Pent Up Demand for Distribution M&A
Acquisition activity in the distribution sector slowed significantly last year in the wake of the 2008 financial crisis. However, the fundamental drivers for industry consolidation have not changed. Strategic buyers have seen their cash balances rise dramatically and financial buyers with significant amounts of committed equity capital continue to express interest in the distribution sector. After a slow year in 2009, distributor acquisition activity appears poised for an uptick in 2010.
Financial Crisis Slowed Distributor Acquisitions
Acquisitions of U.S. distributors rose from a trough of 104 in 2002 to a peak of 405 in 2007. In 2008, there were 377 acquisitions completed, mostly in the first three quarters of the year. Activity then slowed significantly in the after- math of the 2008 financial crisis, with distributor acquisitions dropping by nearly 40% to 229 in 2009.
Strategic Buyers Hoarding Cash
One byproduct of the slowed acquisition pace has been the growth in strategic buyer cash balances. Among ten publicly traded distribution companies that made ten or more acquisitions since 2000, eight have seen their cash balances rise since the end of 2007, with many seeing dramatic increases.
Collectively, cash balances at these ten strategic buyers rose by a total of $3.4 billion since the end of 2007, representing a 166% increase in cash. These cash balance increases are likely driven in part by inventory reductions to align with slower sales, but the reduced acquisition activity has also played a role. Re- gardless of the cause, these excess cash positions should bode well for acquisi- tion activity in 2010 and beyond.
Strategic Buyer Cash Balances
Financial Buyer Interest Continues
In addition to strategic buyer interest, there continues to be strong demand for distribution company acquisitions among private equity firms. Overall, 344 financial buyers have expressed interest to VRA Partners regarding acquisi- tions in the distribution industry. Of course, not all financial buyers are look- ing for the same type or size of acquisition. 106 of the financial buyers are fo- cused on smaller acquisitions and are looking to write equity checks for less than $20 million. Another 154 firms are willing to write equity checks from $20 million to $99 million, and we know of 84 firms that will purchase larger distributors and can deploy equity checks for $100 million or more per acquisi- tion.
Financial Buyers Interested in Distribution
Financial buyers are also flush with cash. Between 2005 and 2008, approxi- mately $700 billion of private equity capital was raised, an amount which ex- ceeded the total capital committed to the industry in the prior 30 years. A sig- nificant amount of this capital has yet to be invested and it is estimated that the current “overhang” of private equity exceeds $400 billion, which represents over ten years worth of normal M&A activity. Much of this capital is subject to “use it or lose it” covenants, so private equity firms are likely to be increasingly aggressive in seeking acquisitions as investment deadlines near.
Acquisition Activity Poised for a Rebound
With strong interest in the distribution sector and excess cash accumulating among strategic and financial buyers, M&A activity should be poised to reac- celerate. In fact, we may be seeing the initial signs of a rebound. After mak- ing just six acquisitions through the first three quarters of 2009, the ten large public distributors closed a total of eight acquisitions in the fourth quarter. In November, Airgas closed its first acquisition of 2009, ending a 10-month hia- tus. After making six acquisitions in 2008, Arrow Electronics took a year off before closing its first 2009 acquisition in late December. If macroeconomic conditions hold up reasonably well, these initial transactions may lead to a ro- bust M&A recovery in 2010, as pent-up demand for distributor acquisitions translates into increased transaction activity.
Distribution Company Valuation Table and Index
Below is our valuation table and the VRA Partners index of small cap and me- dium cap, publicly traded distribution companies charted against the S&P 500.