Exit Strategies: Major Springfield companies seek strategic buyers

For regional wholesaler McQueary Brothers Drug Co., increasing government regulation of the pharmaceutical industry and an enduring wave of consolidation prompted its $190 million pending sale to San Francisco-based industry giant McKesson Corp. (NYSE: MCK).

Consolidation also was among the reasons – along with skyrocketing fuel costs – food-service distributor Banta Foods aligned with Wisconsin-based Reinhart Foodservice LLC.

And poultry processor Willow Brook Foods, reeling from soaring feed grain costs linked to government-mandated ethanol production, sold to Kansas-based Cargill Value Added Meats, a Cargill Inc. subsidiary that will close two Springfield plants and lay off nearly 800 employees.

Small- to medium-size companies facing increased competition in the face of shrinking markets are taking a hard look at the road ahead, said Bill Rohlf Jr., an economics professor at Drury University. Add in rising fuel and health care costs amid a recessionary period, he said, and selling out begins to make a lot of sense.

“It’s not an unusual trend,” Rohlf said. “Sometimes about the only way you can survive is to merge with somebody that’s bigger, because there are some distributional economies and marketing economies that small guys just can’t get – unless you’re serving a niche market.”

Despite the recent string of sales, Springfield also is home to a “big fish” that recently gobbled up a smaller competitor in a strategic move, Rohlf noted.

Last month, O’Reilly Automotive (Nasdaq: ORLY) announced its $1 billion acquisition of Phoenix-based CSK Auto Corp. (NYSE: CAO) to shore up markets in the Western United States.

“You’ve got some local guys that are doing pretty good here,” Rohlf said.

‘Bigger’s the way to be’

McQueary Brothers has been largely insulated from the economic ripple effect caused by rising fuel prices, the housing slowdown and an erratic stock market, company President David McQueary said.

McQueary’s decision to sell to McKesson – one of the so-called “Big Three” drug wholesalers – was influenced more by factors specific to the pharmaceutical industry, McQueary noted. The family-owned company began looking for a buyer in late 2006.

“The government has already gotten more involved in health care with Medicare Part D, and we feel like it’s only going to get more involved … regardless of the election outcome,” he said. “We just thought it was going to be tougher for us an independent to be able to compete. There are pressures all up and down the supply chain from the manufacturer down to retail for cost cutting. Bigger’s the way to be.”

Late last year, after decades of bucking the consolidation trend, McQueary Brothers officials began working with BKD Corporate Finance LLC to seek out a potential buyer.

McQueary said the company first looked at private equity firms but didn’t want to surrender its autonomy to an outfit primarily focused on short-term gains. McKesson, which was No. 18 on the Fortune 500 list and already operates a home health software office in south Springfield, eventually made the best offer.

Adam Fein, a Philadelphia-based business consultant who specializes in the pharmaceutical supply chain, said McKesson paid a significant premium to acquire McQueary in what he called the “last stage of consolidation” in the pharmaceutical sector.

“McQueary was one of the last guys standing in terms of regional wholesalers in this particular industry,” said Fein, who is president of Pembroke Consulting Inc. “The regionals that were remaining really have the relationships with the independent pharmacies that are the survivors, so they’ve become attractive acquisition candidates for the Big Three wholesalers.”

For the last 20 years or so, the number of independent pharmacy customers has dropped dramatically in response to chain pharmacies and hospitals forming buying groups, Fein said. In turn, he added, the number of independent pharmacies has dropped to about 17,000 from 33,000 in 1990.

“I think consolidation and the bigger-is-better approach has proven to be the way of the world,” McQueary said. “Wal-Mart didn’t get bigger because everybody hated them. Obviously, people have spoken with their billfold on that.”

McQueary said his family has been congratulated numerous times since the sale was announced last month, but their preference was to keep the company locally owned and operated.

“It’s not really a celebratory-type situation for us,” he said. “We’ve been in business for 84 years, and we expected to be in business another 84. It’s kind of a bittersweet thing. It was done with a heavy heart.”

Cost crunch

For Banta and Willow Brook, economic conditions did play a critical role in deciding to sell.

Former Willow Brook President Mike Briggs said company officials confronted with rapidly escalating grain prices in late 2006 realized the country’s mandated production of alternative fuels, such as corn-based ethanol, had gravely impacted Willow Brook’s bottom line.

“In that first year, our costs went up over $10 million,” Briggs said. “As a company, we made the decision that it was going to be very difficult to pass that cost on to our customers as quick as it was coming to us.”

This year, Willow Brook was facing an estimated $30 million increase in grain prices tied to the uptick in domestic ethanol production on top of a $4 million jump in energy costs related to relentlessly rising oil prices, Briggs said. In December, Congress enacted a new renewable fuels standard of 36 billion gallons by 2022; the previous standard was 7.5 billion gallons by 2012.

“If you have a commodity – and it basically has a finite supply – and you introduce 25 percent more demand over a two- or three-year period, then that commodity is going to react in a exponential manner,” Briggs said. “That’s what’s happening, and for anybody to not understand that … is really not understanding how commodities work.”

Last month, Banta Food President Chuck Banta told Springfield Business Journal that suffocating fuel costs were among the “land mines” his company faced in the near future.

Banta also mentioned pressure from costs related to inflation, wages and health care.

David Mitchell, an associate economics professor at Missouri State University, said higher wages are due, in part, to the minimum-wage law passed by Missouri legislators that tied hourly pay to inflation.

“This is what myself and other economists warned about a couple of years ago,” he said.

Mitchell said businesses will be at the mercy of these types of costs as they continue to climb, and he suggested that companies in manufacturing, transportation and financial services sectors are particularly susceptible.

“In the long term, some of (these companies) will go out of business and consolidate, and they’ll pass on those higher costs to us,” he said.