DIVERSIFIED INDUSTRIALS M&A UPDATE: FALL 2018

HomeDIVERSIFIED INDUSTRIALS M&A UPDATE: FALL 2018

MERIDIAN CAPITAL OVERVIEW

With over two decades of experience in complex corporate finance and M&A challenges, Meridian Capital serves as a trusted advisor to leading middle market companies. We have over $6B in transaction experience, which offers us deep industry insight and a holistic industry coverage. Our seasoned professionals focus on businesses with $20M to $400M+ in enterprise value.

Twice a year, Meridian Capital publishes its Diversified Industrials M&A Update, which focuses on key M&A trends in industrial distribution and manufacturing sectors. The Fall 2018 edition focuses on activity within value-add and specialty distribution sectors.

For a PDF version of this newsletter please click HERE.

WHAT IS DIVERSIFIED INDUSTRIALS?

OUR DIVERSIFIED INDUSTRIALS TEAM

Brian Murphy
President & Managing Director
Bruce Pym
Managing Director
Kristin Brandtner
Senior Vice President
Mark Mennella
Industry Advisor
Benton Sturt
Associate
Hayley Koellen
Senior Analyst
Sean Maier
Analyst

OUR DIVERSIFIED INDUSTRIALS EXPERTISE

Specialty Distribution

Niche Manufacturing

Engineering Services

Building Products

SPECIALTY DISTRIBUTION

Specialty Distribution Focus for this Update

  • Automotive Aftermarket
  • Branded Wholesale
  • Building Materials
  • Food & Foodservice Distribution
  • Industrial and Safety Distribution
  • Medical and Dental Distribution
  • Power and Electrical Distribution
  • Transportation and Logistics

M&A MARKET MOMENTUM

Sustained macroeconomic momentum in the U.S. industrial markets has encouraged M&A activity. Macroeconomic indicators and key growth indexes continue to reflect positive market momentum. Strong purchasing manager confidence and industrial production output reflect a peak in industrial market confidence. Growth in durable goods orders continues to outpace shipments supporting continued economic expansion in the near term.

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    PMI: The PMI is an indicator of economic health for manufacturing and service sectors. The PMI is compiled and released monthly by the Institute for Supply Management and is based on a monthly survey sent to senior executives at more than 400 companies. Source: Institute for Supply Management

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    IPI: A monthly economic indicator measuring real output in the manufacturing, mining, electric and gas industries, relative to a base year. IPI is expressed as an index level relative to a base year, representing the relative percentage change in production. Growth in the production index is an indicator of growth in the industry. Source: Federal Reserve Economic Data

Middle Market Transactions Leverage Trend (Debt / EBITDA – All LBOs)

  • EBITDA multiples (source: Pitchbook through to 9/30/2018). Average = 5.3x

A positive economic outlook and strong capital markets drove robust distribution M&A activity in 2018. Total deal value through mid November has exceeded $31 billion across more than 423 transactions. This transaction volume activity represents a 2% increase over the same period in 2017 and more than 25% above the trailing 10-year average.

U.S. Specialty Distribution M&A Activity
Last 10 Years; Number of transactions

  • Corporate/Strategic M&A
  • Private Equity

DIVERSIFIED INDUSTRIALS "SPECIALTY DISTRIBUTION" M&A TRENDS:

THE AMAZON EFFECT

  • Amazon continues to pose a significant risk to distributors in B2B distribution markets. The online retail giant has set the market expectation for greater on-demand delivery and pricing transparency causing distributors to adjust their pricing strategies to be more competitive on off-the-shelf items. These shifts are impacting distributors’ gross margins, leading many businesses to seek growth through geographic or channel expansion in order to increase scale and combat margin compression. These market factors have created an active environment for M&A as distributors utilize acquisitions to enter new markets and expand market share.
  • While Amazon has made strides in select B2B distribution markets, the company has faced challenges penetrating industrial OEM and MRO markets. One of the greatest barriers to entry in these markets is the rigorous OEM requirements for purchases of mission-critical machinery, components, or supplies that are technical or complex and require unique value-added services and customization.
  • The higher the levels of service and customization, the more insulated a distribution sector will be from the impacts of the Amazon effect. Distributors are actively diversifying to combat this by developing dominant positions in niche end-markets, enhancing technical expertise and high-touch services, offering vendor-managed inventory, shifting customer conversations toward total cost of ownership, and ultimately participating in strategic M&A to build incremental differentiating capabilities.

AUTOMATION AND TECHNOLOGY ADOPTION

  • Technology can be a source of significant competitive advantage for specialty distributors seeking to scale operations and improve margins. Recently the industry has experienced a rising trend toward implementing warehouse management software systems to increase fulfillment efficiency and drive speed through distribution networks. In response to rising labor costs, some distributors are investing in robotic systems, self-driving lifts, and other forms of automation. Distributors are also building ecommerce offerings to supplement their core businesses.
  • Distributors with robust technology platforms can realize significant value through integrating smaller businesses onto their platforms. Some distributors are driving technology improvement by acquiring other companies that are further along on the technology adoption curve in order to leverage in-house technology expertise.
  • As an example of this, in March 2018, Ficodis Group, a Quebec-based industrial supply distributor, acquired cutting tool supplier, Elite Tools.  Through this acquisition, Ficodis is seeking to leverage Elite Tools’ strong online sales expertise and platform to improve its own ecommerce operations.

