Valuation of Distribution business with significant inventory

March 11, 2020

by a searcher from Carnegie Mellon University - Tepper School of Business in San Jose, CA, USA

I am looking at a reseller/distribution business with substantial inventory size. They keep high inventory to reduce the fulfillment time drastically(and increase margin) of special electronic components. Some of the inventory is multi year old and at times they make a great profit out of it due to its demand. Currently their inventory size is equivalent to 1 year COGS and a portion of that is possibly aged/non-selling. Unless you are into the business it's hard to know the real demand/value of that inventory. I am wondering if anyone here has any experience in valuing such business and structuring a creative deal to ensure you are not stuck with non selling inventory.

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Reply by an intermediary
from Harvard University in San Diego, CA, USA

Inventory consignment is what I have done on somewhat similar deals. You buy a set amount of inventory that will likely sell in the next 6 months and then everything else is on consignment. When you need to sell from that inventory stock, you pay the seller essentially as another vendor. If the inventory never sells, you never pay for it.

Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA

Hi Amit - I represented a company last year with a very similar profile. Their competitive advantage was their inventory -- their customers knew they had the hard to find sizes, parts, skus, etc. and wouldn't have to wait for it to come from some distant distribution center, or longer, from a manufacturer. Their customers valued up-time and rewarded the company with better margins. However, it was a challenge when it came time to put the finishing touches on the transaction price and terms. The buyer, who was in the industry, also had similar questions to yours -- is this really all sellable/needed, or just too much/obsolete? One question for your seller, how well do they track the skus/inventory? A year's worth of specialty electrical, plumbing, HVAC parts that don't change that often and have a long shelf-life/need (i.e., they go into###-###-#### year pieces of equipment) isn't surprising or bad. However, if you find that they start having two or three years' worth of sales of a particular sku, you will probably want to discount those items. Note, you can spend a lot of dollars on an inventory audit company to come in, but I have found that they mostly count, and unless they are niche industry experts, don't count on them for much more than that. Since the buyer was from the industry, we ended up going through the inventory bin by bin and aisle by aisle and assigning a discount to it based on the quantity and months of items on hand. One route that we would have explored had the buyer not been in the industry would be to put a chunk of the inventory on consignment. Thus if the seller is right, and the inventory does sell within a couple of years and you get a good margin on it, they get paid. If it doesn't sell, you didn't pay for it and the seller can take it or dispose of it.

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