Value-added IT reseller CDW (Nasdaq:CDW) went public June 27, up 7.8% to $18.33 in its first day of trading. Getting off to a good start in an IPO market that's suddenly become quite frosty, CDW looks to keep it going. What does the future hold for this Madison Dearborn-backed venture? More importantly--should you buy its stock? Here are my thoughts on the matter.

Background
CDW was a public company when Madison Dearborn came calling back in May 2007. Paying $7.33 billion, it financed the deal with $2.2 billion in equity, $4.6 billion in debt and the $580 million in cash that was on CDW's books when it completed the acquisition five months later. Partnering with Providence Equity Partners, the two private equity firms were keen to take advantage of its strong cash flow. In the first six months of 2007, CDW grew its revenues and operating income 21% and 20% year-over-year respectively. With no debt and growing sales, it was the perfect private equity acquisition.

SEE: How An IPO Is Valued

CDW Today
For anyone who follows the PGA Tour closely, you might be aware that CDW handles the scoring for its website. I personally found IBM's (NYSE:IBM) scoring system was better than the existing one, but that's a subject for another day. CDW's revenue and earnings are definitely going in the right direction after hitting a big bump in the road back in 2008 and 2009 when it was forced to record $1.95 billion in goodwill impairments due to declining sales. By the end of 2009 its revenues had sunk to $7.2 billion.

Fortunately, for its private equity owners business began to rebound nicely, and by the end of 2012 revenues were up to $10.1 billion with operating income of $511 million. Its operating margin of 5.1% is significantly higher than both Insight Enterprises (Nasdaq:NSIT) at 2.7%, Ingram Micro (NYSE:IM) at 1.2% and Amazon (Nasdaq:AMZN) at 1%. Granted, Amazon's not the best example, because it's in the middle of a bunch of costly projects including expanding its grocery delivery business and profits aren't necessarily a priority at this point.

Regardless, CDW's business is doing very well at this point in the game.

Concerns
Without a doubt the biggest concern is its level of debt. Although down from its 2007 high of $4.6 billion, it's still a whopping $3.68 billion with half at interest rates averaging 10%. On an annualized basis it will pay $288 million in interest expense in 2013. Although it's a far cry from the $432 million it paid in 2009, it will take a decade or more to repay all of its debt. Further, although CDW's adjusted EBITDA has increased 65% since 2009 to $766.6 million, it's sill only generating approximately $276 million in free cash flow, which suggests a decade might be overly optimistic.

SEE: A Clear Look At EBITDA

Including the over-allotment CDW has 172 million shares outstanding which puts its enterprise value at $6.5 billion or 8.4 times its adjusted EBITDA. That's a lot to pay for a company with a debt-to-capital ratio of 95%. Worse still, it's more expensive than most of the peers it lists on Page 125 of its prospectus. For slightly more than seven time EBITDA you can own Gap (NYSE:GPS), a company that's on the rise and has $360 million in net cash on its books. Amazing as it sounds, Madison Dearborn paid 15 times EBITDA to buy CDW back in 2007, at the height of the market.

While it might appear that you're getting a deal--the private equity boys badly overpaid. Despite this reality they will still get a return on their money.

Bottom Line
Madison Dearborn and Providence Equity had the good sense to not sell any shares in CDW's IPO, instead letting the company raise some funds for debt repayment. With the over-allotment, it should raise approximately $432 million, which would lower its total debt by 11% to $3.25 billion. While it's a start, it's going to have to do a lot more before I'd be ready to hand over my money.

Like a professional sports draft, I believe you always have to go with the best prospect available regardless of position. In the case of CDW, I think there are better stocks available. Maybe not in its particular industry, but certainly in the total market. I wouldn't buy its stock at this point and I'm not sure I'd buy a year from now even if it was trading below $17.
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Tickers in this Article: CDW, IBM, NSIT, IM, AMZN, GPS

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