It goes without saying that preserving human life is the primary concern in a pandemic or any disaster. With our nation having taken the near term steps needed to curtail the spread of the COVID-19 virus, it is natural for participants in the LBM segment to return to longer term planning as it pertains to the impact of the virus on mergers and acquisitions.
Just like any recession or economic headwind, the impact of the virus will be felt very differently by companies in different regions. Areas where population density is lower had a head start toward social distancing and saw fewer cases. Other areas locked down new construction, while government decision makers in nearby regions classified new construction as an essential business activity. Some companies were forced to close down temporarily, while others chose to do so based upon feedback from their workers.
As was the case in the last and all too recent recession, each company will have its own unique story of the impact of the COVID virus. Similarly, each company will recover differently from any national economic slowdown related to the quarantine. Most LBM companies with whom we are in touch report that they had an outstanding first quarter this year, experiencing only a few days of shutdown at the end of the quarter or none at all. A good guess at press time is that most companies going forward will experience one to three quarters of virus-impacted revenues.
How will buyers approach these suboptimal quarters when LBM companies are brought to market to be sold? In part, that answer will depend upon the trajectory of the recovery and the perception of how completely resolved the virus situation is by late summer or early fall this year. Assuming that the economy appears to be returning to full health and the virus is seen to be nearly completely resolved, we’re left with the question of the soft quarters and how to value an LBM distributor being sold.
The right approach is the one that works for the seller and the buyer. Buyers will be presented with financials containing “noise” related to the virus slowdown and will want to ensure that the target company they are valuing has returned to its historical strength and market position. Sellers, meanwhile, will be unwilling to transact if they feel the valuation of their business is being unfairly affected by lower earnings caused by the virus. At the macroeconomic level, if a given buyer takes a particularly sour view of the overall post-virus recovery, it is likely that they will undervalue companies relative to other buyers.
As a result of these and other dynamics, buyers and sellers will have to agree upon one or more mechanisms in the proposed acquisition to lower the risk of the buyer overpaying, while leaving the seller feeling they’ve received a fair valuation. This includes earnouts to provide additional proceeds to the seller if the company achieves certain financial goals in the year to eighteen months following the transaction. Other approaches could include the seller rolling over enough equity to still own a meaningful stake in the post-acquisition company. In this way, the seller is able to achieve the desired full valuation in a subsequent sale of their minority stake. As long as the seller clears the market by presenting their company to a wide range of potential buyers, a range of valuations from which to choose should emerge.
So, what should companies do now if they are considering selling their business in the next year or so? It will be important to demonstrate that any slow patch in 2020 was due to the virus by creating detailed comparisons of performance during the same (non-virus impacted) months or quarters in 2019. This would include the determination of metrics such as numbers of home packages processed, average order sizes, levels of backlog, and tracking of incoming bid requests. In order to avoid additional noise in the form of commodity price changes, it would be advisable to include board feet amounts and other unit, rather than dollar, measurements that show a better pulse of the business. Any company considering a sale in the next twelve to eighteen months would do well to ensure that all of these internal statistics are in order and ready to be shared with buyers.