MERGERS & ACQUISITIONS: The Fuss Over Specialty
Mergers & Acquisitions
As deal makers, one of the few unique benefits we have when reviewing many different businesses, is seeing what works, and what doesn’t. For those lumberyards pondering non-organic ways to grow their business, why not consider acquiring a specialty business such as drywall or roofing & siding distribution?
Consider the trend: ABC Supply, Allied, Builders First- Source, and US LBM all have significant exposure to roofing & siding and/or drywall. There’s also no lack of private equity investors willing to invest in these specialty dealers (i.e. SRS, RSG, GMS, Foundation Building Supply, etc.)—and more call us every day looking for exposure to these businesses.
What’s the fuss about? Why is there is so much interest in specialty deals? Why isn’t there the same interest in lumberyards? Here’s what we see:
1. End markets, which are more desirable or accessible.
Roofing is a much safer business, where 75% to 80% of the industry segment’s revenues come from repair or replacement activity. Private equity favors these businesses because the cash flows are more stable. Drywall does not have this type of market driver, but what they do have is a set of products and equipment, which can ship to the various end markets as they get busy. Residential slows down? No problem, sell some commercial jobs.
Compare these traits to the lumberyard business, where we rely on housing starts in a big way, and the different end markets of residential single family (custom and production), residential multi-family, commercial, industrial, DIY, etc., which require different products, equipment, staff, institutional knowledge, etc.
2. The manufacturers make a huge difference.
How many significant manufacturers are there in drywall? In roofing? They’re oligopolies, the product of which results in better and less volatile pricing, and some control over how the channel works by picking and choosing which dealers get product, who does not, and rewarding rebates in a meritocracy—leading to higher levels of profitability than their lumberyard cousins. In fact, some drywall manufacturers have even been rumored to want fewer dealers. If this isn’t enough to sway you, consider that the payment terms are also better.
Now compare those channels to the reality for lumberyards. Everyone knows the margins are thin. How about commodity price risk? There is no shortage of manufacturers/suppliers willing to contribute to volatile commodity prices. Lumber and panel price volatility is endemic for lumber dealers.
To pile on, working capital is an even worse attribute. As a distributor, where managing working capital is a key to making a return, buying from lumber mills offers some of the worst payment terms available. Here’s an example: Buy a car load of lumber, pay within 10 days from when it leaves the mill, hope the product makes it to you in a timely fashion (never a sure thing), sit on the product for 4-6 weeks, and get paid 45 days on average by your customers. It is not uncommon to hear from a lumber mill that “their business doesn’t work” if they aren’t paid in 10 days. And yet, they only want customers with strong balance sheets. There appears to be some disconnect here. When the private equity community sees this channel dynamic, they respond, “Well, it might not work for the mills but this doesn’t work for the lumberyard business, either.”
3. Smaller operation footprints lead to outsized results.
Roofing & siding and drywall have a smaller number of SKUs, and need a much smaller operation to distribute than lumberyards. We’ve covered better margins and working capital above, which leads to more EBITDA. More EBITDA on fewer assets equals a higher return on assets (ROA).
4. The timing may be right.
Specialty manufacturers may have figured out they need you. At an invitation-only event a few weeks ago, attended by many of the largest independent dealers in the country, one of the world’s largest roofing manufacturers was in attendance and sponsoring the event. I quipped at the time, that 15 years ago this never would have happened. Due to all of the consolidation, lumberyards are now important. Clearly this isn’t lost on drywall manufacturers, who face issues from consolidation of their own.
Consider these takeaways as food for thought as you decide how to steer your business. We believe the specialty business is worth it, because if executed properly—this business can provide an outsized return to risk opportunity for the independent lumberyard.