CONSULTANTS TO THE AFTERMARKET

Bill Wade

 

Ten Years after "The Big One"

Some Thoughts on the Next Wave in Heavy Duty Distributor Consolidation

By Bill Wade

The basic premise couldn’t have been any simpler. Take a highly fragmented industry facing technological change, customer upheaval and chronic financing difficulties; then add in a few well-healed financial firms or (worse) a couple of previously unknown competitors from “outside the business”.

Since the industry leaders are probably family run businesses (second or third generation) with limited succession strategies, the next step to protect profit and continue growth is clear: Consolidate.

It couldn’t miss. The new company would start out life with the best of everything – smart, entrepreneurial ex-owners as key managers, freshly infused capital from public or private equity funds and savvy top management eager to reap the “low hanging fruit” by combining back offices, systems, inventory, purchasing power and expanded customer contact.

Regional, national or even multi-national market dominance from day one - perfect!

Not So Fast

Amazing as it is to me, this August marks the 10th birthday of FleetPride.

It has been 10 years since names like QDSP, Transcom, HDAPS and AutoZone/TruckPro stalked the halls at every industry gathering. As many as fifty different distributors sold to one or another of these consolidators.

Easily a hundred more did the soul searching math. What exactly is EBITDA? What adjustments could be defended? To sell or not to sell? For cash or stock? Stay involved or retire?

Indeed, 1998 was a watershed year in independent Heavy Duty distribution. Nothing quite like this had ever happened (including the beginning of groups in ‘83 or the OEM all makes programs in ‘79). All of a sudden, heavy duty parts had cash value. Huge networks popped up overnight.

Driving Forces

I’m not going to review all the challenges that made that first industry attempt only partially successful (for that, see “Consolidation Reality” on our website). Rather, this is an attempt to peek at the future.

The difference this time - yes, I said this time - is that there was a last time. As the next wave begins to gather steam, it seems like a good time to reflect on the possibilities and driving forces at work on the structure of the industry today, as they are much different than those that spawned the first episode.

Perhaps the biggest difference between the two eras is the most obvious. It is ten years later. Owners who missed or opted out of the 1998 tsunami are ten years older. The average age is now into the sixties with retirement and estate issues growing daily. What happened to the previously white-hot buyout market?

The interest in acquiring HD distributors seems to have had a time limit. After Transcom crashed, causing some terrible costs to great family businesses, the idea of non-cash based combinations dried up completely.

Successful cash acquirer FleetPride needed to take time to digest and restructure the enormous network created with the merger with HDAPS in 1999. More than 27 individual businesses at 180 locations now flew the FP banner, so it was time to integrate rather than continue to acquire.

Recently, election politics have also accelerated the desire to sell. Senator Obama actually admitted that a tax rate increase might lose revenue, but he held firm to his position that the capital gains rate should be increased from 15 percent to 28 percent.

Even the hint of such an increase is enough to push reticent sellers to the table. In the 2008 version, it will be a ‘cash-is-king’ mentality, but the offers will probably be from industry players, not from pure private equity financial investors.

While not the core of most distributors’ business, combinations among large customers, both common carriers and private fleets, has also added some wind to the consolidation sails. And don’t forget what’s going on with the supplier community. Talk about consolidation!

“Strategic buyers have more power as private equity groups cope with a credit crunch,” says Dr. Adam Fein in a seminar for the National Association of Wholesalers.

Some of the factors currently driving the market:

  • Private business owners in the 55-plus age bracket looking to sell (see above);
  • Foreign buyers taking advantage of currency trends;
  • An abundance of private equity money that still needs to be invested;
  • Strategic buyers are looking for value acquisitions.

The growing success of FleetPride in fact is one of the attractors to entrepreneurs hoping to become a major player, essentially FP is acting as a successful proof of concept. Distribution in general is coming back into favor with the money guys, so funds are not the problem.

The Players

Credit crunch be damned, there is more than enough funding to complete acquisitions on the same general scale as the last time. The players can be aligned into two groups:

Insiders - possibilities from within the heavy parts industry include:

  • FleetPride - The recent purchase of Keller Truck Parts signals the interest and means to build through further large purchases;
  • Very Large Independents - Inland, Crane Carrier or TruckPro know well how to play this game;
  • Truck Dealers - Big guys like Rush or Worldwide may find expanding in service and parts faster through the buy route than thru the build process;
  • All Makes OES Operations - Truck makers have long bemoaned the lousy percentage they get of the parts side.

