Description

WCC is a leading distributor of electrical, industrial, and communications maintenance, repair and operating (MRO) and original equipment manufacturer (OEM) products, construction materials, and advanced supply chain management and logistic services.  Within the electrical distribution industry, WCC serves 100,000 customers in four main end-markets with the following business mix (i) industrial (36%); (ii) construction (33%); (iii) utility (16%); and (iv) commercial/institutional/government (15%).

WCC recently closed a transformational acquisition of Anixter International (AXE) to become the largest electrical, communications and utility distributor and supply chain solutions company - above their primary competitors Sonepar –Irby, Rexel and Graybar.  WCC doubled in size ($17Bn revenue) and is now industry leader (13% share) in utility, data communications and electrical distribution. Combined company will make WCC a stronger company - better than standalone WCC or AXE.  Combined company will allow cross selling in certain areas, less competition in others with differentiated scale and capabilities in a highly fragmented industry.  

Distribution businesses are attractive as they are asset light and generate stable FCF and can efficiently use leverage; these businesses also tend to exhibit positive cash flow characteristics during cyclical downturns. As such, PE players have been active in this space.  Clayton Dubilier made an offer for AXE in 2019  and put AXE in play.  CD&R then made an offer to acquire WCC at $68/share with the hopes of buying both companies.  Leonard Green accumulated a 11% stake during the recent sell-off at <$40 per share. CD&R purchased Whitecap, construction products distributor, from Home Depot Supply last year for 10x EBITDA.

WCC/AXE is expected to drive ~$200MM in synergies within 3 years – significant compared to pro-forma 2019 EBITDA of ~$860MM.  If we look at the guidance, ~$30MM comes from corporate overhead, ~$60MM from G&A, $70MM from supply chain improvements, and $40MM field operations/branch consolidation.  In addition to cost synergies, management expects revenue synergies with organic growth accelerating by 100bps. Most of this is driven by expanding WCC’s products via AXE’s  international footprint, cross sell WCC’s product offerings in electrical to AXE’s customers and extend WCC’s capabilities in broadband, automation and lighting across their customer base.  

Looking at the FCF generation of the company, both AXE and WCC have grown FCF at low/mid single digits.  Pro-forma company will generate ~$300MM of FCF ($200MM from WCC and $100MM from AXE).  Including synergies of $200MM, combined company is expected to generate $500MM in FCF.  

One aspect to note is that leverage has increased due to the merger - leverage has grown to over 6x.  But company has a proven ability to deliver.  Both WCC and AXE delivered their balance sheet through economic cycles (i.e. 2007-2011) as well as through periods post M&A.  Between now and 2023, my base case assumes company will generate >$1bn in FCF which will be used to pay down debt and reducing leverage closer to 4x. This should bring incremental value of ~$25/s+ to equity holders. From a liquidity point of view, bank facilities don’t mature until 2023 and 2025, with limited operating covenants.  

Looking at the projections in the merger proxy, 2023 revenues are expected to be $20bn (vs. $17bn in 2019) while EBITDA is expected to grow to $1.2bn (vs. <$900MM in 2019).  Clearly these #s will likely be delayed by at least a year and most likely 2 due to Covid. But the benefit of the downturn is that it has also accelerated the need to drive down costs which we think will bring synergies above the $200MM guidance.  

Assuming $1.1bn of EBITDA at a 9x multiple (which we think is conservative), we think the stock could be worth close to $120. WCC has historically traded between 8-9x and purchased AXE at 9.5x.  Recent distribution deals from PE were done between 10-11x.  

Catalyst

(i) synergies from merger driven by scale benefits (ii) large secular demand trends (datacenter, IoT, security, 5G) that will drive growth overtime and (iii) the counter-cyclical cash flow dynamics