1 million catalogs and direct marketing pieces in 11 languages to businesses in 77 countries offering them access to more than 7,000 products, the majority of which were private labeled.   Its competition was other direct marketers and distributors and Black Box was able to differentiate itself through its private label brands and high levels of technical support provided by over 100 technical support professionals who were available 24 hours a day, 7 days a week to assist clients.  Its corporate strategy was clear; be a one stop shop for computer communications and networking needs and back up the brand promise with a highly trained technical support team and a high quality private label offering.  In addition to direct revenue, Black Box also had an indirect channel of over 10,000 resellers that contributed 26% of its total revenue.  In fiscal year 1997, the company earned $232 million in revenue and had a net profit margin of 10.3% ($24.2M). (5)

Acquisitions and Transformation

 In January 1998, Black Box took its first step to expand revenue beyond its catalog business when issued it 68,115 shares and inked an agreement to purchase a company called ATIMCO, a Florida-based cable and Infrastructure provider.  (6)  Throughout its corporate history, Black Box had participated in a few other joint ventures with the goal of expanding its catalog presence internationally, but this acquisition marked the company’s first foray into a focused physical footprint and revenue line expansion.  Black Box, after completing its first acquisition and seeing the impact that M&A would have on transforming the company, acquired 12 additional cable and infrastructure companies in fiscal 1999. (7)  The expansion not only grew the company’s revenue portfolio and on-site capabilities, but also its physical brick and mortar presence in key markets.   Black Box was now able to sell, design and install data and infrastructure products in local markets across the US, Canada and Europe.

As Black Box headed into fiscal year 2000, the seeds of M&A were already starting to bear revenue fruit and contribute to an on-site services platform that would come to define the company in the years ahead.  On-site service revenue was  $152 million in FY 2000, up from just $26 million in 1999, an increase of 465% and now accounted for 30.4% of total company revenue compared with 8.2% the year prior.(8)  To justify the continued M&A efforts and help position the company’s strategy for future growth, in the fiscal year 2000 annual report, Black Box made note that the worldwide market potential for telecommunications products and services was expected to grow to $1.25 trillion dollars by 2003 with the fastest growing segment being on-site services. (9)   Seeing an outsized opportunity ahead, Black Box wasted no time putting its newly found expertise as an acquisitive company to work.

In fiscal year 2001, Black Box’s total company revenue exploded to $826 million, an increase of 63% when compared to the prior year, driven mostly by recent acquisitions and a growing demand for its on-site services capabilities. (10)   Purchasing 26 more companies in fiscal 2000 and an additional 28 in fiscal 2001, Black Box turbo-charged its geographic footprint expansion and now had a presence in 39 states and seven countries. (11)   On-site revenue from the sale of data, infrastructure and now telephony products was also growing rapidly and produced $437 million or 52.9% of the company’s total revenue (12)  Black Box was quickly becoming the largest telecom VAR in the country.  One key difference though was it still had a profitable catalog business.  In fiscal year 2001 the catalog/internet business also continued to grow, benefiting from continued demand for infrastructure and ServSwitch ™ products from customers of all sizes and posting a 13% increase (after being adjusted for exchange rates) over the prior year. (13) The catalog business’s steady growth rate paled, however, when compared to the 187% revenue growth rate generated by the company’s on-site services business.  In its 2001 annual report filing, Black Box made it clear that it was pleased with the growth recent acquisitions had provided and intended to aggressively grow on-site services revenue in the future, listing M&A as the primary vehicle to drive it. (14) 


In its 20+ year corporate history leading up to 1998, Black Box had built a strong catalog sales and distribution company almost exclusively through organic  growth.  In 1998, the company began to test the water in a different type of revenue stream by offering on-site data services.   By 2001 it was clear Black Box liked the potential it saw in expanding its revenue mix further into on-site services and, after announcing to shareholders its plan to grow sales through M&A, the company jumped in with both feet and went on an acquisition rampage.  Over the four year period starting in fiscal year 1999 and ending in fiscal year 2002, Black Box acquired 84 companies or nearly one company every 17 days.  When the dust had settled, from 1998 to 2002, Black Box had acquired a total of 85 new companies.  

