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Strong Pace of E&S Merger Activity

Mergers and acquisitions in the foodservice equipment and supplies industry have been strong in the past few years and the trend is expected to continue, according to a study recently released by Cherry Tree, a private investment banking firm, based in Minneapolis that specializes in serving entrepreneurial companies.
"The foodservice equipment industry (FSE) has had significant merger and acquisition activity over the past few years. Our research has identified 66 mergers and acquisitions of foodservice equipment companies between 1999 and 2002. Since many private transactions are not announced and the FSE industry is primarily composed of private companies, we expect that there are a substantial number of additional M&A transactions in this industry that were not reported," the Cherry Tree study concluded, noting that the actual figure could be double the one it reported. The dollar value of the transactions ranged from $4 million to more than $700 million.
Annual foodservice equipment sales tip the scale at nearly $8 billion, according to the study. "The industry is highly fragmented among many companies. Companies that participate in the industry include some large, public companies, but the industry is serviced predominately by middle market (revenues from $5 million to $100 million) privately-owned companies," Cherry Tree noted.
While the North American Association of Foodservice Equipment Manufacturers (NAFEM) lists some 600 member-companies, Cherry Tree estimates that there are between 200 and 300 additional U.S.-based manufacturers of foodservice equipment that do not belong to the association. This group includes 11 companies with more than $100 million in sales, while the remainder consists of smaller, privately-held companies. The average NAFEM member reportedly registers about $10 million in sales. Foodservice equipment manufacturers build durable goods in 33 categories, many of them supplied by competitive sources. Together with companies that distribute, install and service the equipment that is used in foodservice operations, there are nearly 2,000 companies in this marketplace. Illinois Tool Works, Inc., Glenview, IL, with revenues of $1.64 billion in revenue is the biggest FSE manufacturer, while Edward Don & Co., North Riverside, IL, with $395 million in sales, is the largest FSE dealer. Its chairman, Robert Don, was the inducted into the ID Hall of Fame in 2002.

Robust Industry Drives M&A
The principle factor driving foodservice equipment sales as well as interest in mergers and acquisitions in the industry is the robust foodservice business, itself. Citing historical trends that show that foodservice sales have grown twice as fast as the GDP since the 1970s as well as Technomic Inc.'s favorable outlook for this year, Cherry Tree expects equipment purchases to be strong as well. "Operators consider a range of factors when selecting the equipment to purchase. Quality, productivity and labor issues are all more important than the original cost," the study said, pointing out that the average cost of the units last year ranged from $53,000 to $115,000.
"Technomic's recent survey of equipment manufacturers found that 76% reported growth in sales in the last year and 80% expect to grow in 2003. The same survey reported that 65% of FSE dealers increased their sales of equipment in 2002, and more than two-thirds were 'optimistic' about prospects for 2003. An additional indication of strengthening markets is that 70% of equipment manufacturers reported that they expect to increase prices in the coming year," Cherry Tree noted.
FSE manufacturers are attuned to mergers and acquisitions because of the economies of scale in production and in increasing product breadth. In other words, Cherry Tree explained, "larger companies can maximize the value of the smaller companies they acquire. Furthermore, it is typically cheaper and faster to add products from the smaller, acquired companies than it is to develop them internally.
FSE dealers are also involved in mergers and acquisitions because larger ones can improve margins due to their having more negotiating power with the manufacturers and can be more efficient with greater scale. "Furthermore, manufacturers prefer larger dealers that have greater financial strength, more professional management depth, greater geographic reach and more sophisticated management and information systems," the study concluded.
Due to the family or private ownership of FSE companies, proprietors are generally motivated to sell because they are limited in their ability to grow-financially, geographically or with new products, Cherry Tree stated. "Many baby boomer-era owners are reaching retirement age and need to monetize the wealth they have built through the sale of their company. Others realize that the wealth represented in their companies is a single, non-liquid, concentrated financial investment, and they want to diversity their person assets through a recapitalization or sale. In all these cases, the private company is worth to an acquirer that does not have the limitation of a private owner," the study found.

New Trends in Distribution
The investment banking company also explained in its study that the FSE industry has experienced several changes in its distribution channel in the past 10 years. One of the major trends has been traditional broadliners' expansion into the foodservice equipment marketplace.
"Technomic reports that in 2001, 26% of operators bought FSE from their broadline distributor and another 20% bought from both broadliners and specialty distributors. Only 54% used specialty dealers exclusively. We have found that U.S. Foodservice, one of the largest broadline distributors, has recently acquired two FSE dealerships," Cherry Tree stated.
The 2003 ID Operator Survey also found 17% of heavy equipment is purchased from broadliners, 60% from specialists and 23% from both, while 28% of light equipment is bought from broadliners, 35% from specialists and 37% from both.
According to the investment banker's survey, mergers and acquisitions have focused on both manufacturers and dealers. For example, AGA Foodservice in Great Britain, one of two U.K. companies in the marketplace, acquired five manufacturers in the past four years while Strategic Equipment & Supply, Albany, GA, purchased eight dealerships. "One particularly interesting player is the large broadline distributor U.S. Foodservice, which acquired Superior Products and established 'next day gourmet' for equipment sales," Cherry Tree said, noting that its research has not found any M&A activity among equipment service companies.
Some equipment manufacturers, in an attempt to reduce costs and keep their profits, attempt to bypass their traditional middlemen, the dealers, and sell directly to the end-users, the operators. "This causes distrust between manufacturer and dealer, and it weakens the relationships between the two. On the opposite side, there is much talk of 'partnering' between manufacturers and dealers in an effort to jointly improve both parties' revenues and profits," the study noted.
The effort to strengthen the relationship includes information sharing and raising the manufacturer's visibility among operators. "Manufacturers are particularly interested in equipment start-up and training feedback, design and installation issues, information about competitors, and forecasted sales information," the report said.
Cherry Tree said the foodservice equipment industry is stable with "continued historical growth and continued projected growth into the future that attracts financial buyers as well as strategic acquirers." In addition, large public companies have been active acquirers of smaller companies and have raised more than $2.8 billion in anticipation of future acquisitions - "We believe this trend will drive continued acquisitions by these companies in the future."
"With a number of active buyers, owners of companies in this industry should evaluate their personal situations and consider whether now is a good time for them to begin considering selling their companies," the study concluded.

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