What does the increasing pace of M&A activity mean for distributors, manufacturers and reps? How will this change the ecosystem of the electrical industry?
Outspoken and candid industry insider and expert David Gordon has been in the electrical industry since 1995. He helps manufacturers, distributors and rep firms with strategy, marketing, market research and channel initiatives.
In this discussion, Ian Heller and Jonathan Bein, Ph.D., talk with Gordon about the changing electrical channel.
Ian Heller: You are known for your direct and professional writing style. If someone is looking to understand what’s going on in the industry, ElectricalTrends is the place to go. ElectricalTrends is a leading independent blog in the electrical distribution industry. In today’s edition, you announced a couple of acquisitions of manufacturer rep firms that are a bit unusual. What’s going on with these acquisitions?
David Gordon: Let’s talk about acquisitions in general. In the past two and a half years, there have been 80 electrical distributor acquisitions. They’re not necessarily just a small $10 million company getting rolled up. There are large ones and a number of mid-sized regionals. And then there have been manufacturer deals. Rep firms have also had several acquisitions over the past couple of years. And what it comes down to is people aging out. Have I brought up my team well enough for my team to buy me out? Or, if I haven’t, and I don’t have a kid in the business who wants it, I’m going to monetize it, and I’m going to bail. I hate to say it, but that’s what happens.
This last one was ElectroRep and RB Sales merging with Forward Solutions. This was different because they sold to a company that’s outside the industry, a company called Forward Solutions. When you look at their website, they’re essentially an aggregator of rep agencies. They position themselves as an outsourced sales and marketing solution with shared back-office services to support companies. In some industries, they’re a national rep firm with 60 or 70 people across the country.
They now have six to eight different verticals they’re pursuing and want to get into cross-selling. They got into electrical. And interestingly, the company is backed by private equity (PE), which also says something about the profitability of agencies. If you’re a PE firm, you’re looking for the return. Not every PE firm is looking to take their deals and flip it onto Wall Street or flip it to a strategic buyer. There’s a whole network within the PE world where they just flip it to other PE firms.
Heller: What surprises me is that the rep firms’ contracts are 30 days long. Typically, the valuation of a rep firm is one year of commissions. That’s a fairly uncertain revenue stream for a PE group compared to a distribution company that has 20 years of momentum. The probability of those revenues continuing is high, but a PE firm has figured out how to put together a platform of rep firms across distributor verticals.
Gordon: Yes. Whether their same model works in electrical is open to conjecture. As much as they’ve got the 30-day contract you must dig deeper and say it gives them a 30-day out. Some manufacturers have longer deals, but what’s their longevity with those lines? Typically, contracts for the better manufacturers have a change of ownership clause that they can review.
Who knows what’ll happen? But if there’s no change in the operating structure, in the sense of feet on the street and resources, there could be no change in the market. What does that mean for future acquisitions, and will they be able to get alignment in other acquisitions?
Jonathan Bein: When we look at the driver of acquisitions, sometimes it is geographic expansion. Sometimes it is product-line expansion, capability expansion or value-added services. Sometimes, they have the project covered and want to get install and service. What are you seeing now, and will it shift over the next 12-18 months?
Gordon: There are two sides to that. Some companies proactively seek acquisitions. They have a strategy and are usually looking to fill a hole. That hole could be geographic, it could be a market segment, or it could be a product. On the flip side, most deals happen when someone raises their hand and says “it’s time to sell.” The commonality with these deals has nothing to do with the ability to invest. It has nothing to do with technology. It has everything to do with a succession plan. And more accurately, the lack of one.
Who is going to be my next generation? Do I have a family member who is in the business, with a passion for the company and wants to take it to the next level? If you don’t have that, you look to the management team. Do you have an ESOP? Have you mentored your team enough to run the business themselves? Do you have confidence that you’ll get the payout from them on time?
If you don’t have any of these options, you will need a strategic buyer. There are a couple of deals that went to private equity in the past year. They get the dollar amount they want and are able to retain a percentage of the business to get another opportunity down the road.
Heller: Jonathan thinks one of the reasons people are selling their companies is that they don’t have money to invest in the required digital capabilities of the future.
Bein: Yes. We’re seeing this in other sectors. Once you go through those first few options, like succession sell or turning it into an ESOP, and those don’t work out, you’re looking at selling to one of the other options you mentioned. Part of what we’re seeing in other sectors, particularly industrial, is some businesses don’t have a way to make the required transformations. Even at the lower end, they are writing a check for a million dollars, maybe two million. That’s a significant investment for many $10 million-$20 million distributors.
What we’re seeing in other sectors is that acquirers are looking at those companies and asking: Do they have good expertise? Do they have a good customer base?
They recognize they will lose half of the management team upon retirement. Those become great candidates for a company that can inject platform elements into the acquired company. Before Ian separated us and made us put the gloves down and prepare for the call, you said you don’t think that exists in the electrical world.
Gordon: It’s a different dynamic because, within the electrical industry, a large percentage of the business is construction. The buying process is different. I’m not saying that a larger acquirer doesn’t want volume. Buying a small company can give you volume. You retain some of the salespeople; you have economies of scale.
There are a lot of things that can get leveraged, but the technology issue is lack of thought process and personnel. It’s not an issue of electrical distributors not being able to write the check for software solutions and product data solutions. They can write the checks for solutions that will be sufficient to serve their customer base. If they’re 65 years old, they will ask, why do I want to invest in that? I’m going to be looking to sell anyways. They’re talking to their customer base to see what they are looking for. What is sufficient, technology-wise, to serve their customer base?
The 2023 NAED PAR Report, based on 2022 data, showed that ecommerce is 7.7% of the best reporting distributor. That’s going through their website. Consider it hunt-and-peck to order. The median was about 2.5%. I’m not saying websites are unimportant, but it isn’t a main driver for culminating a transaction. There are other ways of getting that content out — other software solutions, ecommerce solutions and data package solutions that people can get that are cost-effective.
The challenge with a $10 million company is, who’s the strategist? Who’s the person who understands even how to use the ERP system? In many cases, it’s the owner. Or if he’s got someone running the ERP, the guy makes $75,000 and is really a network administrator. They don’t have the eCommerce thought process; they don’t have the personnel. They need support in driving that.