The Rollup Option: Distributor Deals Mark a Consolidating Industry

“When you come to a fork in the road, take it.” That nonsensical advice has been attributed to Yogi Berra, the famed New York Yankees catcher of yore. Whether Yogi ever said that is questionable. But the nearly 1,400 large lube and fuel jobbers in the U.S. are indeed approaching a fork in the road — and should be asking themselves, “Which way should I turn?”

Until recently there was no cause for concern about direction. But a few years ago the major oil companies decided that dealing with so many distributors was too much of a hassle. They began agitating for consolidation among distributors.

Thus far, relatively few such consolidations have occurred among the thousands of U.S. distributors. But the trend may accelerate as jobbers see the handwriting on the wall: The majors are able to raise prices sharply and maintain their profit margins, but jobbers are unable to increase their prices enough to sustain margins on sales. And many jobbers find themselves being squeezed because they must pay the majors much sooner than their customers pay them.

[quote_right][dropcap]If[/dropcap] your company’s revenues are less than $200 million, you probably would not qualify as a platform company. But if you make a concerted effort to buy out or merge with other jobbers in your area, you could very well find yourself being courted by a private equity investor.[/quote_right]

How are you going to cope with this pressing problem?

You could grow by acquiring other jobbers, enabling you to improve margins through economies of scale. Alternatively, if your revenues are $200 million a year or more, you could seek to participate in a “rollup” — a term used by merger and acquisition specialists to describe a combination of several companies in the same industry.

Rollups are assembled by investors who band together in what are known as private equity groups. Although the giants in this field usually target individual companies, others specialize in increasing a company’s size through the acquisition of smaller companies. Typically, they will start by buying a company with revenues of $200 million or more, and then use it as a “platform” on which to add other companies in the same business.

Even in these difficult economic times, private equity investors still have money to buy good companies. The largest rollup going on in the country is Maxum Petroleum LLC, headquartered in Greenwich, Conn.

Another rollup was recently started in California when a private equity group bought the Bloomington, Calif.-based Poma Companies as a platform company. Others will probably be started in 2009.

A Price on Success

To determine how much to offer for a jobber, a private equity group will look at what’s called “recast” EBITDA. That’s earnings before interest, taxes, depreciation and amortization, plus owners’ expenses, salaries, perks such as trips, and other compensation. (For example, an owner may be paying himself $400,000 a year, but a private equity group may regard part of that compensation as just a reward for being the owner, and feel that the company could be run by a manager paid a lower salary — which would mean an increase in the value of the company.)

Until several years ago, private equity buyers weren’t interested in jobbers because their EBITDA margins were low. Now that many high-margin businesses have fallen on hard times, they are willing to look at petroleum distributors because of their strong cash flow.

Now, for the purpose of illustration, consider this scenario with two fictional players: Ample Capital Partners, a private equity group, and Jones Distributors, a jobber with annual revenues of $300 million and recast EBITDA of $6 million.

Ample believes Jones Distributors would make a good platform for future acquisitions in its field. So Ample buys 80 percent of Jones for $29 million, or 6 times recast EBITDA, leaving the owner with a 20 percent stake and keeping him on to manage the company. (Like most private equity buyers, Ample doesn’t get involved in the day-to-day management of its portfolio companies as long as things are going well).

Then, with Jones Distributors as its platform, Ample over the next three years buys three more companies, but at a lower multiple of EBITDA, not the 6x multiple it paid for its interest in Jones.

Ample’s objective is to sell or recapitalize the rollup company within five years after acquiring Jones. During the interim, it will seek to increase EBITDA through follow-on acquisitions, superior management, pricing concessions from suppliers and operating efficiencies. If it achieves just a 1 percent improvement, most of that drops to the bottom line.

Assuming that this effort is successful, the 20 percent of Jones still held by the original owner could be worth considerably more than the 80 percent he sold at the beginning of the rollup.

Matchups for Rollups

I’ll turn now to a question readers may have: How do you identify private equity firms that might be interested in buying your company?

You’re not going to find one in the Yellow Pages. There’s no category for Private Equity Investors.

Or you might put the question to your lawyer, your accountant or other financial advisors. But unless they have been involved in a deal in which private equity firms were buyers, these advisors are not likely to come up with even a short list.

The simplest way to find private equity investors who might be interested in your company is to seek out an intermediary who has represented other jobbers in a number of deals with private equity firms. By fostering competition among potential buyers and negotiating with them intensely, such an intermediary can help you get the best possible price for your company and also get a deal done quickly and efficiently, perhaps within six months as opposed to a year or more for deals in other industries.

If your company’s revenues are less than $200 million, you probably would not qualify as a platform company. But if you make a concerted effort to buy out or merge with other jobbers in your area, you could very well find yourself being courted by a private equity investor.

Reprinted from: LUBES N' GREASES, April 2009