PCE recently participated on a panel regarding “Capital Markets Trends in Distribution” at the Strategic Pricing Associates Distribution Strategy Seminar in Fort Lauderdale, Florida. In attendance were owners and senior executives from over 70 different distributors and manufacturers across all major industries.
The gathering included of some of the most experienced and well-respected dealmakers within the distribution industry and provided for some very interesting and engaging discussion. Below is a synopsis of the trends discussed, how these developments might affect your business and some recommendations for how to take advantage.
Capital Markets Trends
This likely will not come as a surprise, but lending is down, valuations are down and M&A activity is down!
Distribution Composite includes: Airgas, Applied Industrial, Barnes, Beacon Roofing, Builders First Source, DXP Enterprises, Fastenal, Genuine Parts, Interline Brands, Kaman Corp, Lawson Products, MSC Industrial, Pool Corp, Watsco, Wesco International and W.W. Grainger.
*Excludes transactions in the retail consumer markets. Source: CapitalIQ
Now that we have that out of the way we would prefer to focus on some of the positive topics for distributors discussed on the panel:
- Capital Availability – both traditional and non-traditional sources of funding are extremely tight in today’s market. These sources include public equity, public debt and bank loans, among others. The good news for distributors is the one area within the lending environment that is relatively strong is the Asset Based Loan market (ABL). These are loans secured by inventory, AR and other hard assets. So the loans that are being extended in today’s market are largely going to distributors and other asset-intense businesses.
- Strategic Buyers – most of the large strategic buyers of distribution businesses have been very inactive with their M&A programs. Instead they have been focusing on internal issues such as headcount reductions, cost reductions and structural changes. The expectation is that this will soon change. There are many strategic buyers with very clean balance sheets and strong cash balances. These buyers seek double digit growth rates and will use their balance sheets to buy businesses to supplement their organic growth. There is also an increasing trend of larger regional distributors completing acquisitions. Finally, private equity firms also have large amounts of capital standing ready to invest once the lending markets improve. Stay tuned.
- Personal Goals and Objectives – several topics were discussed in this area. First, the demographics of the distribution industry show that many privately-held distributors are owned and operated by the Baby Boomer generation. We expect that a growing number of these owners will pursue a sale or wealth transfer in the years ahead. Second, potential changes in personal and corporate tax rates are on the horizon. This has the potential to push more owners to seek a sale of their business sooner to retain more of the proceeds. Finally, some owners are deeply fatigued by this current slowdown and vow “to never go through this again”. We expect this will lead to increased M&A activity as well.
Some Recommended Do’s
Based on these trends above, the panel discussed some recommendations for weathering the downturn and positioning your business to come out of the slump stronger than ever and increase the enterprise value of your business.
- Monitor your cash flow extremely closely in order to service any interest bearing obligations. Your banker who you may have a great long-term relationship with will quickly be replaced by a member of your banks special situations or restructuring group if you breach a bank covenant;
- Tidy up the store. Think about upgrading talent, operations and systems.
- Consider strategic acquisitions. If you have the capital, valuations are attractive, creating a buyers’ market.
Some Recommended Don’ts
We also discussed some typical pitfalls and ways that value is destroyed during times of uncertainty. A list of actions to avoid includes the following:
- Don’t confuse the story. Stick to what you do best and build upon it.
- Don’t make cuts that could affect the long-term value of the enterprise. Balance short-term and long-term opportunities.
- Don’t do nothing. Sitting and waiting for the market to just come back is not a winning strategy.