ACTIVE CONSOLIDATORS DRIVING PREMIUM VALUATIONS

  • The continued availability of debt and equity capital has fueled active consolidation in a number of distribution sectors. In actively consolidating sectors, premium valuations are available for mature companies that represent attractive platforms for consolidation as well as for potential add-on acquisition targets with unique niches or leadership positions in key geographic markets. In sectors with multiple acquisitive players, premium values often come as a result of competitive bidding environments. These environments have, in some cases, yielded values above and beyond what may have been expected based on gross margin profile.
  • The foodservice equipment and supplies (FE&S) industry represents a later stage consolidation environment in which the largest participants remain highly acquisitive backed by healthy balance sheets and well-funded private equity funds. The largest company in the sub-sector, Trimark, changed ownership last year when Warburg Pincus sold it’s position to Centerbridge Partners for a double digit, premium EBITDA multiple. Private equity investors continue to view Trimark as an attractive platform for incremental market consolidation driving this premium valuation.
  • In another example of a consolidating market, M&A activity within the janitorial, cleaning, and paper product distribution sector has recently been accelerated by increased interest from several roll-up private equity groups, most notably Audax Private Equity. Since acquiring Imperial Dade in late 2016, Audax has made seven add-on acquisitions (four in 2018).

EXPANSION OF NATIONAL AND INTERNATIONAL FOOTPRINTS

  • Increasing pressure from online competition, expensive long-distance freight costs, and a need to obtain market share in growing geographies has continued to motivate many distributors to expand their geographic footprints through M&A, both nationally and internationally.
  • One of the most active examples of geographic footprint expansion in 2018 has taken place within the building and landscape supply subsector. SiteOne Landscape Supply (NYSE:SITE) has lead the sector, completing 12 acquisitions through November. SiteOne’s expansion initiative has included adding new distribution properties in Colorado, Florida, Washington, Virginia, Boston, East Texas, and several other attractive metropolitan areas.
  • On the international front, auto aftermarket distributor LKQ (Nasdaq:LKQ) recently acquired Stahlgruber, a leading European wholesale distributor of aftermarket spare parts. The CEO of LKQ Europe said of the transaction, “Stahlgruber will create a contiguous footprint and serve as an additional strategic hub for our European operations, allowing for continued improvement in procurement, logistics and infrastructure optimization.”

SPECIALTY DISTRIBUTION SUBSECTORS VALUATION MATRIX

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For distributors, gross margins are commonly indicative of the level of value-add or unique services offered. Valuations are typically centered on this dynamic with some exception for consolidation / M&A activity, rebate and buying group influence, contractual agreements, etc.

Source: Pitchbook

SPECIALTY DISTRIBUTION PERFORMANCE VALUATION TRENDS

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5 Year Sub-Sector Performance
Monthly, average closing prices

Source: Pitchbook, based on data through 11/20/2018

M&A SELECT CASE STUDIES

PRIVATE EQUITY

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    Rationale and Commentary

    The foodservice equipment and supplies industry has been actively consolidating distributors in recent years as top participants have executed roll-up strategies backed by large private equity groups

    Key considerations for acquisitions include rebate programs and buying group relationships, customer concentration and length of relationship, and value-add services offerings

     

    Source: BusinessWire, Pitchbook

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    Rationale and Commentary

    Center Oak has an impressive track record of developing specialty distribution businesses, including significant experience supporting geographic and product line expansion strategies

    “We are very impressed with the Company’s emphasis on technical expertise, product category leadership and customer service – three pillars of a strong and scalable value proposition,” said Randall Fojtasek, Managing Partner of CenterOak

     

    Source: BusinessWire, Pitchbook

STRATEGIC

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    Rationale and Commentary

    Landscape and irrigation distribution has seen a surge since 2016 with the top publicly-traded companies actively consolidating attractive geographies and expanding product lines and offerings

    SiteOne has made more than 12 acquisitions in the first three quarters of 2018 as the company remains focused on an aggressive M&A strategy

     

    Source: Industrial Distribution.com, Pitchbook, Company websites, Meridian Research

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    Rationale and Commentary

    Bunzl, a business focused primarily on distributor, has opportunistically made vertical acquisition of select manufacturers in the safety space.

    “The acquisition of Revco represents a further development of our safety business in the US with the business, in particular complementing and strengthening our existing presence in the welding and industrial supplies market,“  – Bunzl CEO Franck van Zanten

     

    Source: Industrial Distribution.com, Pitchbook, Company websites, Meridian Research

“The model by which consumer and commercial goods are distributed in the U.S. has evolved significantly over the past decade. Future success will be heavily focused on a distributor’s ability to leverage technology, provide value-added services that create binding relationships, and establish geographic advantage.”

Brian Murphy, President & Managing Director
Meridian Capital