Please stand by. Our presentation will now begin. I would now turn the floor over to Vince Keenan, Avnet's Vice President of Investor Relations.
Good morning, and thank you for joining us for our call covering Avnet's planned sale of the Technology Solutions Operating Group to Tech Data Corporation. Before we get started with the presentation from Avnet management, I would like to review Avnet's Safe Harbor statement. This call contains certain forward-looking statements, which are statements addressing future financial and operating results of Avnet. There are several factors that could cause actual results to differ materially from those described in the forward-looking statement, including the acquisition of Premier Farnell and the sale of the Technology Solutions Operating Group. More detailed information about these and other factors is set forth in Avnet's filings with the Securities and Exchange Commission. In just a few moments, Bill Amelio, Avnet's CEO, will provide an overview of the strategic rationale for the sale and some highlights of Avnet's focus after the transaction.
Following Bill, Kevin Moriarty, our Chief Financial Officer, will review the transaction's expected financial impact and potential uses of the cash proceeds. At the conclusion of Kevin's remarks, a Q&A will follow. With that, let me introduce Mr. Bill Amelio to discuss Avnet's sale of the Technology Solutions business.
Thank you, Vince, and hello, everyone. Thank you for taking time to, on such a short notice, to join us. As many of you know, Avnet has a long history of distributing technology products that have advanced in their complexity and the impact they have on business and consumer markets. During that time, Avnet has adapted its strategies and business model to focus on market segments and products where we could grow the company and maximize returns. The transaction we announced today is another step in that evolution, albeit a very big one, as we have decided to focus our resources and investment on becoming the leader in design chain and supply chain services. With that as a background, let me review the rationale that led us to this strategic decision. I'd like to begin by summarizing why the transaction is a win-win for both companies.
We will be selling substantially all the Technology Solutions Operating Group to Tech Data, except for the Embedded Computing Solutions business that we transferred to EM at the beginning of fiscal 2017. The total consideration of $2.6 billion consists of $2.4 billion of cash and approximately 2.8 million shares of Tech Data common stock. By adding TS complementary business with Tech Data, they expect to be the leading global IT distributor with the most diverse end-to-end solutions. As you saw in Tech Data's press release, they expect the combination to be accretive to their shareholders. The transaction, which is subject to regulatory approval, is expected to close in the first or second quarter of calendar year 2017.
We believe the sale of TS and the pending acquisition of Premier Farnell create a compelling value proposition for our shareholders and our electronic marketing business. The two transactions will strengthen Avnet's position as a leading electronic components distributor, with exciting opportunities for growth and margin expansion. The combination of EM's design and supply chain services and Premier Farnell's reach into a broad base of customers will create a cross-selling opportunity, as well as a new route to Internet of Things marketplace. Avnet will also gain significant cash, which will provide additional capital allocation alternatives, and we will continue our efficient approach to managing our balance sheet.
We've always believed that disciplined capital allocation is key to future success, and we will continue our thoughtful approach, which focuses on investing in organic growth and acquisitions, while continuing to consistently return cash to shareholders via our dividend and our disciplined share repurchase program. Finally, I'd like to review our rationale for selling the TS business. With the growth of cloud computing and hyper-converged infrastructure, the role of the data center is rapidly evolving as organizations change the way they purchase and consume IT resources. The ability to accommodate Third Platform technology is becoming more critical as organizations look for IT solutions that streamline operations and influence business outcomes. This focus on selling IT solutions incorporates cloud, mobility, and data analytics, is driving convergence of the traditional value add and volume distribution model as solutions embrace a broader suite of products and services.
When we evaluated this transaction relative to our internal plan and our projections and other strategic alternatives, we had concluded this transaction is in the best interest of our employees, our customers, our suppliers, and our shareholders. Now, turning to the next slide. We have strengthened our position as a leading distributor of electronic components, and we are now focusing on becoming the leader in design chain and supply chain services. This strategy capitalizes on two of our greatest strengths at EM and provides a platform to expand our role in design and delivery of electronic components and embedded solutions in higher growth segments. If you look at our design chain resources, we have over 1,000 field application engineers supporting 30,000 customers around the world. These engineers generate over 45,000 design wins annually, which equates to approximately $5 billion in annual revenue.
