Using M&A to Change Paradigms

\"MergersEvery year there is much talk about M&A (mergers and acquisitions). Some companies forecast it into their budget. For some it is part of their culture to always be seeking opportunities. Some it is a new growth venture. But each year there is talk about “who will by who” and “continued consolidation.” We’ve seen it with distributors, historically many manufacturers have grown this way and, in the past couple of years, it has been a growing topic for reps.
This year started no different and we still get calls from companies asking “do you know anyone who would be open to talking?” (yes, the question is more specific about what they are looking for!)
According to Electrical Wholesaling, this year seems to have been a little quieter than most, however, we know some companies that are looking, some that are always looking and we’ve heard of some deals that are “pending” (perhaps companies that expect to close, perhaps some that are in due diligence.
Over the years we’ve interacted with individuals at companies, and some private equity firms, who are involved in M&A.  We reached out to Gary Uren, former Global VP for Atkore, who has much experience with M&A (and with an IPO) for his thoughts on what drives M&A activity.

In a red hot and competitive M&A market what drives electrical products companies to seek out inorganic growth?

Currently the M&A market for middle-market private electrical products companies can best be described as “frothy” but with some indications of a softening in valuations. The argument for lower multiples breaks down as: (i) lower public company multiples (TEV/EBITDA) which will flow down to lower multiple expectation for private companies, and (ii) a belief that construction growth may have peaked, which when combined with tariffs and the ongoing lack of skilled labor may mean that the present M&A market for electrical products manufacturers could be as good as it gets in this cycle.

With that said, both strategic acquirers (manufacturers) and financial buyers, such as private equity firms, are heavily in the market for good businesses. With manufacturers wanting to leverage strong balance sheets and financial buyers needing to deploy cash-full investment funds, things are unlikely to meaningfully change any time soon!

So why do companies want to buy other companies?

Growth in mature markets: While most of the end markets for electrical products are clearly strong, it’s true to say that shareholders expect sustainable growth rates greater than 3-4% above what the market delivers.

Increasingly good companies, that have not been able to speak to stronger than market growth, have been punished in the public markets. In these pretty good times not many companies are seeing anything above middle single-digit top-line growth.  LED companies were the exception a few years ago, but even their growth rate has normalized as the market has matured.

Companies have meaningfully improved their bottom lines; a factor of leaner organizations, technology-driven labor saving, and price. Despite this, revenue growth still matters! In this good, but not great, operating environment, one way to satisfy higher growth expectations is to expand a company’s portfolio using M&A. If inorganic growth satisfies market expectations for growth, all the better

Consolidation of market segments: In some circumstances, public and private companies look to acquire competitors to gain scale and euphemistically improve performance with customers. Anti-trust rules notwithstanding, there are several advantages to inorganic growth gained by acquiring a competitor, including significant synergies and lower levels of integration risk.

Moving up the food chain: Every company I have ever worked for has wanted to be something more than just a player in their current market. For example, companies that manufacture wiring devices want to be building automation companies, companies that sell LED lighting want to be controls companies, and companies that manufacture commodity electrical products want to have specifiable solutions in their portfolio. Acquiring businesses that are a “rung up the ladder”, or as it’s sometimes called “adjacencies” (new markets/new products) is a faster, and sometimes a more successful way to move a business towards a more highly differentiated portfolio of products that attract higher margins.

While not without risk this approach can create significant value for owners and shareholders if done taking customer needs into account, often delivering both earnings and multiple expansion if done well, “doing it well” being the obvious challenge.

There are some great examples where this approach has worked well, and distributors and reps can think of examples where this type of combination has been less than stellar. Often the gap between success and less than success is solid integration planning and execution.

