Despite the ongoing problems in the credit market, which almost torpedoed the HD Supply deal last summer, analysts say 2008 is shaping up to be a typically robust year for mergers and acquisitions in distribution.

But blockbusters like the private-equity buyout of HD Supply or Rexel's deal to split Hagemeyer with rival Sonepar are likely a thing of the past, they say, at least until lenders ease up on their credit requirements.

For smaller and mid-market players looking to strike a deal, however, this year could still prove to be an active one on the M&A front.

“Private equity has come into distribution in a fairly big way in the past few years, but the credit market is going to make it tougher for them [this year],” Airgas chairman and CEO Peter McCausland says. “It's not only tougher credit market conditions, but also the prices of industrial distributors have moved up and it looks like the economy is slowing. I think we're moving toward a time when strategic acquirers have more of an advantage over private-equity people than they did a year ago.”

That bodes well for Airgas, which so far during fiscal 2008 has bought 16 companies, adding $450 million in revenues to its top line, McCausland notes. In addition to seeking out companies to bolster its core business, Airgas also looks for companies that will expand its product offering, such as welding equipment rental firms, safety product suppliers and medical suppliers, he adds.

“We're always looking and there do seem to be a quite a few opportunities out there that meet our standards,” McCausland explains. “We'll finish our 2008 fiscal year in March and it's already a record year, the second record year in a row. There is still around half of our core market in the hands of independent distributors—there are about 900 of those and that's just our core market of packaged gases and welding products. … We also try to find companies where the product line is something our customers buy. We expect a continued high level of activity in core acquisitions and product line acquisitions and I think together we could put some significant numbers on the board over the next few years.”

Jonathan Skelly, of Orlando's PCE Investment Bankers, is no stranger to acquisitions—before joining the investment banking firm, Skelly was director of mergers and acquisitions for Hughes Supply. After HD Supply acquired Hughes in 2006, the former named him director of strategic business development.

Like McCausland, Skelly predicts an active year for mergers and acquisitions, though nothing along the lines of last year.

“The Hagemeyer-Sonepar-Rexel deal will probably be the last multi-billion dollar purchase you'll see for a period of time,” he says. “If you do see some of those transactions, they will be quite fewer than in 2007. [But] in the core market for M&A activity, the $5 million to $500 million range, I expect you'll continue to see a quite active pace in that end of the market.”

That's because the overall fundamentals of distribution remain the same: It's a huge industry, made up of myriad companies, that is a vital part of the manufacturing economy.

“The investment thesis is still very much intact,” Skelly notes. “The distribution marketplace is very large—my estimate is probably somewhere in the $400 billion range—and it's still very fragmented. Wolseley, Rexel, Building Materials Holding Corp., Pro-Build Holdings: Those big consolidators still only have single-digit market shares across the marketplace. And distribution is not a type of industry that's going to go away. It's a vital link in the supply chain.”

That perspective is shared by Corey Whisner, a director of investment banking for Credit Suisse who specializes in distribution.

“The economic uncertainty notwithstanding, it's still an attractive sector for investors,” Whisner says.

That said, economic uncertainty (in addition to the credit crunch, the residential housing market has continued its tailspin and the related sub-prime mortgage crisis has yet to bottom out) will probably keep multi-billion dollar leveraged buyouts off the table in 2008, he adds.

“Certainly the current markets will put a damper on private-equity activity in the sector. It's more expensive and more difficult to finance leveraged buyouts right now,” Whisner explains. “Mid-size deals are currently easier to finance than the larger deals.

“That could all change in a month, or it could be nine months [before the leveraged buyout market rebounds]. It's hard to predict.”

That means the deals that go through will likely be strategic acquisitions by companies looking to expand their geographic footprint or enter new markets, Whisner says.

“Strategic buyers will stay closer to their areas of expertise. I think you'll see the mix shifting to more strategic deals this year, as opposed to private equity deals,” he says. “Long-term, you'll see consolidation continue because it's highly compelling [to investors].”

Tom Williams, managing director of investment advisory firm Lincoln International, says 2008 could be even more frenetic than last year when it comes to deals for mid-market and smaller firms.

“We're seeing increased activity around this space,” Williams says. “Most recently, we're seeing private companies and some of the family-held [companies look into a sale]. Some of those are saying, 'You know, I don't know where the economy is going yet. We have an election year, which maybe could change tax rates.' As a result, they're either thinking of selling or doing a recapitalization.”

And more and more companies are approaching Lincoln for advice on a possible sale or investment in a distribution company, adds Lincoln senior vice president Curt Tatham.

“If anything, we've seen an uptick in our pitch activity,” Tatham notes. “Within the industrial distribution space, in November and December we've seen it remain quite healthy.”

The sustained pace of consolidation in distribution leads to a perennial question for the industry: If the big guys and mid-market players keep snapping each other up, what's left for the small, niche distributor?

Skelly says there will always be room for small distributors, especially those with solid roots in local markets.

“Distribution is still a local-market, local-level business. Whether you are a multi-million dollar distributor or a smaller, family-owned distributor, at the end of the day what drives your business are those local-level, local-market [relationships],” he says, noting that many of the smaller firms acquired during his runs at Hughes and HD Supply had higher margins than their acquirers.

“They were pretty darn successful in their local markets, because they grew up there and built strong relationships with their customers,” he remembers. “Another thing that we've seen is that vendors obviously have an incentive to keep local and regional distributors competitive with the larger folks. It's to the advantage of vendors to have multiple distributors in each marketplace, so they don't become so saturated or reliant on a single distributor.

“There's plenty of room for smaller, regional distributors to be successful.”