Acquiring and integrating 85 companies in five years would have put tremendous stress on the internal resources of many of the world’s largest businesses but, for one with only a few hundred million dollars in total revenue, its acquisition spree was starting to wear thin Black Box’s glossy veneer.  Any acquisition, done correctly, would have to be filtered from a list of many potential targets that were carefully sourced and underwent initial due diligence screening.  Then, a more comprehensive due diligence would begin to be performed on the candidate before an agreement could be signed.  Once an agreement was established and a closing date chosen, all the integration planning and timelines would need to be conducted.  When the transaction was finally closed and the business was now wholly owned by Black Box, then the execution of an extensive transition, rebranding and integration plan of the new business could begin.  Black Box did this every 17 days for four years.  

Trying to knit together a blanket of 85 different fabrics started to take its toll and, even as Black Box added another three acquisitions in 2003, revenue was declining.   Total company revenue would fall for three years beginning in 2002 before finally leveling off in 2005.  As revenue fell, Black Box took a break from its acquisitions spree in fiscal year 2004, needing to get the previous 88 companies fully integrated and its own house in order.  This brief pause proved only to be the calm before the storm. 

On January 5, 2005, Black Box announced that it had successfully completed the acquisition of Minneapolis-based Norstan, Inc., a publically traded voice and data telephony provider that generated $225 million of revenue in its 2004 fiscal year along with a $13 million operating loss. (15)   Adding Norstan brought annual revenue up to $721M in fiscal year 2006, still $100M less than the company had generated in 2001 fiscal year.  Although bolting on $225M was nice, the company remained on the hunt and was more determined than ever to take down larger prey. 

By 2006, Black Box had found its next target.  On April 10, 2006 Black Box issued a press release stating that it had signed an agreement to purchase the US and Canadian commercial and government operations of NextiraOne, LLC, a privately held enterprise owned by Platinum Equity, LLC.  Black Box proudly noted in the release that upon closing the transaction, NextiraOne would contribute approximately $270M-$280M to revenues which would bring the company’s total revenue to over $1B.  Looking at the Norstan and NextiraOne acquisitions alone, Black Box had added roughly an additional $500M in new revenue to the business and would finally get its membership to the $1B club in fiscal year 2007. 

From fiscal years 2007 to 2011, Black Box would continue to use M&A to ensure annual revenue maintained near the $1B level, completing 14 acquisitions during the time period.   Black Box was now one of the largest voice and data VARs in the world.  Through acquisitions, it was now considered a systems integrator as well, being licensed to sell and maintain many of the major voice and data manufacturer’s equipment meant it could take on clients that had multiple locations and multiple technologies in their business.  It’s new found title as a “billion dollar company” brought smiles to many inside the company and made its small competitors cringe, fearing the resources and pricing power that a company bearing the billion dollar moniker has.  To all but the most astute observers, things were definitely going very well for Black Box.  However, anyone willing to look beyond the headline numbers could see the fixation on volume was starting to have effects on other parts of the business.

While Black Box’s revenues matured, other metrics across the company fell.  Black Box had radically altered it revenue mix by making acquisitions of companies that performed voice and data services and, the more companies it acquired, the faster its gross and net margins fell.  As of March 31, 2011, Black Box’s gross margin stood at 33.4% for fiscal year 2011, down significantly from the 43.6% gross margin it posted in fiscal year 2000. (16) The company was willing to trade margin and profitability to pursue a growth strategy built on volume and an increase in managerial domain.  

The interesting part of the decision to trade margin for volume is that, historically, gross margins in the three key revenue categories delineated by Black Box have stayed consistent over time. The hotline (catalog/internet) business has earned around a 50% gross profit margin over the last decade and the voice and data service businesses (collectively on-site) have combined for around a 30% gross profit margin.  With margins in the respective revenue categories mostly consistent across the decade, the drop in gross and net profit margin Black Box incurred from 2000 to 2011 can be nearly all attributed to the shift in mix toward on-site services which now account for greater than 80% of the company’s revenues.  Some might then ask why a company would consciously choose to deploy capital from a higher margin business and plow it into a lower margin business, a very good question.  Although revenues recorded measurable appreciation throughout the decade, the same can’t be said for the company’s stock price.


