The 2020 Mid-Year Economic Update_long

Consolidation Fever Continues

Hellman & Friedman, LLC and href=”/pub/1_1/breaking-news/3050-1.html” target=_blank>Thoma Cressey
Capital Partners, LLC
purchased Activant Solutions, which provides vertical
business management software and owns Prophet 21, software focused on
distribution. href=”/pub/1_1/breaking-news/3219-1.html” target=_blank>Singer Equities,
a firm active in the rubber business, bought out Maine-based PRC Industrial
Supply, a distributor of rubber, hose and accessories. href=”/pub/36_12/features/3203-1.html” target=_blank>Heritage Partners
recently invested in electrical distributor OneSource

Don’t Be Left in
the Wake

Smaller distributors will still exist in
niches and local/regional markets. To shore up their positions, many smaller
distributors without a lot of capital are starting to consolidate
geographically. In the middle market, distributors are trying to fill geographic
gaps, build out regions and join together to gain true regional or even national

For these players,
maintaining and increasing service levels will be a key differentiator against
larger platforms. Despite this consolidation, the industry remains highly
fragmented and highly competitive. Successful small to mid-cap players will
leverage this dynamic by investing in long-term customer relationships take no
customer for granted.

Home Depot’s dominance
in the hardware store vertical was not achieved through acquisitions but through
deliberate organic growth that slowly put local hardware stores out of business
one store at a time, one region at a time. Industrial distributors must deal
with this threat, especially with HD’s desire to repeat this strategy in their
sector. No small industrial distributor wants to be left in the wake of HD

If mid-market
distributors have ever considered selling, now is the time to review their exit
strategies. Valuation levels remain favorable, given demand by strategic and
financial buyers as well as a healthy operating environment. It is not uncommon
to see transaction multiples in the 7.0x to 9.0x EBITDA range, compared to a
range of 6.0x to 8.0x only a few years ago.

Many middle-market
distributors will sell based on these favorable financial conditions. Positioned
properly, some mid-cap industrial distributors will witness very competitive
bidding for their businesses, eventually leading to high values and advantageous
selling terms.

Brad C. Yates is a
Managing Director at Stephens Inc., where he provides expertise in middle-market
investment banking to the industrial distribution market and throughout the
Southeast. Stephens Inc., Little Rock, AR, is a full-service investment banking
firm. Yates may be contacted at 404-461-5100 or

href=”/pub/1_1/breaking-news/3242-1.html” target=_blank>Forest Products
Supply Inc., Rice Planter  Carpets, href=”/pub/1_1/breaking-news/3313-1.html” target=_blank>Edson Electric
, href=”/pub/1_1/breaking-news/3330-1.html” target=_blank>Grafton Utility
, Texas
Contractors Supply
and href=”/pub/1_1/breaking-news/3202-1.html” target=_blank>Western

Other large players also
on the acquisition trail include Wolseley, which made more than 30 purchases in
2005. Last year, its North American subsidiary, Ferguson Enterprises Inc., made
two significant acquisitions: href=”/pub/1_1/breaking-news/2844-1.html” target=_blank>Endries
International Inc
. and href=”/pub/1_1/breaking-news/2590-1.html” target=_blank>Full Service Supply
. Since January 2006, Ferguson has acquired 12 companies including United
Automatic Heating Supply, Water Works Supplies, Palermo Supply, Supply North
Central Group, Davidson Electric Wholesale Supply, Central Lighting, Central
Supply Inc., Davies Water Equipment of Wisconsin, Pipe Products Inc., Indiana
Plumbing Supply, Central Georgia Supply and Colgan Distributors Inc.

Airgas made more than 10
acquisitions in 2005, followed in 2006 by purchases of href=”/pub/1_1/breaking-news/3288-1.html” target=_blank>Aeriform Corp.,
Airtec, Inc.,
Alabama Cylinder Gas, href=”/pub/1_1/breaking-news/3069-1.html” target=_blank>Byrne Specialty
Gases, Inc
., href=”/pub/1_1/breaking-news/2998-1.html” target=_blank>West Point Supply
. and href=”/pub/1_1/breaking-news/2950-1.html” target=_blank>Oxygen Service

The big players are
creating businesses that can be responsive and full service to small and large
customers alike. With cost advantages and customer and geographic diversity,
large players should be well positioned in any downturn.

