ScanSource CEO On Taking A 'Risk' With Watershed Intelisys Deal And Sacrificing Top Line To Drive Profitable Recurring Revenue

Changing the Channel

In a deal that ScanSource CEO Mike Baur (pictured) refers to as "heavenly," the large IT distributor announced Monday that it would acquire Petaluma, Calif.-based Intelisys for $83.6 million plus earn-outs.

The deal marks the first time an IT distributor has purchased a master agency. Baur predicts it won't be the last merger between an IT distributor and a master agent, either.

Baur sat down with CRN and shared why the transition to recurring revenue has been such an obstacle for VARs, how the Intelisys purchase will change ScanSource's balance sheet, and his plans to transform the VAR channel by educating partners on the long-term value of recurring revenue, with the help of the Intelisys team.

Tell us about how the acquisition came to be, and the transition to recurring revenue this will mean for your partners.

ScanSource has not been able to figure out recurring revenue. We, like most of the IT distributors, have all been dabbling in the cloud and other types of services, but Intelisys figured it out. We put together a small team of four people last year and I gave them a mission: Find a way for ScanSource and our VAR channel to get into the recurring revenue services business. And they came up with this idea that there's this big carrier services and cloud market that's being served today by two-step distributors called master [agents], and that the biggest master was Intelisys. I'll admit, I didn't know them. But what a great opportunity it's been to get into business with [Intelisys].

[This acquisition] is a watershed moment in the telecom master agent space, and I wouldn't be surprised if there were more that happened as a result.

What's preventing the transition to recurring revenue within the VAR community?

There's this $150 billion cloud and telecom market today and very little of that market is being serviced by the IT channel. We determined that there are several reasons why VARs haven't gotten there yet. What we have learned is two major things that Intelisys used to help their agent partners understand, and it's the same things that are going to help the VAR channel. One is education, and the other is financing programs … It was amazing to get to sit down with the Intelisys team and ask: ’Can we do something that no one has done before?’

Talk about Intelisys' Cloud Services University – which has attracted about 3,000 partners -- and how VAR partners will be able to benefit from this educational program.

The number of VARs that [Cloud Services University] has attracted has been small, and it wasn't growing at the pace that the Intelisys team wanted. When we got together, I was asking: ’why not?’ We need education first. Then, VAR business owners need to figure out how they cash flow a business that pays them a fraction at a time. Selling monthly recurring revenue is a massive obstacle to any VAR unless you're very large, but Intelisys has cracked the code.

How will you help these partners get started with recurring revenue from a financial perspective?

One program [we will invest in] is called the [Intelisys] Advanced Commissions program. Intelisys knew early on that VARs can't do this; they can't even pay their salespeople on commissions they get in one month from a three-year deal. This program will advance [cloud and telecom] commissions to the VAR to help them get in the business and get the cash register ringing with money that comes in every month. So you have to educate VARs first, but then how do you help them financially move from a transaction model to a recurring revenue model? This Advanced Commissions program will be funded by the ScanSource balance sheet. It's a really phenomenal program.

How will the ScanSource-Intelisys deal change ScanSource's balance sheet?

On my balance sheet, I have $400-$500 million dollars' worth of inventory and $400-$500 million worth of accounts receivable. Compare that to the Intelisys model, which is heavily dependent on the way the carriers create the billing systems and bill the end user. Intelisys then receives the commissions on behalf of the channel. They have no inventory and no accounts receivable … and I'm in heaven!

How important is this deal within the industry, as the first time an IT distributor has stepped up to buy a master agent?

First of all, this isn't about revenue. This won't drive a lot of top-line revenue growth. As a distributor who is looking to acquire companies, historically, we acquire companies that have revenues that are material to the ScanSource top line of $2.5 billion. [While] this won't move the top-line revenue, this will move the operating earnings dramatically. This improves the profitability profile of ScanSource ... that's exactly what it will do for VARs.

Once [VARs] get into this business, their top line will not grow at the rate it used to. As a matter of fact, it may shrink. But it's going to move to a more profitable recurring revenue business, and by that I mean more predictably, also. I can't wait to see how ScanSource emerges a year from now with a different financial model than we have today. There is some risk to it, but I believe the channel is ready.

Talk a little bit about how this acquisition was structured, with a buyout price of $83.6 million plus earn-outs.

[Intelisys'] business was not for sale, and they weren't necessarily eager to give up the next few years of growth. But the [earn-outs offer] a way for the owners to cash some now, and potentially, they are going to get even more money over the next four years and that has them excited. For me, its gives me a great way to let these guys run this business without me telling them what to do. I don't want to [mess] them up – it's going so well, and I want to provide them the balance sheet they need to be highly successful.

How excited is ScanSource to expose its channel to the Intelisys portfolio, and to opportunities around recurring revenue?

It's exciting to be with a company that reminds me of ScanSource when we were 120 people. We are 2,400 now worldwide. [Intelisys] lives and breathes the success of their channel and their partners. They love their partners and partners love them. We can't wait to get ScanSource partners engaged with this opportunity. Not every [partner] is going to be ready right now. But the VAR channel is the most resilient channel I've ever heard of [and] amazingly resilient. These guys are looking for change, they are looking for the right leadership, and we want to be the leaders showing the way. We believe we have the right partner in Intelisys to do just that.