In February, MSC Industrial Direct Co. (NYSE: MSM) announced plans to buy Barnes Distribution North America, which has a footprint throughout the U.S. and Canada. This article takes a look at the impact of the deal, both on the individual companies and on the industrial distribution landscape.
MRO distributor MSC Industrial Direct Co. Inc., Melville, NY, has agreed to acquire the North American distribution business of the Barnes Group Inc., for $550 million. The acquisition, which is expected to close in late March or early April, will add fasteners and other high-margin consumable products and services to MSC’s portfolio. MSC also gains Barnes’ vendor managed inventory solution.
The deal does not include the Associated Spring Raymond portion of Barnes Distribution North America.
The transaction will contribute to MSC’s goal of reaching $4 billion in revenues by 2016, according to MSC President and CEO Erik Gershwind.
“Barnes Distribution North America brings to MSC a complete vendor-managed inventory solution, which strengthens MSC’s value proposition to its customer base,” says Tom Lange, managing director and head of Robert W. Baird & Co.’s Distribution Group, which advised Barnes Group on the divestiture.
“Second, Barnes Distribution and MSC have very little customer overlap and very little product overlap, with MSC focused on A and B industrial MRO items and Barnes focused on class C items, so this represents a significant cross-selling opportunity,” he says.
Barnes Distribution North America’s more than 31,000 customers and its coverage of all 50 U.S. states and 10 Canadian provinces adds to its appeal. The company’s strong supplier relationships and its experience in transportation and natural resources end-markets are also plusses, Lange says.
According to the news release announcing the deal, MSC’s sales force will nearly double with the acquisition, another major driver.
The largest initial benefits will likely come from back-office and distribution center consolidation and product purchasing savings, says Wunderlich Securities analyst Brent Rakers.
Ryan Merkel, an analyst for William Blair, says MSC bought the distribution business from an OEM – Barnes Group – that viewed the business as non-core, providing opportunity for more investment. In January 2012, Barnes Group also sold its Barnes Distribution Europe business, including Kent, BD France and Toolcom, to Berner SE for $33 million.
MSC also gains a huge opportunity for expansion. “In one fell swoop, MSC added new products, entered new end-markets and added a new geography in Canada,” Merkel says. “Most distributors are making massive investments in Canada, and MSC couldn’t wait too much longer.” Merkel says he expects MSC to move to expand quickly in Canada, starting with existing BDNA customers.
Impact on Barnes Group
Barnes’ acquired segment will benefit from the deal, Lange says, because of MSC’s position in the market. “This acquisition gives Barnes Distribution North America and its employees an opportunity to continue the strategic plans and initiatives that have been developed at Barnes in partnership with a strong industry player,” he says.
Barnes’ remaining manufacturing segments will also profit. “The sale of Barnes Distribution North America allows Barnes to continue its focus on building its aerospace and specialty manufacturing businesses with the benefit of a strong balance sheet,” Lange says.
Rakers says the selling price probably contributed to Barnes’ decision to divest. “Given the day-of-announcement move in Barnes’ stock price, I believe management and investors consider the sale price to be a highly attractive price for the entity. This deal is an example where the earnings power of Barnes Distribution looks more valuable as part of MSC,” he says.
VMI and Vending
MSC’s Gershwind said about 95 percent of Barnes’ business comes through its vendor-managed inventory channel.
Acquiring Barnes’ VMI programs will add to MSC’s already successful efforts in vending, Gershwind said. Although vending Barnes’ class C products may not make sense because of their low-dollar value, Gershwind said Barnes’ VMI program will broaden MSC’s reach into different segments of each customer facility, further entrenching MSC into those accounts.
“Adding the BDNA sales force, with their VMI expertise, can only further that effort and lead to MSC embracing their customers even more strongly,” says Dave Manthey, an analyst with Robert W. Baird & Co.
Manthey says companies like MSC are well-positioned to address the inherent challenges associated with vendor-managed inventory programs, such as high initial investment and logistics challenges. It gives them an edge over smaller distributors, which have a harder time competing on this front.
“Some of the feedback that we get from the Baird-MDM survey is that some smaller distributors don’t have the capital to invest in some of these supply chain solutions,” Manthey says. “But broadline national distributors like MSC already have a set of solutions that are attractive to a certain set of customers to begin with, and vending just adds to that.
“Despite the challenges, the good small- and medium-sized distributors continue to focus on technical knowledge and customer service, and they continue to be a factor and thrive in this market by targeting customers that put a high value on those types of services.”
While the transaction price of $550 million is public, Lange could not comment on the multiple MSC will pay. “What we can say is that the valuation reflects the substantial combination benefits between Barnes Distribution North America and MSC, as well as a significant tax benefit for MSC due to the structure of the transaction as an asset purchase,” he says.
Barnes Distribution North America had unaudited sales of roughly $300 million for the calendar year 2012. Industry analysts say it’s not possible to calculate a straight EBITDA multiple because not all data is available due to the deal’s structure.
“Looking at the segment reporting of BDNA, we believe that there are costs allocated to that segment that will not transfer via an asset sale, plus there are cash flow benefits that offset the purchase price,” Manthey says. “So from an enterprise value to EBITDA basis, which is normally how we would evaluate the purchase price of a distribution company, there are just too many variables right now for us to make a call on that.”
Generally, company size continues to affect distribution valuations, according to Jason Kliewer, also with Baird. “Larger platform transactions, such as Barnes Distribution North America, tend to trade at a premium to smaller transactions,” he says. “And when you look at opportunities where there is a strategic acquirer, such as is the case here, and where synergy values due to combined entity are significant, you can make a case for a stronger-than-average valuation.”
Rakers says he attributes increases in valuation multiples over the past five to 10 years, which are more pronounced for larger companies, to improving margins. “While the multiple appears higher than we would have anticipated, other recent distribution transactions have also been completed at proportionately high levels,” he says.
Impact on the Competitive Landscape
The industrial distribution market remains highly fragmented, despite recent deals, but Rakers says he has noticed a pattern emerging where large distributors are entering each other’s primary markets sooner than he expected.
Following the MSC-Barnes deal, MSC will become a larger player in fasteners. Fastenal, unconnected to this deal, added Kennametal’s WIDIA line in recent years, pushing itself further into MSC’s main market of metalworking.
“Arguably, these two growth companies, who have largely avoided each other for the past decade, will now be competing more head on with one another in each company’s most important product category,” Rakers says.
Merkel says the deal won’t initially change the competitive landscape much. “BDNA needs to be integrated, and the sales force has to be trained and a strategy formalized,” he says. “For the foreseeable future, share gains will come at the expense of mom and pops who can’t match the combined service package and one-stop shop.”
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