Over 45% of our customers utilize our supply chain services that, on an annual basis, integrate 445,000 embedded systems, program 280 million devices, and ship 87 billion units. These are unique resources deployed globally that we will use to enter new higher growth markets where we can expand margins and returns in the long run. Markets we'll focus on going forward are the ones we shared with you at our last Investor Day. That web enablement, embedded solutions, and the Internet of Things. All these markets represent areas that we will increase our future investment. Our intent is to grow these underlying businesses with the following strategy. First and foremost, expand the customer base and get to our engineers earlier in their life cycle, deepen our engagement with customers, and the digital transformation of our business.
As we look at the rapidly evolving technology landscape, there are going to be new customers from the maker market as a result of the Internet of Things that we need to reach in order to accelerate our growth. We also need to deepen our engagement and add more value in order to maintain and grow our profit margin. We recently added a new digital sales tool that allows customers to tap into a library of designs to quickly produce bill of materials, thereby accelerating their time to market. Whether it's test and validation resources to support embedded customers or prototype capabilities for IoT startups, there are many ways we can expand our role in the technology supply chain and find more ways to get compensated. Finally, we need to invest in our digital platform to both streamline our operations and enhance our customer experience.
Our pending acquisition of Premier Farnell is a great example of that investment. This will allow us to reach a wider base of engineers earlier in the design process, thereby gaining a greater share of wallet over the product life cycle. They also bring 300,000 registered users and a small order DNA, and more importantly, accretive margin. At Avnet, we have many best practices in areas where we do great job of adding value. What we have to do is accelerate how to capitalize on these areas by quickly scaling them and deploying them across all regions. As I said earlier, today's announcement represents another step in the evolution of Avnet as we adapt to changes in the technology marketplace.
With the skills, assets, and resources we possess, along with the expected additional liquidity, I am very excited about the future for Avnet and plan to bring you more update on our initiatives in the future. Now I'd like to turn over the commentary to Kevin Moriarty to provide more color on the financial impact of our pending transaction. Kevin?
Thank you, Bill, and hello, everyone. I'm now gonna turn to slide five in the presentation, and before I get into some numbers, I would like to provide you with a brief update on our pending acquisition of Premier Farnell, as I will be talking about our balance sheet and liquidity after completion of the two transactions. On July 28th, we announced our offer to acquire Premier Farnell for 185 pence per share, which equates to an equity value of approximately GBP 915 million at its current exchange rate. We plan to fund the acquisition with a combination of offshore cash and new borrowings. On September 8th, we received U.S. antitrust clearance, and on September 12th, at the general meeting of the Premier Farnell shareholders, the offer was approved, with 99.9% of the voted shares in favor.
At this point, we are still awaiting approval of the transaction in the EU and Israel, which we expect to be concluded in October. Pending those required approvals, we expect to complete the transaction in November, which would mean we would begin to include Premier Farnell results in our December quarter. Now, turning to the next slide, I want to point out that these are high-level estimates based on what we know at this time. The actual numbers could be different depending on results of operations and changes in market conditions before the two transactions close, and we will continue to update you going forward. Let's begin by taking a look at what the two transactions could mean to Avnet's income statement and business model.
Given the sale of TS will not be completed until sometime in calendar 2017, we have used here our fiscal 2016 results to demonstrate a pro forma version of the P&L impact. As you can see on the slide, the first two columns illustrate Avnet and TS's fiscal 2016 adjusted results, while the next three columns detail adjustments to arrive at a pro forma view. The embedded transfer column represents the Embedded Computing Solutions business previously reported in TS that we transferred to EM at the beginning of fiscal 2017. While the Avnet expected reductions column provides a high level range of expense reduction that impacts Avnet going forward.
