2021 Wholesale Distribution M&A Landscape - Modern Distribution Management

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2021 Wholesale Distribution M&A Landscape

What distributors need to know about buying and selling as they navigate the post-pandemic consolidation boom.
Targeting the business concept

2021 M&A activity is just starting to heat up. At MDM’s recent M&A Virtual Summit, members of Baird’s distribution team mapped out the current landscape and what distributors should keep an eye on as they position themselves for accelerating activity.

After a year like no other for M&A, 2021 could wind up being historic as companies look to position themselves for the post-pandemic boom and leverage the current pent-up demand for consolidation.

That was a key theme that emerged during MDM’s recent M&A Virtual Summit. Investment bankers, private equity partners, distribution executives and M&A advisers outlined how distributors should approach M&A in today’s unusual circumstances of nearing the end of this once-in-a-lifetime disruption.

The summit kicked off with an overview of M&A themes across the industry. The session, “The 2021 Wholesale Distribution Landscape,” provided an overview of the dramatic shifts that have impacted M&A activity, and what is emerging next.

The session’s presenters were Jason Kliewer and Nick Troyer of Baird’s distribution team. They dissected what happened to activity over the last year, but also, more importantly, what’s in store for the industry in 2021. Here, we break down their presentation as an introduction to our 2021 distribution M&A playbook.

What happened in 2020?

While we need to examine last year’s historic upheaval, of course, Kliewer and Troyer stepped further back in history to the 1990s, when distribution was viewed much differently than it is today.

Back then, Kliewer posited, distributors were often viewed as low margin without a clear vision of the value they might add to the channel. Many wondered, why not sell direct? That, of course, evolved, and the public markets and institutional investors soon embraced the power of the distribution model. Distributors’ perceived and actual values soared.

Before long, “private equity, family offices and, even more recently, SPACs [special-purpose acquisition companies] became very interested in this space — and for good reason,” Kliewer said.

That reason? Strategic and financial buyers recognized the fragmentation of distribution markets, and they soon understood how a distributor could use technology and a specialized sales team to offer solutions to customers and truly bring value to a supplier, to a customer, to the entire channel.

That emphasis on technology wound up playing a central role in the M&A story of 2020. For one, the companies that were on the leading edge of technological advancements — strong ERP, mature e-commerce, digital expertise on staff, etc. — rose to the top of buyers’ target lists. And two, technology played a key role in the actual deal-making that got done.

“Many of our transactions have been completed only through Zoom, without even an in-person meeting between senior private equity partners or strategic buyers and a distributor’s management team,” Kliewer said. “We’re having some of those meetings now, finding ways to do that in a socially distanced and safe way, maybe over a dinner in a large conference room, but it certainly has evolved.”

More on that below. But first, as the introduction, offer and diligence phases of deals evolved, so did activity. While the second quarter of last year hit a major roadblock as companies shifted their focus to ensuring the safety of employees as well their top lines, the pause in activity led to a backlog of deals, many of which still made business sense and would eventually resume.

“Our distribution team expects the activity that was lost in 2Q to be more than compensated for as we move into 2021,” Kliewer said. “It’s been interesting in our industry because there’s now actually a backlog of transactions. Those are coming back at the same time as the normal cadence of activity has begun in 2021. That, combined with the expectations for recovery as we move through the year, bodes extremely well for activity in 2021.”

Trends and Dynamics to Watch

During their presentation, Troyer and Kliewer outlined the dynamics that bolster Baird’s forecast for increased activity this year. Here are the top four trends they said could reshape the landscape.

1) Pent-up M&A supply. Deals stalled last spring and summer, and the companies that chose or were forced to sit on the sidelines are looking to get back in the game. Said Troyer: “On the one hand, you have many deals that went on hold when COVID hit starting to come back as we move into 2021. But you also have the regular wave of deals. There’s also a pull-forward effect of valuations; deals that were likely circled for a later time horizon now look like an opportunity, often due to a target’s strong performance through COVID.” What’s more, he added, is that with the backdrop of COVID-19, private equity owners are looking at shorter hold periods for their platforms and bolt-ons. Instead of the typical five-year hold, they might shorten it to two or three and would therefore look to placing assets on the selling block.