The board of directors and key management in publically held companies serve for and at the pleasure of their shareholders.  They are the guardian of shareholder value, ensuring that the strategy of the business aligns with its owner’s expectations and builds long-term value, providing its owners with a reasonable return on their invested capital.  A key determinate in the creation of long-term shareholder value is the capital allocation strategy the business employs for the excess earnings of its collective business units, subsidiaries and investments.  Directors and management have an obligation to make investment decisions with the excess earnings produced by the company that create the highest total return for the company's owners over time.  Although on a micro-basis these capital allocation decisions can be difficult and require much analysis, ultimately decisions fall into one of two main buckets. Retain the earnings and invest them back into high-payoff opportunities that will increase the future enterprise value of the business or pay them back to the shareholders.  Either strategy, or a combination of both, can offer shareholders the potential of high returns over time when done correctly after a thorough analysis of all opportunities.

Giving the excess earnings back to shareholders is a fairly straight forward and simple process for companies that can no longer fully reinvest their profits at acceptably high rates of return.  Companies may choose to pay excess earning back to shareholders in cash by distributing a quarterly or annual payment directly to them called a dividend.  Another option is to increase each shareholder’s ownership of the business.  Management can do this by repurchasing the company’s stock which will decrease the number of shares outstanding and effectively increase each remaining stock certificate’s claim on the future earnings of the business.  A stock repurchase strategy assumes that management has established the correct intrinsic value for the company and only engages in repurchases when the market price of the stock trades at a discount to this value.  Purchases made above intrinsic value will prove destructive to shareholder value over time. 

On the other hand, when management sees opportunities to earn high rates of return on incremental capital left in the business, shareholders benefit when the company retains its excess earnings and deploys them into these high-payoff prospects.   When choosing to retain the capital, the company has several methods in which they can deploy it, all of which can achieve the goal of increasing the business’s future earning power.  Some of the options available to management include repaying outstanding debt, making incremental capital investments of equipment or other assets or using it to acquire other businesses.  Companies may choose to do some or all of these activities and their strategy may change over time based on certain variables and general market conditions. 

Regardless of the specific actions management takes to increase business value, when companies decide to keep their owners money or incur additional indebtedness, they, like a financial advisor entrusted with additional capital, bear a fiduciary duty to make high quality decisions based on a thorough analysis of all available options.  Good management understands that each incremental dollar retained must be carefully allocated, so that it may continue to increase the enterprise earning power and provide shareholders with good long-term rates of returns.  If there is no good immediate use for the funds, management should keep the capital liquid until good prospects arise or pay it back to its shareholders.

In the most academic sense, companies are worth the amount of cash an owner will get back over the future life of that business, discounted back to a present value.  This requires investors to make future projections about the financial performance of the business and sometimes, these models can resemble more art than science.  Putting aside the crayons, an easier way to think about the value of a business is to look at its earning power or the amount of money it generates for its owners each year.  As the business makes money and retains it for reinvestment, its earning power should increase over time. 

Companies may not always increase their earning power in a linier fashion however.  Think about a person that invests in a high efficiency light bulb.  Due to the up-front higher cost of the light bulb, in the first year, the “earnings” (savings) from that bulb may actually decrease vs. using a conventional bulb.  However, when taking a longer-term approach and measuring the cost savings over the life of the bulb, one would probably find they made a good investment.  Companies are similar in the fact that sometimes the manner in which they will invest shareholder capital may cause the earnings to temporarily drop and year to year comparisons can be futile.  However, when analyzing the same business over time, one should easily be able to compare the cash retained by management for reinvestment into the business with the accretive earning power it generated.  

When acquisitions become the weapon of choice for creating long-term shareholder value, their intent should always be aimed at maximizing real economic benefits to the company, not merely managerial domain.  When real economic benefits are realized in the combination of two companies, shareholders will benefit over time as the business increases its earning power.  A business’s true earning power is a subjective measurement without a clear definition and everyone won't always agree as to what the correct metrics to measure it are.  Most, however, will agree that using some derivative of net profit is correct.  So when measuring Black Box’s earning power, it’s important to use a broad basket of metrics to try to assimilate the best understanding of where it stands presently and how it has changed over time.

