Distribution M&A markets have changed significantly in the past six months. Deals, especially in the last quarter, have started to dry up and valuations are dropping fast. Yet there is still a lot of private equity money looking for a place to land. Yesterday I had the pleasure of moderating a discussion with Brent Grover of Evergreen Consulting and Jim Miller of Supply Chain Equity Partners. These two gentlemen have complementary perspectives with strong distribution expertise, but they did not bear much good news.
We clearly are on the back side of the peak of valuations. With tighter debt markets, financial buyers won’t be driving the market the way they have the past few years, but they will be a factor, Miller noted. His take is that there will still be add-on activity, but we won’t see anywhere near the level of platform acquisition as in recent past, where a PE firm buys a solid regional or larger distributor, with intent to grow it additionally with further add-on acquisitions.
Strategic buyers (large regional, national and international distributors) will likely step up add-on activity as valuations soften further and competition from financial buyers decreases. Also, conditions are extremely favorable, with the low dollar, for European distributors to continue their consolidation of select distribution markets in North America.
Perhaps the only glimmer of hope may be for distributors looking to grow through small acquisitions. Brent Grover feels the recent market shift makes it more favorable for smaller distributors to reach a deal with potential add-ons. He sees the playing field leveling out. Seller expectations are in fact lowering, even though everyone seems to have no problem remembering that HD Supply bought Hughes Supply a few years ago for upwards of 12X EBITDA.
Of course, there was talk of the Home Depot hangover (Miller's phrase). While HD Supply's sale was announced mid-2007, the company had effectively shut down its acquisition swat team early in the year. So in a matter of months we saw the primary architect of the valuation peak go away, and debt markets tighten the purse strings of financial buyers.
Grover feels that as the financial disparity between buyers has lessened, the cultural fit gives smaller distributors an edge over financial buyers or even larger strategic consolidators. But Miller noted that buyers such as Wolseley historically have been very selective and tend not to be the ones inflating valuations. (My translation: They drive a hard bargain!)
My takeaway is to expect significantly lower levels of deal activity in 2008, with strategic buyers making most of the headlines. And that is not quite the right description, because there will likely be very few “headline” deals. Bottom line: Dealmakers are going to have to work a lot harder to make deals work and pay off at all levels in the foreseeable future.
