How would you guys answer this questions - it is about how you think about valuation
You have two companies within the chemical sector . One company is the producer of the chemical and the other company is a distributor. The distributor will buy from the producer and sell to clients. however the producer could also do the same but at the moment only sells to distributors who has the client contacts.
They have the same EBITDA. which company do you think would be highest valued and why?
good to know you guys thoughts? I would say distributor due to its asset light model and flexible business model?
Sounds like this is the key to the question. Producer has all the power, distributor relies on producer heavily. Better margins for producer, higher risk for distributor. There are more factors to consider, but this is my initial thought.
This is pretty much the basis for the answer. The distributor can also get squeezed by the retail channel, so it has margin risk on both ends. Therefore, producers obtain higher purchase multiples than distributors.
Depending on the product, there are times where the producer may be as sensitive or more sensitive to changes in raw materials, but that is going to be more of an exception.
Just as another way to look at it from a high level or at least some questions to think about:
Does the distributor distribute multiple products for multiple producers (and possibly multiple industries) and conversely does the producer only have one (or a limited number) of products? The risk mitigation of a multiple products distributor can easily overcome a single product producer. How many distributors does the producer have? The producer may be more dependent on the distributor than the other way around. Although this isn't precisely a producer/distributor relationship, think about WalMart being a distributor and their power over producers (WMT's just well known but an unknown company to most like C&S Wholesale can have much more power than smaller producers of food).
What do the contracts look like between producer and distributor, and between distributor and the ultimate user/buyer? Are they long term and fixed price between any of those parties? Long term and fixed price may seem good but if it's a commodity dependent product and someone gets stuck with a fixed price contract that goes against them, they can get hurt quickly.
What's the market share of each? There's good and bad in both high and low market shares-as examples, high market shares mean more pricing power and you're more powerful in general in the market but it also means there's less room to grow market share and more risk of a downside. But depending on the situation you can look at it the other way as well.
What are the barriers to entry for each? Can someone come in and manufacture the product at a lower cost (China?) or is there IP to keep competitors out? What would the cost be for the manufacturer to set up a distribution network (what are the chances of that happening?) or is there another distributor that can come in and crush our distributor?
Are the distributor's client relationships extremely sticky? Do they add value along the food chain? Is the distributor strong financially and can they basically extend good terms to the buyers? For example, if the end buyers are mom and pops that may need to stretch working capital, can the distributor extend net 60 day terms and finance the mom and pops, therefore making them loyal and sticky customers? And can the producer not do that?
What does capex look like on each side? Are there union issues for either party?
You can't really answer these types of questions and I can't stand them because I've been in the real world for too long but these are at least things to get you thinking.
But this sort of answer is exactly what they're looking for, not an X>Y, but a conversation about valuation.
Very true.
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