In the table are five metrics, all derived from the comparison of Black Box’s earnings in 2001 with its earnings in fiscal year in 2011.  (17)  The first metric, diluted earnings per share (EPS) looks at Black Box’s total net profit and divides that amount over all the shares (and options) it has outstanding.  In 2001, Black Box had earnings of $57.8M and a diluted share base of 19.9M giving the company an EPS of $2.90. (18)  In 2011 Black Box earned $52.8M and had shares outstanding of 17.7M giving it an EPS of $2.97, a 7 cent/share increase. (19)  You can see by looking at the side-by-side comparison that EPS is the only metric that has increased over that past 10 years. (due to share repurchases).  All other metrics have decreased on a real dollar basis, without adjusting for inflation. The best way to think about- the increase in or loss of- earning power over time is to carefully examine how much shareholder capital the company retained to produce the results and compare that amount against the opportunity cost of the capital (what else you could’ve done with it) and the time value of the money (a dollar in 2000 was worth more than a dollar today). 

To examine the true cost to the shareholders, you would need to carefully study how much cash the company deployed into acquisitions over the time period.  Using the annual 10-K reports submitted each year to the SEC, you can see Black Box has spent $778 million on the acquisition of companies and share repurchases from 2001 to 2011; an amount far greater than its total market capitalization today

During the period, Black Box paid $522M for acquisitions, $256M to repurchase shares, and paid their shareholders $33.6 million in dividends.  However, most of the stock repurchases were reissued to executives in the form of options and converted to new shares which were sold.  At the end of fiscal year 2011, the total diluted share float stood at approximately 2 million shares less than at the end of fiscal year 2001 (20), the equivalent of paying about $150 for every share it bought back and didn’t reissue. 

After all the acquisitions and share buybacks, what is the company worth today?  Based on its market capitalization (all shares outstanding x price/share) the company is worth about $488 million as of the market close on 12/16/2011.  In December of 2010, Black Box held an analyst day presentation at their headquarters, having several of the management team present on their division’s performance.  At the end of the presentation during the Q&A portion (1:56:29), someone asked an interesting question pertaining to the company’s M&A methodology and how Black Box values the companies it purchases.  To answer the question on how it values acquired telecom VARs, its CEO stated that deals are based on historical data as well as “looking out a few years…” hinting that some form of a future cash flow analysis would be incorporated.  He concluded by saying Black Box “typically does deals in the 3-5x EBITDA range..” as a general rule when acquiring telecom VARs.

Black Box, by way of 100+ acquisitions over a relatively short time period, has become a market maker for establishing the price of privately held voice and data VARs in the industry.  However, it wears both the hat of teacher and student when it comes to evaluating its M&A practice and concurrent operating business.  Its operating business is essentially no different from those of the businesses it acquires,  it is the sum of its parts plus whatever premium/discount an investor might place on the entire business. Using its very own valuation model, we can now get an idea or starting point of what Black Box might consider to be a fair value for its business.  Using the same framework, we can also compare the change in its internal value over time.

The company had $108.9 million of earnings before interest, taxes, depreciation and amortization (EBITDA) in fiscal year 2011.  Using that number and applying it to a 3-5x valuation range, we can arrive at a value of $326M to $544M for the total company.  But that won’t necessary give us the true value of the business to a private buyer.  Typically, in a private transaction, once a value is established based on an EBITDA multiple or another method, the buyer will then calculate the true enterprise value of the business by backing out the debt from the value and adding the cash back in.  This is because the buyer is buying an operating business and the price they are willing to pay is usually not influenced greatly by its capitalization structure (equity/debt).  So, when cash nets out to be more than the purchase price, the buyer gets the initial value plus the excess cash.  When debt nets out to be more than the businesses cash, the difference is taken off the purchase price.  By using its own calculations, if Black Box were to purchase itself in the marketplace, it would probably consider an offer in the $176M to $394M for the company, which would work out to be $9.94 to $22.18 per share.  If you applied the same framework to calculate a historical value, you would find that the company’s value was probably higher in 2001 than it is today.  Any way you calculate it, there has been a substantial premium paid to be a member of the billion dollar revenue club.