Included in this column are costs that will transfer with the TS sale, cost reductions previously anticipated from our Avnet Advance program, and other efficiencies and cost reductions contemplated as a result of the lower revenue. After the sale of TS, Avnet will be a $17 billion company with operating income down anywhere from $215 million-$235 million, depending on the final expense reduction. Earnings per share could decline between 25%-28% to a range of $2.05-$3.15 per share. However, operating income margin would increase 40-60 basis points. I would also point out that this scenario does not assume any delevering, which would reduce the reported interest expense of $99 million in fiscal 2016.
From this level, we will realize the positive impact of additional operating income and EPS with the addition of Premier Farnell. For purposes of illustrating the impact of Premier Farnell, we have excluded our potential synergies and the 25 million cost reduction Premier Farnell expects to complete in their fiscal year ending January 2018. The trailing twelve months adjusted operating income from continuing operations of approximately $69 million would equate to another $0.38 per share using Avnet's fiscal 2016 tax rate, as well as add further accretion to operating margins. In addition to the pro forma P&L impact, we would also realize a one-time gain on the sale of TS between $3.75 and $4.75 per share, depending on the final tax rate and final accounting adjustment.
Most importantly, we would significantly strengthen our balance sheet with approximately $2 billion of after-tax cash proceeds and 2.8 million shares of Tech Data common stock. Now, turning to the next slide on potential uses of cash. Let's take a high-level look at what this means to our balance sheet and liquidity, as well as some potential uses of that cash going forward. When we close the Premier Farnell transaction, we expect to use approximately $200 million of offshore cash and borrow an additional $900 million, a portion of which will be used to pay down Premier Farnell's existing debt. Our net debt position will increase to $2.6 billion, and our leverage ratio will approach three.
When you layer in the $2.6 billion we expect to receive for the sale of Technology Solutions, our balance sheet will improve materially. As you can see on the slide, we estimate our after-tax cash proceeds, excluding the Tech Data shares, would be approximately $2 billion, which would reduce our net debt to $600 million. However, our leverage ratio would increase to the mid-threes as a result of the reduced EBITDA. With approximately $2.8 billion of cash on hand, we will have several alternatives for capital allocation after the transactions close sometime in the first half of calendar 2017. Our objective in the process will be to achieve a balance of debt reduction and returning cash to shareholders, with the goal of maintaining our investment-grade rating and providing ample, ample liquidity to fund future growth.
The graph on the lower left part of the slide provides an example of how we could reduce our leverage. If we want to reduce our leverage ratio to 2%, we would need to reduce debt by roughly $1.5 billion, which would still leave us with approximately $1.3 billion of cash. In this scenario, we will still possess additional borrowing capacity if we want to invest in acquisition. Just increasing our leverage from 2x to 2.5 x could provide an additional $750 million of capital for growth if a compelling opportunity should arise. I do want to remind you that the exact numbers will depend on future results and market conditions, and we are talking about projections almost four quarters from now.
While we have made no decisions on specific capital allocation strategies, we thought it was important to illustrate how today's transaction adds future firepower to fund growth as we focus on our investments on the strategies Bill laid out earlier. In conclusion, we believe today's announcement is a major milestone in the history of Avnet. We will be better positioned to execute on our strategies for growth, focused web enablement, embedded solutions, and the Internet of Things. With our leading position in design chain and supply chain services, a strengthened balance sheet, and the addition of Premier Farnell, we plan to accelerate growth, expand margins, and increase shareholder value going forward.
Before we move to Q&A, I would like to remind you that the U.K. Takeover Code places a number of restrictions on what we are allowed to say in relation to the financial details of the Premier Farnell transaction, including synergies and forward projections. With that, let's open up the line for Q&A. Operator?
Thank you. Ladies and gentlemen, we'll now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Please limit your questions to one question and one follow-up. Our first question comes from William Stein from SunTrust.
Hi, guys. This is Joe Meares calling in for Will. Thanks for taking my questions. How should we anticipate the company's profile to change going forward? Just based on the capital allocation strategy, it seems like there might be a pause in acquisitions for a little while. Should we expect near-term acquisitions to slow down, or how should we think about that?