Outsiders - these are some related distributors who need to find greener fields for future sales and profit growth:

  • NAPA - Announcements of a Traction- modeled approach (along with the recent Brake Service purchase) shows that the guys in Atlanta are serious about becoming the “NAPA of the Heavy Parts Business”;
  • Carquest - If NAPA can do it, why not CQ, especially with their experience in ‘joint venture’ style acquisitions that are designed to keep existing personnel involved.
  • Industrial Crossovers - Grainger, Fastenal and others have developed sophisticated systems that would probably fit the HD business beautifully. There may even be some of these based in Europe or Asia that are interested.

Valuation

Forget the formulaic type of valuations from round one. This time, strategy trumps all. It won’t be a case of how much is my place worth (EBITDA times some magic multiple), rather how much is it worth to whom and why.

Strategic interest may come from pursuit of the mythical national footprint, or from the presence of bench or on-vehicle service in distributor locations. Service will elicit a premium price this time, as will locations that fall logically into an acquirer’s logistical map for customer service or branch inventory support.

The importance of keeping talented players (especially at the branch level) is certainly one of the key lessons from 1998. Operations with stable, well trained employees will find themselves on top of the target list.

The Role of Groups

Groups exist as a form of virtual consolidation, offering suppliers and widely dispersed fleet customers many of the benefits of a consolidated service channel, without the distributor having to survive the emotionally wrenching family issues and expensive legal sale question.

However, successful acquirers as diverse as FleetPride, Motion Industries and O’Reilly Automotive have proven the absolute strength of an equity combination as an unbeatable model of continued profitability, operational control and shareholder value growth.

Consolidations can vastly reduce the marketing clout of groups, as the better players tend to be the prime targets. Last time, Heavy Duty America was the hardest hit, losing the likes of Jim Stone, Larry Clayton, John Sharkey, Ray Fay and David Seewack.

It looks like this time may be Vipar’s turn in the barrel. They have a disproportionately large membership among the targets as outlined above. Even an extremely well run group can’t out duel a pile of cash.

The aftermath could be entirely different this time. I think that there will be only one important marketing group left, but it will be much different than the four or five today.

The most important change is that it will feature some form of equity pooling, with super-strength common marketing. While still a virtual consolidation, this super group will be able to provide first class locations in markets that could otherwise pose a geographic lockout for suppliers.

This ‘group on steroids’ will be a major player and could eventually form the platform for a full fledged equity consolidation.

The Future Landscape

By 2010, coverage of the national market could rely on:

  • Four integrated heavy truck makers;
  • Five full range trailer builders;
  • Three heavy engine choices;
  • Six major truck & equipment dealers;
  • Five large HD distribution chains;
  • Three OES parts only spinoffs;
  • Two Internet –based parts expeditors;
  • One super marketing group;
  • 75% of today’s independents.

Seventy-five percent of today’s independents servicing the 75 top 100 (2008) fleets that survive the fuel, labor and regulatory shakeout, as well as then environmentally compliant local vocational and municipal truck operators.

Interestingly, while splintering of the supply base looks equally likely to further consolidation, fleet- direct still doesn’t fit into the industry model in a meaningful way.

If It Were So Damned Simple, They Wouldn’t Need Us!

Like we said at the beginning- the basic premise couldn’t be any simpler. Ten years later, we still have:

  • A highly fragmented industry;
  • Facing technological change, in both the products carried and the technology to train people and deliver parts and service;
  • Customer economic and regulatory upheaval;
  • Chronic financing difficulties.

Industry leaders are still family run businesses (second or third generation) with limited succession strategies. The next step to protect profit and continue growth is once again clear: Consolidation.

The big difference might be that this time participants will keep and grow the smart, entrepreneurial ex-owners as key managers.

Maybe this time participants will use freshly infused capital to combine back offices, systems, inventory, purchasing power and expanded customer contact - immediately.

Maybe this will be the chance for the HD distribution to catch up in providing world-class customer service, while making a fair margin.

In short - regional, national or even multi-national market dominance - from day one - still possible!

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