Earning power aside, there are parts of the company that Black Box has grown over the years in addition to revenues, namely its assets.  In 2001, the company earned $57.8M and had assets of $652.9M, giving it an 8.8% return on assets (ROA).  In 2011, Black Box earned $52.8M and had assets of $1.1B, a ROA of 4.8%.  The company nearly doubled its assets over a ten year period but managed to earn slightly less total profit.  When ROA drops significantly over time, it’s important to dig further in order to understand the quality and make-up of the underlying assets in question.


When one company buys another, the amount paid by the acquiring company in excess of the identifiable assets of the company being purchased is classified as goodwill.  A simple, hypothetical example:  Company A buys Company B for $1 million.  Company B has $750,000 in assets.  In this transaction, Company A would record the $750,000 as assets in the same way Company B did and then record the additional $250,000, paid in excess of the identifiable assets, as Goodwill.  Goodwill is therefore an intangible asset used to balance the accounting equation (Assets=Liabilities + Equity).  There are plenty of reasons to purchase a company for more money than the dollar asset value that appears on its balance sheet.  Companies regularly buy other companies to gain access to their trademarks, patents, brands, talent, processes, systems, customer lists, and a host of other “assets” that won’t show with an attached dollar amount on their balance sheet.   

Up until 2001, Generally Accepted Accounting Principles (GAAP) allowed for the amortization of goodwill.  Companies could gradually write off this intangible asset for up to forty years following the purchase of a company.  It was classified broadly under the title-“intangible asset” and grouped with other intangible items such as non-compete agreements for example.  In 2001, the accounting rules changed and forced companies that incur goodwill (now differentiated from other intangible assets) to abide by Statement of Financial Accounting Standards (SFAS) No. 142 which disallowed the amortization of goodwill over time but required companies to test the goodwill for impairment at least annually.  An impairment of goodwill simply means that the carrying value (the amount listed on their balance sheet) is lower than its fair value or “market value”.  On page 25 of the fiscal year 2011 10-K report, Black Box discusses its two-step process, common to many public companies, in assessing their goodwill.  In addition to using an income approach to test for impairment, Black Box also uses a market-based approach which relies on values based on market multiples from comparable companies.*

*A request for clarification on which comparable publicly traded companies are used in the market-based approach, submitted to Black Box investor relations on 12/7/2011, was never returned.   

On page 26 of its 2011 10-K filing, Black Box discusses its estimated fair-value of goodwill across each reporting unit, currently classified as: “North America”, “Europe” and “All Other” and lists the aggregate fair value of goodwill at $905 million vs. a carrying value of $725 million, giving the company a comfortable paper surplus of $180 million.  

There are two issues related to the amount of goodwill carried by Black Box that may give some investors pause.  The first of which is that goodwill, an intangible asset, is more than 50% of Black Box’s total assets.  This percentage is far higher than at any of its competitors, listed below at the end of each respective latest fiscal year. 

The major risk to having such a high percentage of its total assets as goodwill is that the company would have a (potentially substantial) portion of its assets wiped out if it were to incur a goodwill impairment charge in the future.  If future testing or a reorganization of its reporting units deemed there was impairment, the company would need to take the amount of goodwill deemed impaired, and record that as an expense during the period of impairment.  The first result would be a large expense that would negatively affect the company’s earnings during the period of impairment.  The good news is that goodwill impairment charges are noncash, meaning that the write-down wouldn’t affect the cash flow of the business.  Thus the evidence is inconclusive as to how the price of its stock price might react as markets have tended to look through noncash and nonrecurring expenses to the underlying, long-term cash flows of the business.  The final concern, determined by the size of the impairment, would be how the write-down changes the debt-to-equity ratio of the company and if it has the potential to cause problems in the covenants tied to Black Box’s credit line and other loan agreements.

All considering, starting in its 2009 10-K annual report, Black Box recognized that the amount of goodwill on its balance sheet was becoming increasingly large and began to inform investors as to the risk factor it presented to its business.  Its discussion of risk factors in its 2011 10-K report on p.7, noted:

“We have a significant amount of goodwill that could be subject to impairment. As a result of our acquisition program, we have accumulated goodwill. We conduct an impairment assessment of the carrying value of our goodwill at least annually. No impairment of goodwill has been identified during any of the periods presented. We will continue to monitor market conditions and determine if any additional interim review of goodwill is warranted. Further deterioration in the market or actual results as compared with our projections may require us to conduct an interim assessment of our goodwill and could ultimately result in a future impairment. In the event that we determine that our goodwill is impaired in the future, we would need to recognize a non-cash impairment charge, which could have a material adverse effect on our consolidated balance sheet and results of operations.”