Well, we got an active funnel, and if one of them happens to be something that we think fits a key piece of our strategy, we'll still engage on it, especially since we'll get these two transactions completed. But clearly, we're not going to put the balance sheet in jeopardy in the process, but we will make sure that we have the appropriate cash on hand and keep our investment grade statistics.
Got it. And then just as a follow-up, should we expect any new type of segment reporting going forward, some, maybe some more granularity among like within the the component segment? And then as just a follow-up to that, should we expect that acquisitions or sales are done now or expect any potential other parts of the business to be sold going forward?
Yeah, I, I'll take the second part and let Kevin answer the first part. There is no other anticipated sale of Avnet. We, as I described in my remarks, we're going to double down on the EM business, and we're going to become the clear-cut leader in the design chain and supply chain space.
And as relates to the first aspect on segment reporting, we're not planning anything at this time. We are looking at it, but obviously based on our geographic structure and how we go to market, at this time, we're not expecting any changes.
All right. Thanks, guys. Helpful.
Thank you. Our next question comes from Shawn Harrison, from Longbow Research.
Hi, morning, everyone. My first question really is, if you know, Tech Data mentioned the conversation regarding the sale to them had been going on for some time. Bill, maybe you could discuss or just talk about the internal conversations of what changed in terms of why couldn't you fix TS to either get the growth profile you wanted or the margin profile that you wanted? Did it require too much capital investment to get you down the road? Are there more M&A activities that are more enticing on the component side of the business? Is there something else that I didn't touch on that was part of the consideration?
No, you hit the consideration. We looked at this for a relatively long time with the board of directors and the Avnet executive board and discussed lots of different alternatives, and it was clear we were gonna have to make an investment in TS, and we're starting to make that investment, as you saw with our move to the SBU structure and for us to be able to focus on those growth areas. But it was clear we were gonna have to do some key acquisitions in the space that would be able, we'd have to space out over time.
When this opportunity arose with Tech Data, it was clear that at this juncture, that's the best thing in order to, I would say, make a win-win scenario, because we essentially put together two companies that now have a bit more scale and more girth to them, and therefore, they're gonna be focusing entirely on making sure that the TS business in the Tech Data space is gonna be a world-class winner. So we thought that was the best alternative at this juncture.
Then maybe, I guess if I could follow up on, you know, cash usage. You guys typically make, you know, make cash, particularly if things are slow. We haven't been in a growth cycle for some time, and understanding that there may be investments down the road, I wouldn't understand the need to significantly delever. And so, you know, I view this as a, you're flush with cash. Are there deals out there, enough of them or large enough deals that you can, you know, at least maintain a, the leverage that's probably appropriate for a distributor and deploy it appropriately toward, you know, creative endeavors?
The short answer to that question is yes. There's plenty of opportunities out there. As you've seen, the world is essentially collapsing. We're seeing consolidations happening all over the place, and there's therefore opportunities that are popping up. But we want to do it in a very prudent way. Our capital allocation process that we've had in place for years has worked well for us, and we will continue to do that and be prudent with how we do our dividends as well as our share repurchases. So you'll continue to see us be very active there, as well as making sure that we're focusing on our future growth, which includes both organic growth. So there'll be opportunities that we'll invest in our company organically, as well as M&A opportunities.
Are those M&A opportunities similar size to Datwyler or within the funnel, or I'm guessing there's a number of, the range of sizes, but is there anything as large as Datwyler or not Datwyler? I'm sorry, as Premier Farnell out there.
There, there's a whole host of ranges of, of various different opportunities that are out there. None, none that are far along in the funnel that I would be willing to comment on.
Okay. Thank you, Bill.
Thank you. Our next question comes from Steven Fox, from Cross Research.
Yeah, thanks. Good morning. Just two questions from me. First, on a big picture standpoint, this transaction seems pretty significantly dilutive for Avnet shareholders. So I understand, you know, there's a lot of moving parts post the deal, but can you talk about how quickly you think you can recover to the earnings power we were thinking it had pre-transaction? And then just the second question is, can you just sort of reset the bar in terms of what your Embedded Solutions business is now as a percentage of the new Avnet? Thanks so much.
Second question was percent of our total business, the embedded business?