The pace of
consolidation isn’t likely to slow. Home Depot has publicly stated its expansion
plans: grow at a double-digit pace every year with equal parts organic and
growth by acquisition. DeAngelo said the division’s sales will likely reach $12
billion this year and could grow to $25 billion by 2010. (See story href=”/pub/1_1/breaking-news/2975-1.html” target=_blank>here.)
International players will also be busy buying out competitors to gain or
increase their foothold in the U.S. According to many industry observers, the
pipeline is full of good acquisition opportunities in North America and Europe,
and industrial distributors will pursue transactions

Forecast Calls
for Competition

As deal volume picks up in the coming
months, strategic buyers face increasing competition from private equity
interests. In the past three years, private equity buyers have jumped back into
the wholesale distribution deal business. Private equity firms are seeking
investments in solid business models that can be leveraged by taking advantage
of a generally healthy economy and strength in basic industrials such as energy
infrastructure, commercial construction, mining, and paper and forest products,
shying away from the more tech-heavy spending of the 1990s.

Private equity deal
volume has shown considerable strength since 2003. For example, href=”/pub/1_1/breaking-news/2892-1.html” target=_blank>Brazos Private
of Dallas purchased ORS Nasco, a master distributor of brand and
private products. href=”/pub/1_1/breaking-news/2411-1.html” target=_blank>Clayton, Dubilier
& Rice Inc
and two partners bought Paris electrical distributor Rexel
As 2006 comes to a
close, M& A in distribution continues at a fast pace. Look for more deals
going into 2007. Home Depot Supply and Wolseley plan to carry on their
acquisitive growth strategies, and private equity groups’ interest in the sector
persists. Consider how best to position amidst increased

Overall U.S. merger and
acquisition trends remain healthy in 2006; the first half of the year saw volume
rise to $702 billion from $569 billion for the same time period in 2005. This
robust trend seems impervious to public equity market uncertainty related to
interest rates, fluctuating oil prices, war in the Middle East and U.S. economic

Industrial distribution
M& A has followed in the footsteps of global M& A trends. Why? Industrial
manufacturing and capacity utilization have been on the rise for the past five
years. According to the href=/databank/ism0906.html” target=_blank>August 2006 Manufacturing ISM
Report on Business
from the Institute for Supply Management, the
manufacturing economy has witnessed 39 consecutive months of economic growth.
This has proved a windfall for industrial distributors.

Flush with balance sheet
cash and friendly financing, large industrial distributors and conglomerates are
looking to expand their market share through organic growth and acquisitions.
Expect movement into new geographies and the establishment of new platforms
across every end market focus from infrastructure to construction to lifetime

Strategic buyers are not
the only bidders href=”/stories/pequity3604.html” target=_blank>private
equity funds
have become significant players. Alerted to the industry’s
growth, attractive valuations and consolidation trends, all of which provide a
logical exit and equity return on their investments, private equity buyers
remain interested in distribution.

Small to mid-market
distributors find themselves in the crosshairs of large distributors and private
equity investors. Distributors may decide to participate in the current
consolidation trend or face increased competition from larger, better
capitalized distributors that are growing both organically and through

Further exacerbating the
situation: the eventual slowdown of manufacturing activity as we approach 2007
and 2008. Distributors have two options: work through another possible downturn
or consider an exit at an attractive multiple today.

Concentration by
Large Caps

Companies such as The Home Depot, Wolseley
plc, Sonepar USA and Airgas, Inc. are using their healthy balance sheets and
revolutionizing the industry taking away customers from niche small- and
mid-cap distributors. They are proving to be formidable adversaries able to
provide all-in-one services, off-shore solutions, supply chain technologies and
other value-adds demanded by large customers.

Early in 2006, Home
Depot Supply announced the blockbuster $3.47 billion purchase of href=”/pub/1_1/breaking-news/2958-1.html” target=_blank>Hughes Supply
., ranked among the top 10 industrial distributors. “The strategy of Home
Depot Supply is to repeat in the professional space the same type of market
transformation The Home Depot has pioneered and executed in the do-it-yourself
retail space,” says Joe DeAngelo, HD Supply executive vice president.

The strategy seems to be
working: Home Depot Supply completed more than 17 distribution acquisitions in
2005, and has been on a buying spree in 2006 with eight acquisitions YTD (as of
9/30/06), including Hughes, href=”/pub/1_1/breaking-news/3121-1.html” target=_blank>Cox Lumber
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