Future Prospects

In my paper Death of the PBX VAR, I laid out a base case derived from both personal experience and research/data analysis  going back several years in the study of small voice and data VARs across the county.  The paper concluded that, in their present form, VARs won’t be around two years from now.  Black Box, by way of its revenue mix is a large (and probably the largest) voice and data VAR in the country and is faced with the exact same challenges its smaller competitors are.  To be fair, a decade of acquisitions has made Black Box a leading and formidable competitor in the voice and data market.  Embedded within the company are several distinct competitive advantages that are superior to that of most local or regional VARs.  The most important differentiators of its business model are:

  1. Manufacture Agnostic- Through acquisitions, Black Box is licensed to sell and service most of the top manufacturer’s brands and is not reliant on any one specific supply partner.
  2. Geographical Footprint- Operating in most key markets allows Black Box to establish relationships with larger clients that have multiple offices and make the company less prone to regional economic downturns.
  3. Organic Resources- Black Box has the largest staff of Registered Commercial Distribution Designers (RCDDs) in the country and also has the ability to share training and support resources across the company down to its local branch offices.
  4. Discounts- Due to its sales volume, its increased purchasing power allows Black Box to receive deeper discounts from manufactures which helps contribute to higher gross margin rates.
Even with these important strategic advantages, it is still worth a conversation to discuss the major challenges to its business model based on the clients it sells to and the technology it provides to them.

Revenue Mix 

Black Box could have as much as $480 million or 45% of its organic revenue at risk going forward with the biggest concerns lying within two specific categories.  The first is small businesses (< $50M in sales) which currently accounts for approximately 20% of Black Box’s total revenue.  The second is revenue from various government agencies, which accounted for about 25% of total revenue in fiscal year 2011. (21)  Both of these sources are set to face enormous headwinds in regards to procurement of telecom equipment and services in the future.

Small Business

The first concern is the small business segment which accounts for about 20% of Black Box’s total revenue in fiscal year 2011. There is a growing mountain of recent evidence that suggest that smaller firms will increasingly adopt more hosted and cloud-based solutions for many of their voice and data needs in the future.  These thoughts are backed-up by publically traded companies that provide telecommunication services over Internet protocol (IP), like BroadSoft, Inc. (BSFT), which makes software to deliver voice and multimedia services over IP, or 8x8 (EGHT), which develops and sells voice and video applications for IP.  Both of these companies have been very clear in recent announcements that an increasing number of business clients are moving away from on-premise equipment and adopting cloud based telecommunication services, with smaller and medium sized clients paving the way.  A recent article published by Channel Partners Online written by Scott Stewart, Director of Sales for Adtran Inc., also concluded much of the same; many of the smaller firms are planning to outsource more of their telecommunications equipment to the cloud, forgoing large investment  for on-premise equipment.  (22)   

Black Box’s competitors, the regional and local voice and data VARs, are also struggling to adjust their business model to accommodate lower sale volumes to smaller clients (23) .  Many of the smaller VARs, having less resources and, coupled with the fact of being confined to local or regional  geographic footprints,  see far less of their company sales from large companies and depend of small or medium sized firms for a much larger portion of their revenue then Black Box. 

Voice and data VARs of all sizes are facing three main challenges related to selling and servicing telecom equipment to small and medium sized business (SMB) clients today.  First, there is more competition from sources that were not around a few years ago.  During the economic downturn, other types of companies that dealt with SMB clients began offering “telecom” services to augment their revenue.  Included in the list are: high voltage infrastructure companies, software and IT firms and office product companies, just to name a few.  The second major challenge is that increased competition has led to lower mark-ups and gross margins for companies selling voice and data products, with some currently selling at a razor thin 1.2 mark-up just to maintain cash flow.   Third is the increased competition with “cloud based” technology companies, some selling direct and others fanning out their indirect sales channel to include hundreds or thousands of agents operating under master-agent agreements.  These firms have perfected their product and technology over many years and are now aggressively targeting small and medium sized firms as cloud-based technologies are set to enter the mass adoption phase of their product life-cycle. 