Yeah, under the, you know, post this divestiture, how much sales are you getting from embedded?
It's roughly $2 billion, and when we do finish up with the Premier Farnell acquisition, we'll be a $17 billion company.
And then in terms of the dilution that you're taking on here?
I would actually say, this is Kevin. I think that this deal is compelling for our shareholders in terms of the multiple we've received. When you look at our, you know, not only our trailing, but our forward, when you look at it from an EBITDA, EBIT standpoint, it's in the neighborhood of 8.5x-9.5x. So again, from a it's a pretty compelling offer here. And as we look forward, what we're trying to highlight in the slide with the, you know, there's certain things we're not able to talk about related to the Premier Farnell transaction, and there's other things that we're trying to do to address our cost base going forward.
So if you think about, you know, what we paid for Premier Farnell and what we're receiving for the TS business, again, we think it's a compelling value for our shareholders.
I appreciate that, Kevin. I know, actually I wasn't concerned about the value you got for the business. It seems fair, but I mean, just you're sitting on a bunch of excess cash, and I'm just trying to get some comfort level in terms of reinvesting it to get sort of a return, like, forward cash flow that would sort of, you know, relatively speaking, give us some sense of, you know, the business is gonna recover some earnings power going forward.
Oh, I appreciate that. I think as I commented on in the script, if you were to look at what our objectives are going to be, we obviously recognize we've got to achieve a balance of debt reduction, right? So that's a key aspect. We recognize that there's going to be some ongoing M&A investment, as well as we know that there will be some form of return to shareholder, and to Bill's point, either through a buyback or dividend, but none of that's been concluded as of yet to help minimize the dilution here that we're gonna see. But clearly, we know that there will have to be a debt paydown and some of the other aspects.
So, we will continue to update you as we move forward here, but that clearly has been on the board and other members of management's mind as we move forward here in the next few months.
From an organic point of view, we wanna stoke the flame on the three areas we talked about, embedded, digital and IoT.
Thank you very much.
Thank you. Our next question comes from Brian, excuse me, Brian Alexander from Raymond James.
Okay, thank you. This is Adam in for Brian. Just wanted to ask, I mean, if we look at the adjusted operating income that you laid out for Premier Farnell and the implied enterprise value of around $1.1 billion, the ROI on that deal looks like a mid-single digit type of a range. Now, you mentioned some of the qualitative elements that Premier Farnell brings, but hoping that you can maybe quantify the synergies or you know, some way for us to get a little bit more comfort in the overall ROI appearing a bit lower.
Well, as we mentioned, because of U.K. takeover rules, we have inability to be able to describe that now, but rest assured, there are synergies that are involved that make this a very favorable deal to our shareholders.
Okay, fair enough.
Closer to that announcement, clearly, we'll, we'll be highlighting more as that gets closer, but obviously, we are not allowed at this point in time to comment.
Understood. Okay, I'll still shift gears. So, help us understand your thoughts on the remaining liquidity. You know, to an earlier question, we could probably get to EPS power of where we were pretty quickly if we, you know, use the remaining liquidity for buybacks. So just wanted to understand, you know, how you're thinking about a buyback versus an acquisition in light of the Premier Farnell deal and what you've been focusing on lately.
Well, it's clear. We wanna have our shareholders' best interest in mind, and we'll only do another acquisition if, in fact, we know that that's accretive, and will get us back to the same position that we were previously as fast as possible. So our aim is to make sure we optimize the speed at which we get back to that position again. So that's what our strategy will be from a capital allocation point of view.
Okay, and if I could just, one last follow-up. How, how does the loss of TS affect cash generation? What does the typical cash conversion cycle look like now, and, and what level of cash flow generation do you anticipate?
Give us a second. We'll hold on that second, and we'll, for a second, we'll get you an answer on that. We take a look.
Yeah. In fact, we may follow up with you on that.
Okay, no problem.
Thank you. Our next question comes from Sherri Scribner from Deutsche Bank.
