Newsletter 27, May 2009 (No comments so far)
A call for transparency and openess
A call for transparency and openess
This article was published in August 2009 in "Penta in focus" in Frankfurt
The world of chemical distributors and their stakeholders was stunned when they read the announcement on May 18th 2009 that JLM Industries, the tenth largest US Distributor with a turnover of 330 M$ went into bankruptcy and liquidation. Let’s reflect on the facts which emerged out of the JLM case and make a call for transparency and openess.
- Facts about JLM Industries
1. Overstated sales revenues
“Purchasing” which publishes the list of the 100 top distributors, reports the figures which distributors give them for publication. Some distributors are keen to look bigger than what they are in reality. In the case of JLM Industries, their annual revenues are estimated by some traders familiar with the company to be about a third lower than what was published over the years! JLM Industries included in its revenues the sales they made as agent or trader without taking title of the goods. Accurate reporting should include commissions as income, and not as sales. By misleading the public, JLM Industries shed a wrong image on chemical distribution and damaged the credibility of the Top 100 North America chemical distributors ranking published by “Purchasing”.
2. Distributor or Trader?
JLM Industries was a trader with some distribution sales. It was not a true distributor as it did not take title of the large volumes of phenol and acetone it generally sold on a "back to back" or commission basis. Fortunately in this instance, since the revenue level is much smaller than what was reported, the creditors’ losses are significantly less than what was originally feared.
3. Hazardous financial construction
The acquisition in 2004 of JLM by a New York based Private Equity boutique “Phoenix Enterprises” doomed them. Phoenix, which overextended their feeble financial resources, became insolvent and drove JLM Industries into bankruptcy and liquidation. Phoenix Enterprises financed some of its acquisitions using guarantees and collaterals. Bankers realized only too late that those guarantees were not backed with tangible assets and they withdrew their support. In the previous unregulated world of finance, bankers failed to appraise the quality of Phoenix assets and blindly provided funds to finance its risky investments.
- A call for transparency and openess
The transmission of misleading and bogus information to the news media should not be tolerated as it creates an industry credibility gap. Information on distributors published in the professional press should be based on audited figures. Agency sales and traded revenues, when the distributor or trader does not take title of the goods, should be reported as commission income and not as sales. This reporting standard should be applied globally and chemical distributor associations should set the reporting standards for their membership accordingly. Figures used to estimate chemical distributor markets, market shares or industry growth rates should be defined on the basis of acknowledged standards. Of particular importance for transparency sake are the following points:
- Distributors sell to each others.
This is a perfectly acceptable and normal practice, which may represent 10% to 15% of the market, in addition to the sales by distributors to their industrial customers. However, it increases by a significant amount the "distribution" market size defined normally as sales to industrial customers. Nevertheless, it is only a question of awareness and clarity. - Larger distributors manage a myriad of distinct legal entities.
In such case they may sometimes add their internal transfers to their external sales, which may lead to revenues’ double counting, particularly when such data from different geographical regions are aggregated. - Distribution markets are heterogeneous.
Some chemical distributors are also involved in polymers and sometimes polymer distributors sell chemicals. For transparency sake, polymer sales should be reported separately, as polymer markets have completely different characteristics than chemical markets. The chemical distribution market is normally subdivided into three markets: Industrial (bulk commodity) chemicals, specialty and fine chemicals. - Some distributors report publicly total sales of companies in which they hold only a minority interest below 50%, adding them all to their own corporate sales.
In such instances, the company sales might be wrongly reported twice, both by the minority and majority owners. - Market shares should be reported on the basis of defined “pertinent” markets and not as an unprecise % of the total chemical market.
Market shares estimated on the basis of heterogeneous markets which might include polymers, building and insulation materials, consumer and industrial goods give a distorted view of the distributor markets. For instance, larger distributors’ respective market shares look smaller on broadly defined markets than they actually are on pertinent market segments. It is more realistic to consider the consolidated revenues of distributors selling on a specific market rather than going top down to estimate the segment size and arbitrarily define a % to estimate the distributor market. Generally , larger markets have the advantage of reducing the market shares of the main distributors and avoid giving the impression of being dominant on a specific market. To consolidate the polymer and chemical markets is a source of confusion. For instance, Carrefour, Tesco or Aldi are also chemical distributors as they sell chemicals like white spirit, antifreeze, detergents, caustic soda pearls and hydrogene peroxide in small bottles. They take title, store and sell chemicals. Should their revenues be added to the revenues of polymer and chemical distributors to estimate the market size? It would make more sense to include them rather than Ravago, Albis or Federsen! - Distributor market growth rates or Compounded Average Growth Rate (CAGR) are often inflated.
Some analysts estimated the growth of chemical distributor markets to be twice the level of GDP growth rates, even at 10% per annum which is unproven and probably optimistic. The German Chemical Distributor Association “VCH” consistently publishes each year the reported sales of their membership and calculates accurately an annual volume CAGR around 1,3% and a revenue growth around 5 to 6% before the crisis. This CAGR of the largest distributor market in Europe is credible and representative of industry CAGR. It only makes chemical distribution look less attractive to investors than the possibly inflated 8 or 10% guesstimates. - EBITDA should be replaced by PBT.
EBITDA alone is of limited usefulness from a business and strategic standpoint and was rarely mentioned before 2000. It does not take into consideration interest payments and high amortization and depreciation figures coming out of acquisitions or large capital projects. Customers and suppliers want to know if their distributors are profitable, well managed and not overloaded with debts. For this purpose, PBT (Profit Before Taxes) is a far better and more visible standard than EBITDA. EBITDA is only interesting to support some financial analyses, like estimating cash flows or setting debt levels for covenants. PBT is less shiny but was the widely accepted financial performance standard until 2000, before the speculation bubble started to materialize. To get a complete picture of a company's financial health, balance sheets and P&L accounts on a corporate consolidated basis are necessary. Suppliers' credit managers routinely request this type of information when they sell to distributors on open account. PBT is going to become again the standard when private equity owned distributors become public or are sold to public companies
These proposals aim at strengthening the distributors’ credibility and image in front of their stakeholders. Many distributors’ partners are concerned with the lack of transparency and openess which is lingering around the industry. In the future, there should be no new extravagant story, like the bizarre JLM case or the Neochimiki saga.
Marc Fermont
mfermont@districonsult.com
Leysin, May 22nd 2009