US Electrical Services LLC has built a $300-million distribution business in the Northeast with three acquisitions since May. The company plans to reach $500 million in revenues by year end. In this interview, President and CEO Richard Worthy discusses USESI’s business model, consolidation in distribution, and the goals of private investors.
Richard Worthy is a seasoned veteran of the electrical distribution industry. Before he founded USESI, he was CEO of Sonepar USA, where he led a series of acquisitions for the electrical distribution giant. He is now the professional manager of this new distribution entity, backed by private investors, including Michael Dell of Dell Computers. USESI has focused on the Northeast, but the company has appointed a former regional manager for Rexel to the post of president of USESI’s Florida region even though the company does not yet have a presence there.
MDM: Why did you choose the name US Electrical Services versus something with “supply” in the name?
Richard Worthy: We chose our name because we believe that the range of services required in the electrical distribution industry has evolved beyond just ‘supplying” materials. As the industry continues to evolve, the range of services will broaden and we will serve end customers and manufacturers in a far greater capacity.
Marketing, product selection, credit facilities, electronic interface, product training are all services we provide to our customers so we feel our name better reflects what we offer. But no doubt, we still fulfill the order, ship and bill electrical products. That is still at the heart of the electrical supply equation.
MDM: What is your business model, and how does and will USESI differentiate from other electrical distributors?
RW: Our business model is built around our ability to deliver goods and services to our customers on a regional or local level in a far superior fashion than available elsewhere.
First all customers are local so our business model is local. USESI business leaders are called ‘presidents’ for a reason they make the decisions that matter most which products to carry, what price to sell at, credit and so on. Unlike other distributors, we will never take a one-size-fits-all approach. When they centralize key decision making like vendor lines, pricing and credit, what is invariably lost is the crucial and intimate understanding of why customers buy from you versus your competitor. You become focused on reports, numbers, trends because you aren’t able to focus on the customer. At USESI, we certainly have reports and analytics, but we are able to balance that with the local strategic thinking our presidents bring.
Second we strive to have the best people in the industry. The best people are passionate and proud to be in the electrical industry. They are innovative, aggressive, smart and entrepreneurial. Such talented people don’t want to be a small cog in a big machine. They want to make decisions, service customers, and drive their business and control their own destiny. USESI provides an environment for their personal and professional growth.
Third we play to win. At a personal level the best people want to win because winning is fun. So our businesses play to win. Within a geography or segment we aim to be strong because our customers want locations, product, pricing, and service. Our decision to service a customer base is based on two critical criteria: First, can we engage the right, high caliber team, and second, can they secure a convenient branch location? We won’t enter a market just because the demographics appear favorable or because a suitable building becomes available.
Give the best team a good facility. Give that team the authority to make sound local business decisions and that team will successfully compete for market share. Our business can be captured by the catch-all phrase ‘people, process & IT’ with people being the variable in the equation that is the differentiator.
MDM: How does the portfolio of companies you are assembling fit into this model? What do Monarch, Electrical Wholesalers, and Wiedenbach-Brown contribute to your organization?
RW: All fit the local model and all have the dynamic leadership required to drive the business. In the cases of Electrical Wholesalers and Wiedenbach-Brown, both businesses are clear industry leaders and winners. Within Connecticut and now with the recent expansion into Rhode Island and Massachusetts – EW continues to build upon its 50 years of strong customer service. EW is a powerhouse. In the National Accounts segment, WB has the same status. Monarch has been in business since the 1920’s and has altered its focus from being primarily industrially focused to a more balanced electrical distributor. Monarch has the ability to become one of the top 2 distributors in its market (based on number of branch outlets and total sales) within the next five years.
MDM: Is scale critical for USESI to compete? How large, revenues-wise, do you want USESI to be?
RW: Scale is important, yes, but regional scale is of greater importance. If we were to have five regions with $300M of sales per region on average, then we would be $1.5B. Seven regional businesses would equate to $2.1B on so on.
MDM: Is it necessary to have a national presence, or can you be competitive as a large regional player? Do you plan to expand beyond the Northeast?