Hi. Thanks. You talked a lot about what you're seeing in the future, moving to the Third Platform and some of the challenges for the business, that you need to be more of a converged volume and value-added reseller. It seems like the sale, in some respects, validates the concerns about the cloud. Could you maybe address what you were thinking in terms of the challenges related to the cloud when you were selling the business? And then I have a follow-up.
Yeah, it's pretty simple. We've noted that in the data center, it was a hardware-led selling opportunity, whereas when you go into the Third Platform of cloud, it becomes a software-led sale. We needed to bolster up those skills, either by hiring those skills or by doing an acquisition to acquire those skills.
Okay, and then are there any dyssynergies with this deal? I mean, you guys have had the two businesses together for a while. I assume there are some integrated pieces that need to come apart, and there's probably some cost related to that.
There's very little from a business-to-business point of view, although we are gonna continue a partnership that we've talked about with respect to IoT, so we could have a cloud through edge solution. Additionally, yes, there's some synergies with respect to the corporate functions, which we will, we anticipated, and we will have plans in order to be able to get that cost out of the business.
Okay, thanks.
Thank you. Our next question comes from Mark Delaney from Goldman Sachs.
Yes, good morning, and thanks very much for taking the questions. First question is on the returns profiles of the two business segments. You know, the company laid out the TS had lower margins and lower growth historically, but I think they also needed a lot less inventory. So what should we thinking about for our returns on capital for Avnet going forward? And how has that varied in the past between EM and TS?
Mark, it's Kevin. I would say that, you know, clearly, when we look at this, when I look at RemainCo, we should be operating somewhere in the neighborhood of 11%-14% returns. Clearly, the EM business, and again, I'm looking forward for a couple of conclusions of the transaction, so much more of this we'll be able to get into as we go forward here. But it's clear that, when we look at the return on working capital, which is really 75% of the balance sheet as we go forward for EM, we would be expecting to be operating in the neighborhood of 25% to, say, 28%-30%, and then the math goes from there to get us down to a return on capital.
That's helpful. And then, just two quick clarifications. So given the leverage target you talked about getting down to two, two turns if you did use the $1.5 billion of proceeds, was that a gross debt to EBITDA or a net debt number?
Uh, gross.
Gross. Okay, and then just one last clarification, just tax rate going forward. I'm just not sure if there are any differences between TS and EM, and, you know, maybe how Premier Farnell may also impact your tax rate, as we think about the future earnings power.
For now, I would use our kind of rate we just used in our most recent year. I mean, if you look at the dimensions of the revenue split, it will obviously have less U.S. revenue as we move forward. So I would predict that we will probably have a lower tax rate, but more to think through as we update you in the coming quarters.
Thank you.
Thank you. Our next question comes from Jim Suva, from Citi.
Thank you very much. Considering the size of the divestiture that you're doing is, you know, quite large, should we think about, is there gonna be a need for, like, additional restructuring or looking at the way that you guys do, whether it be OpEx, SG&A, footprint, various things like that?
Well, as I talked about on some of the last earnings calls, we're also embarking on a transformation of the entire company. So the remaining company that we have, the EM business, we will in fact be... We're well into our diagnostic that I described in our last meeting, and we're in a position that we're putting together key projects that's going to go after some of the synergies that I mentioned earlier, that we'll make sure we get that cost out of the system, as well as moving beyond that and getting some abilities for us to continue to grow the business in the three areas that we talked about, as well as being able to go after other, cost opportunities in the company, well beyond some of the dis-synergies that we've just noted.
Okay, and then a quick housekeeping item. The gain of, I believe you said, like around $375-$475 from the sale, is that pre-tax or post-tax? I assume you pay tax on that because it's an asset transaction, but if you could just, you know, clarify. Maybe I'm right, maybe I'm wrong, and let us know if it's pre or post-tax.
It's post-tax, Jim.
Great. Thank you so much for the clarifications. I appreciate it.
Thank you. At this time, we have no further questions. I will turn the call back over to Vince Keenan for closing comments.
Thank you for participating in our call today. A copy of the press release and slides from today's call can be accessed in downloadable PDF format on our website, www.ir.avnet.com, under the Events and Presentation section. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.