DSGR - Merion Road Capital - Distribution Solutions Group: Reasonable Valuation In A Fragmented Industry
2023-07-26 08:30:00 ET
Summary
- Distribution Solutions Group was formed from the merger of Lawson Products, Gexpro Services, and TestEquity in early 2022, with a focus on leveraging corporate synergies.
- DSGR has grown revenue organically at a mid-teens rate since the merger, and has a fully built-out M&A team with a disciplined investment framework.
- In March, DSGR announced the acquisition of Hisco, a distributor serving various industries, which is expected to enhance customer value and provide cross-selling opportunities.
The following segment was excerpted from this fund letter.
Distribution Solutions Group ( DSGR )
During the quarter, I built a position in Distribution Solutions Group ahead of their rights offering. In addition to exercising our basic subscription rights, I put in for over-subscription and was pleasantly surprised to receive additional shares. DSGR is a specialty distribution platform formed when Lawson Products combined with two privately held entities, Gexpro Services and TestEquity in early 2022.
Lawson is a North American industrial MRO distributor serving 80k customers across a range of industries including manufacturing, automotive, government/military, and construction. Lawson maintains cabinets at the customer location that they frequently restock with a myriad of low-ASP products. This allows their customer to reduce downtime and streamline product management.
Gexpro is a global specialty distributor of highly specified products serving manufacturers in various markets including renewables, power generation, aerospace/defense, and consumer/industrial.
Lastly, TestEquity is a global distributor of electronic production supplies and test and measurement solutions for aerospace/defense, industrial electronics, semiconductor production, and wireless communication. In aggregate, these can be described as low churn, highly recurring business models.
While DSGR is organized as a platform company with the three entities retaining prior leadership, they have a strong focus on leveraging the benefits of the three entities. This includes things like corporate synergies in IT and insurance, leadership incentives for cross-selling, and enhanced go-to-market strategies.
Since they closed the merger, DSGR has grown revenue organically at a mid-teens rate and consolidated EBITDA margins have expanded nicely. Importantly, DSGR has a fully built-out M&A team with a disciplined investment framework around risk and returns and a developed pipeline. Management is fully aligned with shareholders as they own 10% of the company, while the former owner of Gexpro and TestEquity, Luther King Capital Management ("LKCM") owns another 65%. LKCM has significant experience investing in distribution companies and brings financial expertise to the table.
In March of this year, DSGR announced that they would acquire Hisco and merge it with TestEquity. Hisco is a mission-critical distributor that serves electronic assembly, aerospace/defense, medical, and other industrial customers with things like adhesives/sealants/tapes, soldering, and cleaning supplies.
While Hisco's product mix differs from TestEquity, there is alignment between the industries they serve and their supplier base. This should enhance their customer value proposition and provide for cross-selling opportunities. Operationally, the two companies have meaningful overlap and there is the opportunity for consolidation.
Furthermore, Hisco's Mexican footprint will benefit TestEquity in supporting nearshoring trends. DSGR made this acquisition at a stated EBITDA multiple of just 9.4x with the potential to bring it down to mid-7x when accounting for synergies. It was funded with debt as well as cash raised from the aforementioned rights offering. LKCM exercised their subscription rights and put in for oversubscription as well.
DSGR is currently trading around 9x pro forma EBITDA. This seems like a reasonable valuation for a company with a strong management team and a board of directors executing a thoughtful acquisition plan in a fragmented industry.
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Merion Road Capital - Distribution Solutions Group: Reasonable Valuation In A Fragmented Industry