RW: We will expand beyond the Northeast, absolutely. Our strategy is not to be in every city and every town. USESI will enter markets where we can be a major competitor. Our focus is not to be national, but rather to be the leading distributor in a given market. It is all a question of time. Wait long enough and we will be national.
MDM: Traditionally, roll-up strategies have not worked in distribution. Do current conditions favor the USESI model?
RW: We hate the term roll-up. It has such a financially engineered overtone, which leads to my answer. Roll-ups imply that incremental EBITDA or “cash flow” must be generated to pay not only the higher debt service expense but also pay down acquisition debt and overall debt. This must be accomplished within a time frame that generates an IRR (Editor’s Note: Internal Rate of Return, or the return a company would earn if it invested in itself, rather than investing elsewhere.) that is acceptable to all parties. There are three primary ways to generate this incremental EBITDA: cost cuts, raise gross margins and last, and least favorable, grow sales.
Some may be curious as to why I say sales growth is last and least but the reality of relatively low-margin distribution businesses is that they bring tremendous returns on equity but annual sales growth much above 10 percent requires significant incremental external financing. This constant financing requirement makes the attainment of high IRRs that much more difficult.
Raising gross margins is hard work and can actually require even further investment more product, better lines, better facilities. And it can take time.
Thus roll-ups tend to favor cutting costs never a pleasant exercise and especially less so immediately after buying a good, well-run company for a price that went into the stratosphere. Cost-cutting has inherent risks (morale, operational effectiveness) and some opportunity.
But if you’ve just paid a premiumfor a company it’s probably because it is a well run, financially sound enterprise without a tremendous amount of excess cost. Most well run platforms have conquered their regional market, have reached market share saturation or optimization, have excellent positions on their internal cost curves and asset turns, and so the ability to repay acquisition debt will directly correlate to the multiple paid. This is usually a bad scenario for the CEO and Board if the multiple paid was very high.
Financial firms love the traditional ‘cut cost, squeeze cash, repay debt, sell in 3-5 years’ scenario. The electrical distribution industry profit paradigm does not align well with such a path, or at least does not stay on that path except for very short periods of the most robust economic times (which usually include significant commodity inflation).
To build a financially strong distribution business you must either have excellent market timing or make a significant bet that scale will bring cost reductions and procurement synergies beyond the existing paradigm.
Or you can prime the pump with equity investment to create value by buying ‘fixer-uppers’ or building de novo start-ups. There have not been many financial sponsors willing to sign up for such. I feel very lucky to have found two such firms.
MDM: Describe the impact of consolidation in this sector as you see it.
RW: Clearly we are seeing the disappearance of the middle-tier distributor. The large national or North American distributors are becoming significantly larger than the large regional players. We are seeing the emergence of the $5 billion sales plateau for the big players in North America, whereas a large regional player is defined by the $100 million to $300 million level. This gap creates interesting scenarios for distributor-owners, management and the manufacturers they represent. It is financially very painful to be a mid-sized distributor or put another way, a distributor who is caught between the small-size distributor revenue/cost curve and the large-size distributor revenue/cost curve. Fewer and fewer owners are willing to make the investment in IT and logistics infrastructure that a multi-branch network and an increasingly more sophisticated customer base demand. The consolidation is only increasing this stratification. Of course as professional management working on behalf of investors, we apply financial metrics to all activities to determine their worth and validity, whereas owners have many reasons for being in business. A friend of mine, Ken Renwick, the former CEO of All-Phase Electric taught me this years ago and it still rings true today. So you must resist the temptation to fast-forward the consolidation pace it is far easier to intellectualize the process than actualize it. The small distributor with a unique niche will always exist and prosper.
MDM: Does consolidation benefit the customer?
RW: Yes. And no. There are clearly benefits such as: more accurate and predictable product delivery, fewer billing errors and potentially deeper inventory levels. But it can also mean less choice with fewer suppliers in general. Larger distributors with standardized processes are normally the result of consolidation. Fewer errors usually result from less flexibility so customers can be forced to accept certain rules in order to deal with a supplier. The good news is that, on balance, the industry still has a lot of competition. There is still plenty of room for innovation and for companies which focus on servicing the customer and inculcate such a winning value proposition into the fabric of their culture.