SMB and the Cloud

Starting a company that sells cloud or hosted services is relatively easy and requires very little investment.  To prove the point, I set one up myself this past summer.  Conceived as a research project from which I could share back data and key learnings, I started a company that sold hosted voice in Minnesota with an initial investment of less than $100.  I hired two contract employees that had no background in telecom and could barely transfer a phone call on an existing phone system.  Their training consisted of learning three cold-calling scripts, a few technical details and functions of IP phones and QoS routers and how to run a bandwidth test over the internet to see if a client would be able to make calls with a cloud-based PBX.   The business carried no inventory, had no trucks, and required no expensive software packages.  Within 30 days of putting up a website and 14 days of cold calling, we had closed our first sale to an insurance business with seven employees.   The company would go on to sell side-by-side with businesses that were capitalized with several hundred thousand or even millions of dollars of fixed investment.  The biggest takeaway by far was just how easy it was to generate appointments and close sales to small businesses despite not having an established business history, physical presence or any substantial fixed assets to speak of.  Many of the owners of smaller telecom businesses couldn’t believe how simple it was to deploy a voice solution to a business client without ever going on-site.  Many, I think, still don’t believe me.  In any case, the data pulled from this project provided all the first hand proof I need to be firmly convinced of one conclusion: The day of reckoning is near for anyone or any business with high levels of fixed investment selling on-premise telecom equipment, particularly to small businesses.

The final mix concern is the 25% of revenue Black Box earns from various departments within the US Government.  It shouldn’t be a surprise to anyone that that US federal, state and local government are faced with deep spending deficits and will need to curtail expenditures of all types immediately and well into the future.  Black Box noted recently that it has seen its government business drop by 20% and notes that its exposure to the public sector has grown in recent years and provides investors with unique risk. (24)  An article by Bloomberg on December 20, 2011 describes exactly how the government may plan to continue to cut costs while maintaining and upgrading its IT infrastructure.  The article states that Congress has recently pushed for more use of cloud-based technologies and providers which may ultimately lead to new contracts with companies like Microsoft, Google and Amazon in the near future and result in more bad news for Black Box.

Summary, Conclusions and Parting Thoughts   

Shifting Business Models

A bet on Black Box is a bet that companies will be installing and maintaining more on-premise voice and data equipment 20 or 30 years from now and Black Box will be the company they will turn to do it.  Consider this, the volume of “paging” continues to rise every year but yet there is not a single pager store left.  We continue to rent more movies every year yet nearly every store that rents movies has now gone out of business.  The country continues to read more books, yet Borders the second largest bookseller in the nation, recently went bankrupt and had to liquidate its stores.  How can all that be true? 

All products and services, especially technology, change over time.  These changes can come in form, function, procurement or just plain obsolescence.  Change is what keeps society moving forward, increasing productivity and standards of living.  “Paging” is now called SMS texting and is just a feature (one of many) built into cell phones today.  The movie rental business was uprooted by a Kiosk and most brick and mortar movie stores, big and small, are now out of business.  (Soon, movies streamed over the internet will make the Kiosk obsolete).  Book sales are now increasing being driven by electronic books that can be downloaded to a tablet or stored in the cloud rather than ones made out of paper and sold in a store.  (Any remaining booksellers with stores will find themselves in a battle for survival in the upcoming years.)  And the list goes on and on.   

Changes to business models and products will continue to happen.  PBX hardware volume will continue to decline over time as it, like the pager, becomes an application built into software or other technology and sold as a service.  As its hardware component rides off into the sunset, PBX functionality will be alive and well, served over the internet and based in the cloud.  Then, that model too faces extinction as someday, in the not too distant future, somebody smart will figure out how to monetize the user rather than the technology and give away the functionality for free.   

There will also be a measurable depreciation in the demand for wired infrastructures over time.  The high prices paid for connectivity through structured cabling that runs behind the walls of buildings will be eliminated as a growing amount of data is moved wirelessly through Wi-Fi and satellite spectrum.  Some cabling and data companies are still holding out for the day when businesses start to upgrade to “fiber to the desktop”, however, most have realized that this has already happened via a $200 Cisco wireless router. 
In general, as more technology and equipment gets outsourced to the “cloud” there will be less and less of a need for the existence of the “phone shop” to check the lights in the closet or install the next version of software upgrades.