Accelerating growth by leveraging new or emerging technology company M&A: One thing that most companies, even companies in the tech sector wrestle with is repeated breakthrough innovation. All companies were good at this at some point in their existence.  Most companies are good at identifying new product innovation close to their core, few successfully identify early enough disruptive market opportunities that are either a risk, or an opportunity! One does not have to look far to find a cable company buying a software business, or an electrical products company buying a technology business (the lighting segment has some examples as do automation companies). The risks of acquiring innovative companies or entrepreneurial businesses is cultural alignment and consequentially keeping innovation alive. Regardless, sometimes the risks are worth the reward, or just a necessity, as the market moves to an alternative better solution based on technology. Ask light bulb manufacturers about missing the boat on the market shift to LED.

Customer scale. Being more valuable to existing customers is arguably the safest growth strategy. This typically involves acquiring businesses with product lines that are bought elsewhere by customers of the acquiring business. If executed well there can be significant commercial and cost synergies for the acquirer. Think duplicate warehouses and sales organizations, not to mention logistics and material sourcing savings. Frequently the issue with this strategy is competitive reaction, customer multiple sourcing objectives as well as channel conflicts. Some of these challenges amplify as customers and manufacturers consolidate and there has been a lot of both over the past decade.

Cost of debt: There is no doubt that money matters in M&A, and whilst interest rates have risen it’s still a good debt market for M&A. It won’t last forever, which fuels a competitive mindset to get deals done. One of the most common debt metrics for borrowers is the debt leverage ratio (Debt/EBITDA).

Conceptually adding debt while adding acquired EBITDA means that a good deal can be nearly neutral to the ratio, with a good synergy case the chances of this improve. However, leveraging-up only makes sense if the debt can be financed. Servicing debt gets harder as markets soften, and the cost of borrowing (interest rates) increases.

In the end there are many reasons why a company acquires another company, there is rarely just one good reason. Most often there is a combination of objectives an acquirer is seeking to achieve. I have outlined some of the most common as it relates to manufacturers acquiring other manufacturers.

Gary Uren: former Global Vice-President, Atkore International, non-executive board director & strategic growth advisor to industrial companies and private equity firms in the US, and Asia Pacific. Email: guren@mckbp.com. Phone: +1 708-897-4279

As you can see, good, strategic reasons to consider M&A as part of your growth strategy and/or as consideration for an exit plan. We continue to hear “lots of money out there” but there are also many “inside” the industry seeking to grow, hence there are strategic / industry buyers available.

A recent example …

Horizon Solutions acquisition of NH BraggHorizon is primarily an industrially-oriented electrical distributor in northern New England and western NY. They are a Rockwell distributor.  NH Bragg is an industrial and safety supplies distributor.  There is geographic overlap which infers some customer overlap. The acquisition enables Horizon to capture greater share of wallet from existing customers who were doing business with both (and probably some synergies), creates opportunities with both companies\’ customers for the others products and creates a strong regional supplier for industrial accounts that want to consolidate MRO spend with more technical spend.  Layer over a robust eCommerce system (and now only need one versus each company needing their own) and robust eCommerce content and there is then a strong regional competitor to Grainger, Fastenal, MSC and others for this type of business. Not to mention some operational efficiencies at a point in time.  A case of M&A changing paradigms and, to a degree, business models.
The same concept could be used in the residential / commercial market … electrical and plumbing? electrical and HVAC? and there are others.

2019 Outlook

The process, and rationale, is very similar whether you are a manufacturer, distributor or rep. The opportunities can be significant but, also make sure that your company can handle an acquisition as it takes more than financial resources to do the integration well and to ensure that “one plus one equals three” and you get your ROI.
And the inevitable challenge with M&A?  It takes “two to tango” which is why many acquisition plans end based upon the first call and some take much time to germinate.  Timing is everything.
What is your prediction for the number of manufacturer deals next year? For the number of distributor deals?  According to EW there was 15 distributor deals and 32 manufacturer deals in 2018 YTD (and some are companies you haven’t heard of.)
Your 2019 prediction?
Thinking of M&A as part of your growth strategy? Give us a call. Channel Marketing Group can help manufacturers, distributors and reps with M&A strategy idea generation and target research.

Share on:

About The Author

Leave a Comment

Your email address will not be published. Required fields are marked *