Come together

Even with the major national firms slowing the pace of acquisitions, propane dealers nationwide can expect continuing consolidation as independent marketers struggle to remain financially competitive.

“I think we’ll see increased consolidation in the industry at a moderate pace,” says Tom Knauff, managing principal for Jordan, Knauff & Co., an investment bank based in Chicago.

The large, multi-state retailers that have traditionally driven industry acquisitions no longer are gobbling up tiny businesses from every veteran propane marketer ready to retire. As publicly traded master limited partnerships, it’s getting tougher for them to find deals that generate enough growth and profitability to satisfy shareholders.

“The acquisitions have slowed quite a bit and purchase prices have come down,” confirms Ronald F. Londe, an analyst who monitors the propane industry for the investment firm of A.G. Edwards & Sons. “It’s going to be difficult for them to show growth beyond the industry average of 1 percent.”

AmeriGas, Ferrellgas and Suburban Propane are top retailers that could be hard pressed to buy smaller firms, Londe observes.

“They would either have to make many smaller acquisitions or acquire each other, and it doesn’t look like they’re interested in acquiring each other,” he says. “They also could look outside the (retail) propane arena, such as acquiring pipelines or terminals.”

There appears to be room for growth beyond the seven publicly traded multi-state retailers, however.

“The regional companies are in a great position, but there are a limited amount of players and they have a limited appetite,” says Carl Hughes, vice president of business development for Inergy and business columnist for LP Gas Magazine.

Still, consolidation figures to play a strategic role in the general outlook for the overall propane marketplace over the next five to 10 years.

“Small will be bigger in the future,” says Hughes. “I know it’s a Yogi Berra-type of statement, but it’s the truth.”

The industry will continue to be fragmented with multiple companies competing for propane accounts, Hughes believes. But for most of the current family-owned independents to survive they will have to become two to three times larger to cover the bills and make a suitable profit.

“They will have a bigger footprint and be more sophisticated,” he predicts. “You have to be bigger than today to be able to afford the resources required to remain a viable enterprise.”

Bigger does not necessarily relate to adding up the gallons sold by a given propane dealer.

“It’s a mistake to talk about gallons because it’s a financial question. Gross margin is really the issue,” Hughes says.

Maintaining an acceptable profit margin can be vexing on a number of fronts – finances, employees and marketing – as propane businesses struggle to succeed.

“Volatility is a serious issue for these guys,” says Hughes, noting that volatility comes more through business management issues rather than the fluctuating cost of the gas itself. “It will be tougher and tougher for the independents to want to stay in business. That’s why I think consolidation will continue.”

According to Hughes, the factors feeding the volatile nature of today’s propane climate, include:

• Complying with ever-more complex regulatory requirements.
• High insurance costs.
• Finding, hiring and training and keeping qualified employees.
• Industry-specific issues such as purchasing the right amount of propane at the correct price.
• Price issues (being able to charge customers fees that are high enough to gain a profit without driving them away).
• Weather (a smaller operation is less able to withstand sustained climactic conditions that are unfavorable to propane use).

Inergy, ranked No. 8 on LP Gas Magazine’s list of Top 50 retailers, remains active in pursuing acquisitions within the nation’s varied climates.

“You get a balance of weather all over the country,” Hughes explains. “We intend to be in places where we aren’t today.”

Independent propane proprietors can help ensure that their doors stay open and their bobtails remain on the road by uniting with others in the industry, according to Tom Klein, president of Hancock Gas Service in Findlay, Ohio. Inergy has recently signed a letter of intent to buy Hancock, an independent serving 8,500 customers out of four customer service centers and two satellite plants throughout northwestern Ohio.

“It’s going to be tough for the independents to survive,” Klein cautions. “The regional companies are going to be the ones that continue to grow and expand.”

Forming partnerships with other propane providers allows marketers to better absorb and spread out fixed overhead costs.

“The best thing for you to do is to join forces with others in your area and create your own regional company,” Klein suggests.

In California, Delta Liquid Energy recently purchased the Visilia-based Fischer Propane. Delta, owned by the Platz family, now has nine outlets and remains open to the possibility of additional purchases.

“To continue to be more competitive in the marketplace, they need to acquire more plants,” notes an industry insider familiar with the transaction. “They are after volume-buying.” William Platz, Delta’s president, has gained recognition for his focus on promoting propane as a motor fuel.

“I see engine fuel as the one and only true growth opportunity; acquisitions are attractive because of the cash-flow,” says Platz, who serves as president and executive director of the Propane Promotion Consortium and is heavily involved with CleanFuel USA.

Taking stock

A specific acquisition arena varies according to the region of the country, the individual community and the businesses themselves.

