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Where are acquisition values holding?

Wagner

WE GET A STEADY stream of emails and phone calls from LBM dealers who want to know one thing: Are acquisition values holding in this period of inflation and higher interest rates?

The answer is nuanced. Inflation continues to be a threat, as measured by how aggressively the Fed is moving to tame it, but the catastrophic housing recession that many feared is probably not going to arrive, and even a moderate recession is likely to be focused on geographic pockets that lack growth fundamentals.

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To track what values are being paid, our firm subscribes to a database from GF Data that tracks acquisitions by sector. GF Data tracks a wide range of companies, but they also issue a break-out report that shows the values paid for companies with “above-average financials characteristics.”

The GF Data chart shown here tracked 2,302 deals completed from 2003 to 2022, including deals not in the LBM sector, but hundreds that were. The multiple paid in 2021 for companies with “above-average financial characteristics” was 6.6X EBITDA for companies that sold for between $10-$25 million. It was more likely 6.6X Adjusted EBITDA, as that is typical of all the deals that we see.

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If you look at companies that sold for $25-50 million, the multiple was 7.6X in 2021. And for companies sold for $50-100 million, it was 8.7X in 2021.

But look! The multiple paid in 2022 held or— in the $50-100 million range—increased! How could values be holding in a time of inflation and higher interest rates? These were companies with “above-average financial characteristics.”

Before we look at what “above average” means, let’s look at the key performance indicators (KPI) used to separate above-average from average, and then we will look at the target numerical values for those KPIs.

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The leading KPIs acquirers focus on are growth and EBITDA margins. For growth, an above-average company is growing revenues at 10% a year or greater. That’s aggressive, but a 10% YOY growth is what you need if you want a premium multiple on your Adjusted EBITDA.

For Adjusted EBITDA percent, the baseline target for an above-average LBM company is 10%. (A 10% Adjusted EBITDA margin means that for every $1,000 in sales, $100 is Adjusted EBITDA.) Here too, if a company slips below that 10% target, it also slips off the 6.6X and starts looking at 6X, 5.5X, or lower. (A company with 10% YOY growth and 10% Adjusted EBITDA margin is called a “Ten & Ten” company.)

How would the slippage from 6.6X to 6X affect value? Say your Adjusted EBITDA is $2 million. The 6.6X deal value would sell for $13.2 million; the 6X for $12 million; and the 5.5X for $11 million. So, the difference in “TEV” paid (the Total Enterprise Value) for a $2 million Adjusted EBITDA company that dips below that “Ten & Ten” distinction would drop from $13.2 million at 6.6X to $11 million at 5.5X.

In the LBM sector, the 10% Adjusted EBITDA margin is fairly common for companies that have a relatively small proportion of commodity lumber in their product mix. As a product class, commodity lumber is not high-margin, yet you have to carry it. But if the commodity mix starts to creep upward above, say, 40% of your overall product offering, your Adjusted EBITDA percent will slip, as will the multiple offered to you in an acquisition. For LBMers that are offering value-added products like millwork and trim packages, window/door shops, paint, diverse retail, and especially high-margin manufactured components, we have seen midto-high teens for Adjusted EBITDA percentages. Make no mistake, that KPI is of keen interest, and these elite companies invariably sell more quickly, with less leverage (seller notes, earnouts) applied by the seller to hedge risk, and they will likely obtain a premium TEV as a result of the higher multiple applied.

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