The lubricants business is being reshaped by a number of significant factors. These include consolidation, growth in private-label products, OEM performance specifications, battles between fast lubes and car dealers, plus concerns around lubricant quality, extended drains, globalization and more. But for lubricant distributors, one factor in particular has garnered increasing attention over the past few years: the expanding presence of private equity. Specifically, many are asking why private equity is investing in lubricant distribution, and how it will impact the business moving forward.
For those unfamiliar with private equity, its capital invested by businesses that are not typically publicly traded. Funds are usually managed by private equity firms that often raise cash from institutional investors (pension funds, endowments, the wealthy). They commit large amounts of capital to make acquisitions, develop new technologies, and/or buy out public companies. The investors hope to enjoy hefty returns on their money from such activity. And if successful, the private equity firms managing partners often reap great personal wealth, too.
So why is PE getting into the lubricants business?
Private equity firms often hunt their trophies in the jungles of overcrowded, fragmented markets experiencing change. These markets are characterized by an abundance of small-to-mid-size players that compete intensely for market share in a business environment that cannot sustain them all. Private equity firms see the potential to enjoy big gains in such markets by hunting for and acquiring (rolling up) multiple suppliers. In doing so, they hope to increase the value of the combined businesses by commanding greater scale, reducing costs, expanding capabilities and other tactics. Once thats accomplished, the private equity firm exits – sells the business – hopefully at multiples of what they originally paid for the acquired companies. This brings high returns to their investors, and riches for the private equity managers themselves.
The lubricant distribution business has many of the characteristics of a market ripe for rollup. Its a business where there are still close to 5,000 marketers, competition is intense, and the industry is moving through transition. Its also a business where there are opportunities to increase valuations by building scale through vertical integration/acquisitions, reducing fixed costs, and leveraging supplier and customer relationships. In addition, value can be added by horizontally integrating companies that offer synergistic and complimentary products and services.
So one reason private equity is investing in lubricant distribution is because the business environment fits the investment model many use, a model based on buying, building and selling. Remember, for a private equity firm to deliver the kind of returns its investors expect, it usually has to sell the companies it invested in, and do so at a sizable increase in value. Further, it usually has to sell the asset within a reasonable period of time, typically four to six years. For these reasons, private equity firms have an exit strategy in mind before they pursue a rollup.
In general, there are two highly desirable ways private equity firms ultimately exit a business. One, a home run, is an initial public offering (IPO); the other is to find a strategic buyer. Who might be interested in strategically buying a bundle of lubricant distribution businesses? Think of major oil companies, transport companies, chemical distribution companies, MRO suppliers, and large, rival distributors. Interestingly, some of these strategic buyers themselves are owned by private equity, and they too will be looking for an exit.
But not every planned exit works out, and private equity groups sometimes have to exit in less-desirable ways. These include selling back to the previous owners, dismembering and selling off pieces of the rollup, or accepting a distressed price from turn-around specialists. Few in the world of private equity want to talk about these deals, but they do happen.
Although those behind the closed doors of private equity firms are the only ones who truly know how they plan to exit, some hints are given by what has already transpired. Maxum Petroleum, for example, filed with the federal Securities and Exchange Commission to go public in 2007; so it appeared this rollup venture (clearly the biggest in lubricant and fuel distribution) would exit private equity via an IPO. Instead, Maxum pulled its registration shortly after filing and today, nearly eight years after its launch, is still run by private equity.
Then there is Windward Petroleum. Windward is now into its twelfth year of private equity ownership and recently divested its interest in a number of locations in the southern United States, selling them to other lubricant marketers and manufacturers.
It may be too early to tell (especially considering the economy) how these or any of the private equity rollups in the lubricant distribution space will exit the business, or if they will make big bucks when they go. But you can be sure they are leaving their mark.