Acquisition activity among electrical distributors will accelerate now, says C.A. “Burke” Burkhardt, senior managing director, HT Capital Advisors LLC, New York, a private investment banking firm that has managed several of the electrical industry's largest acquisitions in recent years. In a question-and-answer session, Burkhardt offers his take on what electrical wholesalers should expect regarding mergers and acquisitions in the coming years.
Is merger/acquisition activity about to increase?
Yes, definitely. With the improved economic conditions over the past year in most regions of the United States, electrical distributors had significantly better financial results in 2004 than in the prior two years. So far, 2005 is shaping up as a very good year. Potential acquirers also have experienced better times, and most are back on the acquisition trail, or planning to be in the near future.
Unlike at the two previous annual conferences of the National Association of Electrical Distributors (NAED), St. Louis, at the 2005 NAED Annual Conference in Boston last month, we heard some acquisition chatter. Some NAED members have been our clients for several years. Many owners, some at retirement age, previously missed the boat, and are very receptive to selling their companies to the right party at a fair price. Many of these distributors do not have family members or employees to take over the business, and many are faced with substantial capital expenditures to upgrade their information technology (IT) capability.
Do you think there will be a frenzy of acquisition activity similar to four to five years ago when Rexel and Sonepar were aggressively competing for desirable companies and bidding up the prices?
No, we do not see a repeat of those hectic times when the competition between Rexel, Sonepar and in some cases, Hagemeyer, drove earnings before interest and taxes (EBIT) and revenue multiples to record levels. For one thing, given the sale of Rexel, the fierce competition between it and Sonepar as two French rivals no longer exists.
Who will be the buyers this time around?
Generally, the same ones as previously: Sonepar USA, Berwyn, Pa.; Rexel Inc., Dallas; Consolidated Electrical Distributors Inc. (CED), Westlake Village, Calif.; Hughes Supply Inc., Orlando, Fla.; Crescent Electric Supply Inc., East Dubuque, Ill.; WESCO Distribution, Pittsburgh; and on a regional basis, Mayer Electric Supply Co. Inc., Birmingham, Ala.; Summit Electric Supply Co. Inc., Albuquerque, N.M.; and a few others, including some private equity funds.
How does the sale of Rexel to the equity groups affect the acquisition dynamics in the electrical market?
This transaction essentially validates the electrical wholesaling market as an industry worthy of consideration. Private equity funds have billions of dollars to invest and are hungry for deals. In our opinion, several of the 50 largest companies in Electrical Wholesaling's Top 200 could be viable “platform” investments for private equity funds. In fact, the owners of two Top 200 companies recently told us they have been approached by equity funds. In addition, three major distribution companies that sell products to the same customer base as electrical distributors have approached HT Capital. These companies want to explore acquisition possibilities in the electrical wholesaling industry.
Do deals with private-equity firms work any differently than with “inside-industry” acquirers? Are they looking for a different rate of potential return or different type of company?
Generally speaking, unless it's working with an experienced industry executive or knowledgeable consulting group, a private equity firm will not have the same in-depth understanding of the industry as a strategic buyer. They may not grasp the key elements for success in the electrical business, such as inventory management and account receivables, controls, and the importance of customer service and vendor relationships.
Private equity funds would be looking for a higher rate of return over a shorter time period than a strategic buyer, typically five to seven years, and often coinciding with the need of a “liquidity event” because of the terms of the fund. Also, equity funds usually highly leverage their acquisitions, which can constrain the availability of capital for future growth.
Are any regional markets particularly attractive to acquirers right now?
As in the past, the regions that seem to interest acquirers most are the high-growth Sun Belt areas — basically the Southern tier of states, Texas, the Southwest and California. However, in our opinion, some outstanding companies in the Northeast, Mid-Atlantic and Midwest can probably be acquired at somewhat lower prices. Some of them would fit very nicely and enhance the footprint of certain leading acquirers.
What customer mix interests acquirers most? And with the downturn in the industrial market, are electrical distributors with a heavy industrial focus at a disadvantage in their marketability?
Currently, the most desirable customer mix would be one heavily targeted toward residential and commercial contractor business. Those sectors are growing faster and typically the gross profit margins are better than on industrial business. In the 2001 to 2003 downturn, many companies with a high level of industrial business experienced anywhere from a 10 percent to 25 percent decrease in sales. Although many have recovered, acquirers are aware of the risks when a company has a high level of industrial business.
In the past, there has been limited interest in distributors with a heavy focus on utility business. Will that change?
The electrical infrastructure in many parts of the United States is in need of substantial upgrading. That should make such companies more attractive to acquirers than in the past.
What wild cards do you see that could derail the favorable acquisition scenario?
At the moment we do not see any wild card that would derail the developing favorable acquisition environment. If interest rates rise dramatically, the economy turns down, or we have a catastrophic terrorist event, the window of opportunity that owners now have to sell their companies at fair and attractive valuations would close again, as it has in the past.
What other distribution-based industries have a similar acquisition climate?
HT Capital has worked in several other distribution-based industries — most notably the HVAC and plumbing, safety product, MRO, filtration and valve, and building supply distribution industries. All of them are fragmented and are ripe for a continuation of their consolidation trend, given the current favorable acquisition climate.
Several of the potential acquirers rely on or are now building regional distribution centers to support operations and growth in a particular region. How does this trend affect the types of companies that acquirers are looking for?
We know from a potential transaction on which we are now working that this trend can affect the desirability of an acquisition candidate and can also have valuation implications. In this case, it's a big plus for the potential acquirer that it and its acquisition target use the Eclipse IT system. This avoids the extreme management time, expense and uncertainty when conversion to a new IT system is required.
The quality and strength of management of acquisition targets is always a key factor for acquirers. Generally speaking, acquirers with a regional distribution center structure prefer to acquire companies with strong management teams who have good inventory and accounts receivable controls in place because this facilitates a smoother integration of the acquired company.
If you had to give owners thinking of selling their companies just one piece of advice, what would it be?
Be realistic in terms of price expectations, and remember that timing is often everything. The time to consider selling a company is when revenues and profits are good and where several prospective acquirers exist. We are now entering such a period in the electrical wholesaling industry.
HT Capital's Burkhardt: A Unique Perspective on the Acquisition Game
“Burke” Burkhardt, senior managing director, HT Capital Advisors LLC, New York, has been quite active with mergers and acquisitions in the electrical wholesaling industry. HT Capital has represented the owners of many well-known electrical distributors in the sales of their businesses, from the very large Tristate Electrical Supply, Hagerstown, Md., and Viking Electric Supply, St. Paul, Minn., to smaller electrical distributors such as Fromm Electric of Piscataway, Piscataway, N.J., and Kennedy Electrical Supply, Jamaica, N.Y. Most recently, the firm orchestrated the sale of Braid Electric Supply, Nashville, Tenn., to Rexel Inc., Dallas, in September 2004.
Burkhardt has written several articles for Electrical Wholesaling on mergers and acquisitions in the electrical wholesaling industry. He can be reached at (212) 759-9080.