2) Corporate buyers well-capitalized. Many public distributors fared well during COVID-19; at the very least, they have scaled back their capital investments. That could be a recipe for those companies to invest in strategic additions as a way to jumpstart their top lines. Said Troyer: “In terms of the corporate buyers, there has been this trend for the last few years of very strong corporate balance sheets. That has only increased in the last 12 months, in part due to COVID. There was certainly an inward shift from a lot of the large corporates that were typically active acquirers going into the COVID period. What we’re hearing more broadly across the Baird universe is that well-capitalized corporate buyers are looking at ways to reaccelerate and redeploy through M&A.”

3) Financial sponsors poised to deal. Troyer said the sponsor front is experiencing a similar dynamic. “We’ve been seeing this increasing growth of dry powder sitting within private equity holdings. Part of that is influenced by record-low interest rates, finding ways to chase yields, greater allocations toward private equity as an investment class. In 2020, we saw a larger and larger threshold of average funds raised, and yet deployment was — across most pockets of the economy, not all — lower on the M&A front. What that led to was more dry powder than ever sitting within private equity looking for deals.” In other words, PE firms have money to spend and distribution is a safe bet after its value creation during COVID-19.

4) SPACs as incremental buyers. Troyer said, “2020 was supposed to be the year of the SPAC,” but COVID-19 had other plans for these special-purpose acquisition companies. “Last year, there were 250 SPACs, which was up sixfold from where it was in 2019,” he said. “And in 2021, we’re already well above that pace. The expectation is that SPACs will eclipse IPOs this year, by potentially a wide margin. What’s important about that from an M&A perspective is that SPACs have a finite window to go out and complete an acquisition, so we’re seeing SPACs become more active participants in M&A.”

What’s the Impact on Distribution?

What, specifically, do these trends mean for wholesale distributors looking to either buy or sell? Deal activity already has been picking up since late 3Q and into 4Q and now 1Q 2021.

And distributor valuations are increasing, according to Troyer, who said that across the industrial and building products verticals — two of the main sectors this Baird duo covers — “nearly all of these companies are trading at record levels from multiple standpoints. From a share price level, they are at or near record levels in terms of their trading point. In terms of private valuations, we’re seeing a similar trend. Certainly, the companies that have demonstrated strong resilience through COVID, those counter-cyclical opportunities, are getting the greatest attention and have seen the greatest move in terms of valuation.”

He added, “In general, there has been a rising tide lifting all ships regarding valuation across distribution. That thematic further supports the idea of more sellers potentially looking at a window to bring a business to market in the year ahead.”

The rising tide was evident in the latest quarterly MDM-Baird Industrial Distribution Survey. According to the report, the market has shown improvement each quarter since 2Q 2020 when COVID-19 decimated revenues. While the industry average revenue was down 10% year-over-year in the spring of 2020, it ended 4Q 2020 down just 1.5% below forecast.

And several sectors notched low- to mid-single-digit growth in the final period of 2020. They include HVAC (+6.2%), LBM (+5.8%), Roofing (+4.5%), Pool & Spa (+4.1%), Safety (+4%), Landscape Supplies (+3.6%), Plumbing (+3%) and Waterworks Products (+2.8%).

These upbeat numbers send a signal that business owners who were looking to sell in 2020 — but had to shelve those plans due to COVID-19 — can now put their companies back on the market. “Generally speaking, it’s much more of a seller’s market,” Kliewer said. “The debt markets are incredibly attractive for businesses that performed well through COVID. Combine the scarcity of best-in-class distribution with all this dry powder and very low interest rates — which strategic buyers and private equity firms can tap into — and then throw in family offices and SPACs that weren’t part of the discussion a few years ago, you have a very strong overall seller’s market.”

How Deals Will Differ This Year and Beyond

No matter what happens with M&A in 2021, the deal-making process will be altered — perhaps for good. As activity slowly accelerated in the third and fourth quarters of last year, both buyers and sellers finally found a comfort level with performing due diligence virtually.

