Compared to the 1999-2001 period, relatively few electrical distributors were acquired over the past year. Three fundamental economic shifts during approximately that same time period have exacerbated the depth and intensity of the decline in the valuation of companies, and have contributed to this slowdown in consolidation activity.
The bubble bursts
The first factor was the collapse of the dot-com bubble, which brought a bull market that lasted almost a decade to a screeching halt. This market phenomenon had driven values of all economic assets dramatically and unrealistically higher than their historic norms.
Most people knew the excesses of the market were not sustainable. But few were willing to be the first to exit the marketplace for fear of leaving too much on the table. When the correction came, it was swift and merciless. It's still happening.
The second factor was the recessionary environment, which was to some degree coincidental with terrorist attacks of 9-11 and the subsequent malaise that has enveloped the country. Of course, down markets and recessions often go hand-in-hand, and in many ways this is one of the worst periods we have had since the Great Depression of the 1930s. It will be a few years before the “experts” agree on what exactly caused it and just how bad it was in a historic context. However, there is no doubt just how dramatic the effects have been in most sectors.
New consolidators in the electrical industry drive up values
The last factor at play was industry specific and related to acquisitions in the electrical wholesaling industry. To put this in proper perspective, we must look at the history of the consolidation movement, which really started in the late 1970s.
During this early period, most of the founder-owned distributors that were sold were acquired by one of the super-regional distributors such as All-Phase Electric Supply Co., Benton Harbor, Mich.; Consolidated Electrical Distributors, Westlake Village, Calif.; GE Supply, Shelton, Conn; and Westinghouse Electric Supply Co (now WESCO Inc.), Pittsburgh. The vast majority of these transactions took place for prices approximating book value or in some cases a small premium to book value (shareholder's equity) when the target company had especially good margins or a very desirable location.
But when the British conglomerate Thomas Tilling started to consolidate distributors, the industry saw a small increase in relative valuations. This trend pretty much remained constant until the French company CDME (now Rexel) acquired Southern Electric and paid a significant premium to the then industry norms. Once again, this new pricing matrix remained fairly constant until the mid- to late-1990's when Sonepar, Rexel and Hagemeyer entered the market.
This created a very interesting competitive dynamic with each of these giants often bidding against each other to acquire premium distributors. We had entered a true sellers' market, the likes of which had never been experienced before in the electrical business. There were transactions taking place at eight-to-nine times EBIT (earnings before interest and taxes).
As you might guess, a glut of sellers started to appear on the market at about the same time as the stock market began to crash. The result was a decline in multiples being paid. This decline continued along with the deteriorating business environment. The large international buyers were starting to get indigestion from prior transactions and sensed that it was becoming a buyers' market in the electrical wholesaling industry. Some of these buyers are also experiencing their own financial problems and are no longer chasing deals or competing with each other.
This is where we are today in the electrical wholesaling industry. We have a glut of sellers, very few qualified, anxious buyers, poor operating results and acquisition multiples once again trending along historical norms.
Considering these trends, if you want to sell your business, the valuation of your company as a multiple of adjusted EBIT could be 4x-6x EBIT — compared to 5x-8x EBIT two years ago — when a “feeding frenzy” existed as the major consolidators, (particularly Rexel and Sonepar) competed for acquisitions. Where in the 4x-6x EBIT price range a distributor would fall depends on many factors, including the company's size, historic and projected profitability, product mix, reputation in its marketplace and management strength.
When economic conditions improve, the level of acquisition activity will increase, but don't expect company valuations to increase to the levels seen two or three years ago. The industry is still very fragmented and many owners wish to sell. We know this to be the case because we represent or are currently in discussions with several of them. Their reasons for considering sale include a desire to retire and no family member successor; concerns that the business might be adversely affected by competitive factors; and an unwillingness or lack of capital to upgrade facility or management information systems.
The advice we give to clients who want to sell their companies varies. In two situations recently where sales and profitability have held up exceptionally well over the past year, and where we know at least two consolidators would be very interested, we have advised the companies to move forward. In both of these cases, we have given the owners our preliminary indication of what the acquisition price range would be and they are comfortable with the range.
In many other situations, where sales and profitability are down over the past year but expected to improve, we are advising our clients to wait until the environment improves. One exception is a company with profits off about 10 percent, but which is in a very desirous geographic area and has been approached by four potential buyers. They will probably proceed with the sale process shortly.
My firm was recently involved in the sale of Fromm Electric Supply Corp. of Piscataway, Piscataway, N.J., to Sonepar USA, Berwyn, Pa., and the sale of Kennedy Electrical Supply Corp., Jamaica, N.Y., to Crescent Electric Supply Co., East Dubuque, Ill. The owners of both companies were pleased with the valuations received, and their other objectives were satisfied.
In both situations, the owners had realistic price objectives. They understood prices paid during the 1999 to 2001 period for electrical distributors were not achievable, and were an aberration that probably would not be seen again. In both situations, we were able to orchestrate competition between several potential buyers. That was really the key to ultimately achieving a good price and favorable transaction structure.
Multiples of 4x to 6x adjusted EBIT for an electrical distributor are very fair and favorable and historically in the general range that private middle-market companies typically sell for in the vast majority of industries.
Mr. Burkhardt is senior managing director, HT Capital Advisors LLC, New York, N.Y. He can be reached at 212-759-9080.