January came in like a lion for electrical distribution on the M&A front. Here’s what it means for the industry, the role that private equity is playing in this momentum, and what distributors need to know about the road ahead.
It looks like the new decade is already off to a roaring start on the mergers and acquisitions (M&A) front, with Anixter International initially entering into a definitive agreement with an affiliate of Clayton, Dubilier & Rice to be acquired in a $3.8 billion all-cash transaction and LKCM Headwater Investments acquiring Rexel’s Gexpro Services business.
While Anixter did change course and was ultimately acquired by WESCO, the fact that both deals involve private equity firms acquiring some or all of a distributor’s business is a trend that could continue or even gain speed as we move further into 2020. Investment management companies that provide financial backing and make investments using leveraged buyout, venture capital, and growth capital, private equity firms are clearly taking an interest in the electrical distribution segment.
To find out why, and to learn more about how this could impact distributors—and the sector as a whole—tED magazine spoke with Joe Wagner, managing director at Chicago-based P&M Corporate Finance (PMCF). He leads his firm’s Distribution group and co-leads the firm’s Diversified Industrials group, where he advises businesses that serve the manufacturing, distribution, and transportation industries. Here’s Wagner’s take on the current M&A environment and what’s ahead for the rest of the year.
Q: As we make our way into 2020, what trends are you seeing in industrial distribution M&A?
A: The market’s still fairly robust and active. We’re continuing to see that across distribution markets, including electrical distribution. The CD&R/WESCO situation with Anixter is just one example of a strong M&A market heading into 2020.
Q: Why is electrical distribution an M&A target?
A: It’s still relatively fragmented with growth potential. These are two key ingredients for industries ripe for consolidation. Further, it’s a market that’s being driven by the strength of the overall economy as well as the availability of capital from strategic buyers and financial buyers.
Q: What does it mean when private equity shows an interest in an industry sector?
A: Globally there are over 200 electrical distributors with private equity ownership. So financial buyer interest in electrical distribution isn’t new, but significant consolidation opportunity still exists—as evidenced by the headlines that we’re seeing. In 2019 alone, 47 deals were completed with electrical distribution firms; and 25% of those deals involved a financial buyer. We don’t consider electrical distribution a “large market” for private equity, but it’s one that’s attracting the attention of sophisticated funds.
Q: What makes electrical distribution an attractive sector for these investors?
A: When private equity groups—or private equity as an asset class—take interest in a sector, that generally means the sector is ripe for generating returns for that investor. This can take different forms. For example, it can mean that the industry is very fragmented, or it’s undervalued. Both present opportunities for an equity fund to acquire a platform (generally their first investment in the sector). Then, the investor will complete what’s known as a “buy and build strategy,” where it completes multiple other add-ons in order to build a larger platform. Finally, usually within 10 years, the fund will sell that platform and secure an attractive target return on its investment.
Q: What if the private equity doesn’t understand electrical distribution?
A: Just because they’re not experts at running electrical distribution businesses doesn’t mean they’re not valuable as owners. It’s all about specialization. Where 10-15 years ago private equity was largely focused on financial engineering (i.e., buy a business, fund it with debt, grow the business, pay down the debt, and then sell), many of them are now finding ways to differentiate themselves in specific markets by partnering with industry experts to lead an investment strategy in a particular niche market. For the most part, private equity doesn’t look to come in and drastically change the way businesses are doing things. They’ll make improvements, use their expertise, invest in management teams, and bring an angle (e.g., new relationships, access to capital, industry leadership, etc.) that help the company accelerate its growth.
Q: Are there times when these investors overreach into areas where they lack expertise and when their long-term plans fail?
A: Unfortunately, the term “private equity” has a negative connotation. This is due to a small sample of funds that really do look to “slash and burn.” They cut costs, bring in new management teams, close facilities, and try to ring out costs for every profit dollar. In reality, things are very different with private equity, which for the most part is positive for markets and good for business. They’re brought in as a source of capital that’s then used to grow the business. Yes, they’re seeking a return, but the best returns are generated through growth—not through cost-cutting.
Q: What else should electrical distributors know about the M&A trend and how it might impact their businesses this year?
A: Right now, we’re seeing new growth avenues for companies that participate in the electrical equipment sector, including manufacturers, distributors, and service providers. One key driver is the fact that electrical power is replacing other power sources, creating a nice growth runway for the sector. And, corporate strategies aligned with capturing this “white space” are positioned favorably with buyers (i.e., investors are interested in companies that put time/effort into alternative power sector). Separately, distributors will want to keep an eye on the upcoming presidential election and how it may impact timing to pursue a sale or acquisition. Should personal or corporate tax rates increase, we expect an acceleration of business sales as sellers look to benefit from today’s favorable tax rate environment.
Tagged with mergers and acquisitions
Been a part of that scenario. Firms goals are to paint a beautiful picture and sell stock. It is absolutely terrible for the customer, the employees and the electrical
distribution business!