Black Box

The last decade can be characterized as one of change and transformation for Black Box.  The company has long left its roots as a catalog business and today is a massive conglomerate of small voice and data VARs.  It generates most of its revenue through the sale, design, installation and maintenance of complex telecommunication systems for clients large and small.  The size and scale of its operations manifests into several differentiators that give it significant advantages over many of its smaller competitors. 

Black Box faces key challenges to its business model going forward.  Its business plan will need to adapt to a host of new realities as small and medium sized businesses migrate their purchasing trends to hosted and cloud platforms for their technology needs.  Its core employee talent set will need to change as expertise in software becomes much more important than hardware.  The commoditization of voice and data equipment will continue to push down prices and unit volume in the future.  Its vast network of branch offices around the world, an advantage today, could quickly become a huge fixed-cost liability in a cloud-based future.  Goodwill, the result of many acquisitions, could change leverage ratios should it be deemed impaired going forward.

The rearview mirror is always viewed with the clarity of 20/20 vision.  Shareholders have a right to question the motivations and results of any capital allocation strategy that consumes massive investment but doesn’t result in substantially higher earning power or total returns over a long-term time period.  Markets tend to penalize companies that don’t increase value with retained capital by discounting their assessment of future earnings based on a “what will they do with the money” analysis.  Shareholders today should acknowledge that a strategy built on increasing revenue is not good enough.  They would be wise to demand a plan that generates substantial inflation-adjusted earning power as the best bet to earning a good rate of return on their capital left in the business.   

The nice thing about life is that you can usually find someone to take the other side of nearly any trade.  Let me give you an example: I believe that most people today would agree that payphones will cease to exist in the future.  Don’t tell that, however, to a company called Pacific Telemanagement Services.  They are the largest payphone operator in the country and, just purchased 50,000 more phone booths in October of 2011.  Despite the fact that payphones are disappearing at a rate of 10% per year according to the article, the company was optimistic about their future citing "People tend to forget about pay phones, until their cellphone doesn't get a signal, until there's a natural disaster…”. 

Like payphones, the PBX “box” will cease to exist in the future.  Black Box, with all of its resources, competitive advantages and current profitability is in a unique position to decide its own future.  If it chooses to use current and future cash flows to invest ahead of technological life cycles, it will give its owners and employees the best possibility of enjoying a bright future.  However, if the company continues to choose to increase revenue by purchasing VARs selling dated technology, Black Box, like the payphone giant Pacific Telemanagement Services, will be the biggest fish in a very small pound.


1.  p.6, 10-Q FY 2012 Q2
2.  1998 10k p.15 and 2008 10-k p.14
3.  2011 10-K p.4
5.  p.12 1997 10-K
6. P.13 1998 10-K
7.  2001 10-K p28
8.  2000 10-K p.12
9.  FY 2000 10-K  p.2
10.  FY 2001 10-K p.11
11.  FY 2001 10-K p.27-28
12.  FY 2001 10-K  p.11
13.  FY 2001 10-K p.12
14.  FY 2001 10-K p3
15.  FY 2004 10-K p.13
16.  FY 2000 10-K p.21, 2011 10-K p.12
17.  FY 2001 10-K pp.21,23; 2007 10-K p.8; 2011 10-K pp.31,34
18. FY 2001 10-K p.34 
19.  FY 2011 10-K p.57
20.  17,795k 3/31/11 vs. 19,929k 3/31/2001
21.  FY 2011 Annual report ARS p.5 and IDEAS presentation 11:45
23.  Data compiled by Sonic Management Group shows YTD profit margins for privately held voice and data VARs to be 1.6% vs. 3.1% YTD in the previous year.
24.  FY 2011 10-K p7

Additional Resources
Financial Spreadsheets

Black Box SEC Filings
Form 10-K
ARS (Annual Report to shareholders)

Black Box Investor Presentations

Southwest IDEAS Investor Conference Presentation:

Norstan SEC filings

Norstan FY 2004 10-K (

Black Box Press Releases

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