The Fallout from HD Supply
In June, I wondered if M&A activity in wholesale distribution was peaking. Well, I guess we don’t have to wonder anymore.
As you’ve surely read, Home Depot was forced to lower the price of its HD Supply unit by $1.8 billion and guarantee $1 billion of debt for the buyers – private equity firms Bain Capital, Clayton Dubilier & Rice, and Carlyle Group. HD Supply CEO Joe DeAngelo was “thrilled to be associated with this group of distinguished private equity firms.” (See HD Supply Deal Closes.)
Many big private-equity deals outside wholesale distribution are facing similar troubles because of so-called “turmoil in the credit markets.” Translation: lenders were taking on too much risk to buy companies that were over-valued. The Wall Street Journal’s Deal Journal summarized the status of many big deals last week.
But the renegotiation is not surprising given the sharp slowdown in revenues of building materials wholesaler-distributors. The chart below, which updates data from my NAW Economic Reports, shows double digit drops in revenues in 2007. The numbers look equally bad after adjusting for price deflation (not shown).
The next big shock will come if commodity prices return to historical levels, closing an inflation-led growth gap. For example, electrical wholesalers have been riding high on the price of copper for a few years and face an especially painful return to earth.
Bottom line: I suspect that valuations of wholesale distribution companies will return to more sensible levels over the next few years. Good news for companies looking to expand by acquisition, but bad news for sellers hoping to get out at the top.
3 comments:
I do not believe this to be the end of consolidation. However I do think Distribution Companies need to acquire based on synergies to be realized. HD Supply is a consolidation of many non-related types of distributors from various disciplines having no game plan as to how to leverage the group. They certainly were headed down the correct road with their thrust into the Waterworks and Electric T&D Industries but some of the other components, including Master Distributors and General Line Construction Supplies, as well as Fastener Companies just had no value to add other than more revenue.
I sat through a construction forecasting conference in October 2006. John Mothersole of Global Insight was introduced as a commodities expert. He said copper's price would fall in 2007 and the average price would be about $2.75/pound.
Not only is my memory of that moment clear -- I was shocked anybut I have one would say such a thing -- but I still have his PowerPoint here in my office.
That hasn't been the case. JM of GI was wrong-o!
In 2005, lots of commodity experts predicted the red metal would rise, but peak out around $2.00 or $2.20.
That wasn't the case. In fact, if you believed that “advice,” you either missed the copper bull market completely – or, even worse, went short the metal at $2.20. Bad move!
Adam, you now say electrical distributors will have to cope with a deflating copper price. You might be right, sooner or later.
But there are 2 things I am now sure about:
1 -- no one should ever make a prediction out loud about the price of copper in the future. I've had a lot of fun regurgitating errant predictions at www.tedmag.com!
No one should print any such prediction. And savvy folks will avoid putting any such warning on the Web anywhere, of course.
2 -- the bottom has fallen out of the U.S. housing market -- worse than most "experts" imagined. It might or might not worsen from here. But even with what's happened thus far, copper's price has been above $3.20/pound since mid-April. See the One-Year price chart at:
http://www.kitcometals.com/charts/copper_historical_large.html#1year
A third thing (about which I am NOT sure) is that the question of copper's future price will be answered in China.
The International Copper Study Group, in releases I've seen, notes that it has a good handle on the copper supply/demand equation . . . except for China!
That’s like saying the Boston Red Sox have been the best team in the American League since trading Babe Ruth away . . . except for the New York Yankees!
What’s more, there are scary facts out there (if one cares about copper's future price). I recently read an article from The McKinsey Quarterly, "Global trends in energy." It includes this:
"China . . . is expected to add another 500 gigawatts of generating
capacity by 2020, on top of the 400 gigawatts added over the
past two decades."
Assuming the Chinese build roughly FORTY 1,000 megawatt power plants -- annually -- on average between now and 2020, that’s a lot of copper.
Beyond whatever they use in building the plants, I would guess that the Chinese will use a lot of copper building places for people
to live and work . . . a lot of copper goes into those buildings, you know.
Thanks, Joe. Great comments, as always. I also suggest that interested readers check out your February Copper Report. I do hope that electrical distribution CEOs are appreciating the real source of their superior profits.
BTW, you’ll notice that I did not predict *when* copper might decline. My secret to perfect forecasting: give an event or a date, but never both.
Adam
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