MDM: Will electrical distribution remain as fragmented as it is five years down the road?
RW: More yes than no, but the bipolar distribution and the decreasing number of large players will continue. Roughly 75 percent of distribution today still goes through local and regional supply houses. That will shrink but it won’t disappear. The generational effect should hit its peak over the next five to seven years where quite a number of owners will be in their 70s and 80s. History has shown that many of these owners of mid-sized distributors tend to sell for estate reasons. There are hundreds that fall into this category. They have companies that are rather large relative to historical measures.
MDM: Rexel recently announced it would buy GE Supply. How does this shift the competitive landscape in electrical distribution?
RW: GE Supply was founded to distribute GE products and Supply has stayed true to that mission. It is very good at what it does. More than one-third of the GE Supply locations don’t have a warehouse or inventory so GESCO is different from many other distributors.
MDM: You are supported by private investors. How does being supported with outside money affect strategy, decision-making and growth potential?
RW: I searched for the right investment partner a group that could be patient, willing to do a build-up versus big, “blockbuster” deals and could stomach the inevitable downturns this industry experiences. Kelso is a rather special group who on their own understood why ‘roll-ups’ fail as explained above, and why build-ups require significant financial and operational execution risk-taking.
Meeting Frank Nickell, Tom Wall, Dave Wharhaftig, Church Moore and Shane Tiemann sold me on Kelso. In spite of their tremendous success in private equity, they are well grounded as individuals and truly partner with management. Twenty percent of the current fund’s equity base is derived from the Kelso partners’ personal pockets. That speaks volumes. Kelso has a 32 year track record that focuses on ‘plain Jane’ industrial sectors including distribution. Kelso held Jorgensen Steel Distributors, a $1.6B revenue steel distributor for over 14 years. Obviously this was not by design, but they did not abandon their investment or the management team. They continued to invest through the tough times and actually did rather well when the company went public last year.
Kelso is very seasoned and after seven months of working together and having closed a number of transactions together I am very happy that Kelso is my lead partner. MSD is Michael and Susan Dell’s family estate fund created when they sold multiple billions of dollars of Dell stock a number of years ago. Michael Dell likes distribution as do Eric Rosen and David Caro, the MSD private equity executives responsible for this venture.
The effect on strategy and decision-making thus far has been very fluid as the Kelso, MSD and operating management executives have incredibly similar views on risk / reward, value creation and pricing discipline. This alignment of thought and outlook makes co-existing very easy. We want their opinions and insights and they want ours.
MDM: In five years, how do you see USESI’s customer segment mix, in terms of profitability and growth? Which customer segments have the most potential for you?
RW: USESI won’t focus on any one segment that’s dangerous especially given that our industry has had several very good years in a row and a business cycle is due. We like to have some geographic and customer portfolio balancing. Having said that, a good core customer base is the smaller to mid-sized customer, whether it be an institution, contractor or industrial account. If we successfully service this base, we can leverage our infrastructure to other customers like National Accounts and large projects. The core customer is a difficult one to please the small to mid-sized customer is loyal, demanding, and expects deep inventory, excellent local logistics and delivery capability and good prices. Each region has different buying habits and customs so our model fits this customer nicely.
MDM: How many companies do you aim to have in your portfolio by the end of 2006?
RW: Having personally closed more than 30 acquisitions and examined hundreds I’ve learned you can’t predict or anticipate when an owner will sell. There are so many variables. Many are outside our control, so it makes predictions very difficult. As of late July 2006 we are over $300 million on an annualized run rate basis. I’d like to get to $500M or so by year-end.
MDM: Do you plan to continue growing at this pace?
RW: Again, it’s tough to plan some things but I intend to continue working the dozens of potential deals already in progress.
USESI to Buy Wiedenbach-Brown Co.
Monarch Electric to Join USESI
Richard Worthy’s USESI to Buy Electrical Wholesalers Inc.