“There are regions today in the country where there are no active buyers,” Hughes reports. “In the healthy areas, there are active buyers,” he adds.

The Midwest in general is weak as a sound investment opportunity, according to Hughes. An area’s value will drop even lower if it has a strong agricultural base (vs. residential development) and a shrinking population.

Throughout the nation, the possibility for a propane acquisition looks more promising if the region or community in question has an annual population increase of 2 percent to 3 percent. Buyers can look at population trends, housing starts and income demographics to determine where a successful acquisition might occur.

The road to a successful acquisition faces a variety of practical challenges.

Buyers can be stopped in their tracks by a lack of money. Banks have drastically tightened up their lending procedures, although there are investment firms that finance the energy industry in general, and propane firms in particular. As with banks, these companies have tight standards to make sure that the proposed deal is a sound transaction.

Merging company cultures can be a huge – and costly – undertaking once the deal is done.The task can be especially challenging for a larger propane operation that is set in its ways.

“Integrating (the acquisition) into the Mother Ship has not always been successful. Independents operate differently than multi-state operations,” Hughes says.

That’s particularly true regarding customer relations. Each customer must decide if he or she will remain loyal after the company name changes, the telephone number changes and the hours of service change. Keeping that customer is no lock. Often, customers are lost because the new company doesn’t return phone calls like they used to or they no longer come out to light the pilot light at 2 a.m.

“You have given the customer a reason to look elsewhere,” Hughes contends.

Knauff agrees that a switch in ownership will usually change the acquired operation forever.

“It’s hard to make money on some of the ancillary services that the independents provide. The majors know this; the independents don’t,” he explains.

“It’s always been the case that the independents are willing to provide services that the majors aren’t able to provide.”

Financial experts recommend that owners of propane businesses remain broad minded when considering either consolidation or expansion.

For the entrepreneurial-minded propane proprietor, “the number of high-quality companies available for acquisition is still very strong,” reports Dave Schulte, managing director for Kansas City Equity Partners and a member of Inergy’s board of directors.

Conversely, within the propane industry there remains strong performers that are still looking to diversify geographically, according to analyst Ronald F. Londe of the investment firm A.G. Edwards & Sons.

“If there’s a Mom and Pop that wants to sell out, they can blend their operations together” with another company interested in broadening its scope, Londe says. He notes that a business owner looking to completely divest an operation should be prepared to sign a no-compete agreement with the buyer.

For potential buyers, bank loans can be especially tight in this dreary economic climate. But there are investment firms still willing to take a look at what your business can provide.

An operation with a significant number of company-owned tanks already installed on customers’ properties can be a good candidate for financing, as are firms that provide superior customer service while maintaining a healthy profit margin. Having a business located in an expanding upscale community – especially where the residents are not particularly concerned with the price of their propane – is yet another plus.

“If you have a well-run mom-and-pop operation where the population is growing you’re in a better position to achieve good value,” says Londe.

There is an emphasis on growth when propane companies are pursuing buyouts, consolidations or expansion financings, agrees Schulte. But he also stresses issues of ethics and how well a business is run. “We want to align ourselves with good people, not just gallons sold,” he explains.

Schulte points out that an owner of a propane business needs to be aware that there are a number of factors in play within the investment marketplace.

For “emerging- and growth-company financings” by Schulte’s firm, the operation should have:

• A well-formed business plan.
• A strong management sponsor, although the team may have some “holes.”
• Sufficient revenues to validate market acceptance and operating economics.
• An investment target of $2 million to $6 million, with the financing provider usually assuming a minority position in the company.

• A valuation range from $10 million to $100 million.
• A mature and complete management team.
• Attractive industry prospects and a positive performance history.
• An investment target of $2 million to $6 million, with the financing provider assuming either a controlling or minority position.

To get the process going, the company’s owner submits a business plan that includes:

1. A summary of the company history.

2. A description of products or services.

3. An overview of the business strategy.

4. A profile of the industry.

5. Background on the management team.

6. Current financial statements.

7. Detailed financial projections.

8. A description of the proposed financing package and how the funds will be used.

The propane industry does appear to be tapped-out when it comes to backing startup operations, which can take two or three years to begin making a profit.

“The barrier to entry into the propane industry really isn’t money; it’s time,” says Tom Knauff, managing principal for Jordan, Knauff & Co. “It takes a long time to build up a customer base to be able to make a living.”

At Delta Liquid Energy in California, an expansion-minded William Platz has opted to buy existing propane enterprises rather than starting up new branches.

“It’s always more attractive to buy a business rather than start up a business. An acquisition gives you instant cash flow,” says Platz, who has nine Delta outlets.

He remains in an entrepreneurial mode: “We’re looking to make more acquisitions.”