OPEX reductions may wipe out pandemic losses

Acquiring new leadership

Most LBM dealers that we work with—either consulting on their valuation or bringing them to market for acquisition—are actually having remarkable success in the midst of the pandemic. Some have even seen record days for sales volume.

Despite lumber and materials shortage in some product sectors (like pressure treated wood) and spiking prices, demand is strong for new housing, and—as people sit around their homes, unable to spend money on vacations—remodeling has benefitted as well. The fact that some states have designated LBM dealers as “essential businesses” has helped enormously, allowing them to remain open, even when restaurants right next door have been shuttered.

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That said, not every dealership is having record sales. Some have booked lower sales due to the pandemic. Yet even for those companies, there’s an interesting dynamic at work, and companies that are suffering with sagging sales have discovered a silver lining. The reduction of sales has seen a coincidental reduction in operating expenses (OPEX), as reduced operations demand less cash. Interestingly enough, in the cases we have seen, the reductions in OPEX has been, freakily, almost dollar for dollar, equal to the loss of revenue due to the pandemic, a wash!

How does this OPEX reduction look on P&L (profit-and-loss) statements?

Readers of this column and attendees at our webinars know that when you reduce your OPEX, you add to your EBITDA, on a dollar-for-dollar basis.

If your company cancels its attendance at a contractor trade show, or you skip your summer customer-appreciation picnic, you may save $10,000 here and $5,000 there. The restrictions brought on by the pandemic may have forced you to forgo other OPEX expenses too, such as the salaries of furloughed employees.

These savings add up. However, it’s not as important that these savings add up, as it is where they end up.

Save $10,000 by not going to a trade show lops that amount off of OPEX, and adds it directly to EBITDA. If you were to sell your company, where values are very often calculated on a multiple-of-EBITDA basis, that $10,000 savings can be a $50,000 increase in company value if you were acquired on a 5X EBITDA basis.

Caveat: From the “be careful what you wish for” department, it’s advisable not to feast on too much of a good thing. If you are carefully watching your OPEX (and it’s probably the most important line in the P&L), and carefully watching OPEX as a percentage of sales (a central KPI for any well-run business), you may be happy to see your OPEX drop, and your company value rise as a result of better EBITDA performance. Inspired by these savings, you may say: “Well, give me some more of that!” and perhaps cut OPEX too deeply, diminishing its return on profitability.

Here are the implications of that in an acquisition. When an acquirer takes interest in your company, they will plot your OPEX on a trailing twelve-month basis, while also looking back over two or three years. If your OPEX as a percent of sales drops over time as your company grows (a welcome trend), perhaps you moved from OPEX as a percent of sales of 15%, then 13%, then 11% over the last three years. The acquirer will like that performance. However if you are trending at 15%, 13% and 11%, but then you drop dramatically in the year before the sale of your company, or in the trailing twelve months going into the sales, dropping from 11% to, say, 8%, the acquirer will likely raise a red flag. They’ll rightfully ask if you are reducing OPEX to artificially heighten EBITDA, just to drive up the total enterprise value (TEV) at the long-term expense to the company’s future fortunes. “Are you cutting skin, muscle, and bone here?” is something you might hear, if the OPEX is dramatically reduced as you approach the offering of your company for sale. The acquirer may even look at your OPEX and argue for add-backs that are more normative from past yearly trends. You’ll resist doing so, because those dollars come off EBITDA, but you really do owe the acquirer a company that’s operating within the “swim lanes” and trends of past years, and not a company whose books are being worked to artificially heighten value.

 

John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at j.wagner@1stwestma.com

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