The distribution M&A landscape has changed dramatically, with good news for potential sellers. Last week at a Distribution Strategy Summit hosted by Strategic Pricing Associates, a great panel discussion on capital markets illustrated just how much has changed in a short amount of time.

 

Strategic buyers are in a sweet spot right now to buy market share in 2010. (Acquisitive distributors are defined as strategic buyers because they use acquisition as a growth tool within their industry versus a financial investor outside the industry who is primarily interested in maximizing a more objective financial return on invested capital.)

 

The valuations of publicly-traded distributors have bounced back over the past two quarters (chart below), and that’s setting the stage for some serious M&A activity. However, sellers are not likely to have the number of potential buyers courting them – at least for a while – as financial buyers (private equity funds and other outside investors) don’t have the same flexibility because of current credit rates and conditions.

 

Here’s what’s happening. First look at the 2009 trend on a chart of distribution median EBITDA multiples below, courtesy Jon Skelly of investment banker Vetus Partners, with a core focus in distribution Skelly argued at last week’s session that publicly traded distributors have to justify current valuations in the current 10X range with a combination of organic growth and acquisition this year. Otherwise investors in these public distributors will go elsewhere to find stronger returns. Skelly estimates public distributors have roughly $5 billion in cash available to invest in this needed growth.

 

Jim Miller of Supply Chain Equity Partners, a private equity fund focused on distribution, noted how credit markets, while improving, made the 2009 environment difficult for financial buyers. There were only 18 acquisitions of wholesaler-distributors by financial buyers in 2009, and 11 of those were add-on deals. Some of those add-ons may have been driven by the need to buy EBITDA to avoid tripping loan covenants.

 

Market share is cheap right now, and strategic buyers don’t have the competition they did just a few years ago – at least for now. There are some at-risk distributors out there who don’t have an adequate financial foundation and are vulnerable, Miller said. If there’s another downturn, they don’t have the cash or debt capacity to survive. If there’s a sharp upturn, they don’t have the cash to buy inventory.

 

Miller also made the point that this might be a good time for even smaller distributors with strong balance sheets to bring in an equity partner for potential acquisitions. Otherwise, larger strategic buyers could snatch market share with the accumulated cash they have access to right now.

 

Prior to the credit markets meltdown, financial buyers were in the catbird seat. Today strategic buyers are. But don’t blink. There is actually a lot of capital looking for a home, but current conditions aren’t favorable quite yet, Miller said. At some point the playing field will level again between strategic and financial buyers. As this latest realignment of the distribution M&A market illustrates, it can happen quickly.