While this cut down on the number of “de novo” deals (those in which neither party knows each other), it had little impact on transactions that were already in progress or involving buyers and sellers familiar with one another.

In the post-pandemic phase of M&A, expected later this year, look for some due diligence to still occur over Zoom or Teams rather than with everyone in the same conference room.

“I think buyers and sellers have gotten more and more comfortable with the ability to not only execute a lot of the workstreams that have to happen in terms of the information sharing and the diligence side of the equation, but also the interpersonal side of getting to know a potential partner,” Troyer said. “That is certainly not ideal — and I think we’re all hoping that a lot of this can move back to in-person sooner than later — but what it has done is introduced efficiencies into a process, and one result has been shorter execution timelines.”

He added that while parties are eager to return to the old ways of meeting in person and breaking bread together to get a better sense of a potential new partner, those old ways of doing business will be balanced with some virtual interactions this year and beyond.

“We think some of that will be with us to stay,” Troyer said. “We don’t think an entire deal will happen in a virtual world once we’re back to normal, travel restrictions are lifted and everyone’s comfortable, but elements of the deal that are more diligence-oriented will remain virtual.”

Key Drivers Informing M&A Activity

M&A Returns with a Vengeance: After a pause due to COVID-19, deal volume returned in earnest at the end of the second quarter and into the third quarter, with activity accelerating to close the year. Some of the larger consolidators in distribution — both on the financial and strategic side — made plays or announced their intent to step off the sidelines and steer their capital toward prime targets. The move that kicked everything off was WESCO’s $4.5 billion acquisition of Anixter, the roots of which date back to late 2019. The deal survived the pandemic and closed in June. A flurry of deals, though none as sizeable, followed in the ensuing months making 2020 a somewhat decent year for M&A. Look for this trend to continue in 2021.

PE Firms Deploy Dry Powder: Private-equity firms made headlines in the latter half of 2020 for the fat stacks of cash they invested in distribution, especially building materials and construction. Here are a few examples. Clayton, Dubilier & Rice bought HD Supply’s White Cap division for $2.9 billion (and also distribution ERP provider Epicor for a staggering $4.7 billion). Clearlake Capital Group L.P. acquired PrimeSource from another PE firm, Platinum Equity. Affiliates of American Securities LLC paid $1.4 billion for Foundation Building Materials Inc. and $850 million for Beacon’s Interior Products Business. And Bain Capital Private Equity bought US LBM Holdings.

Building Materials Sector Blows Up: In addition to the mega-deals mentioned above, consolidation was rampant across the building materials sector, with both strategic and financial deals regularly being announced to close the year. The strategic highlight was HD Supply Holdings Inc.’s return to its roots when The Home Depot bought the building products distributor for $8.7 billion. In 2007, Home Depot sold HD Supply to private equity, and HDS went public in 2013, operating on its own for the last seven years but slowly shedding business division until it went back to its core focus — and back to its original owner.

A New Deal-Making Landscape: While due diligence became harder to navigate thanks to social distancing and reduced air travel, companies that saw deals as advantageous to their businesses found a way to get them done over Zoom, Teams or Webex. However, this new dynamic did cut down on “de novo,” or new, transactions where the parties didn’t know one another. “In this current environment, conducting due diligence is harder, and assessing individuals and personalities is harder,” Reed Anderson of Houlihan Lokey told MDM for a mid-July 2020 report on M&A. “If you are a strategic buying a smaller player in your space, you can take comfort in generally knowing what that target has been doing, and you have personnel capabilities on your team to make sure that M&A transaction works well post-close.”

Valuation Becomes More Challenging: With lockdowns in place and many companies’ revenues stunted due to COVID-19 restrictions and the general economic slowdown, valuations became increasingly difficult to gauge. Was a company’s struggles — or its successes (think PPE) — due to COVID-19 or something else? “I definitely would not say that a business that experiences challenges right now is going to face a distressed valuation,” Nick Troyer of Baird told MDM. “On the other end of the spectrum, however, I do believe there will be a premium for businesses that outperform through this crisis. When we’ve analyzed valuation multiples over time across distribution sectors, we clearly see the value in downside protection. The stronger performers are also likely to be the first to come back out.”

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