Acquirer of Choice
There’s an aura of “aw, shucks” that surrounds David H. Hannah, chief executive officer of Reliance Steel and Aluminum Co., the Los Angeles-based service center operator. To listen to him talk, you could almost believe that Reliance, the industry’s second-largest player and among its most profitable, prospers by serendipity.
“Ryerson? Well, they’re huge, just huge,” he says, shaking his head in apparent awe of rival Ryerson Inc., the industry leader with 2005 sales of nearly $5.8 billion. “Ryerson is a giant, you know.”
Yes, we do know, but what we also know is that under Hannah’s leadership, Reliance has become its own King Kong, a match to Ryerson’s Godzilla. In 1995, the year when then-CFO Hannah became president, Reliance had sales of about $561 million and operated just 30 service centers in 10 states. Last year, Reliance notched sales of nearly $3.4 billion and operated 111 service centers in 32 states, plus small operations in France, Belgium and South Korea.
With the acquisition this year of Earle M. Jorgensen Co., Reliance sales will rise to something north of $5.1 billion, with 150 service centers, including a stronger presence in the Midwest, operations in Canada and sudden strength in specialty metal bar and tube products, previously a relatively minor part of the company’s metals mix. The deal was valued at about $934 million.
“We’re not chasing Ryerson,” says Hannah, whose relentless humility masks the heart of a driven competitor. “We’re really competing with ourselves, you know. Our focus is on the bottom line. You can look at our numbers and any of the others in the industry, and you can see who leads in the profit category. Consistently.” (See table).
Reliance achieves profitability when times are bad. During the agonizing industry downturn of 2001-2003, with almost no exceptions, every Reliance business remained profitable, cranking out sufficient cash to support eight acquisitions of weaker competitors. Those purchases were part of a decade-long series of 35 Reliance acquisitions of companies and strategic assets.
Reliance EBITDA (earnings before interest, taxes, depreciation and amortization, a clean measure of performance) as a percentage of sales was 12.03% in 2005, 11.66% in 2004, 6.29% in 2003, 5.78% in 2002 and 7.2% in 2001.
In good times, Reliance is immensely profitable. In the recovery year of 2004, the company produced then-record net income of $169.7 million, or $5.19 a share, more than double its previous high earnings total of $62.3 million, or $2.28 a share, in 2000. Last year, after a decade of rapid expansion, with metals prices somewhat lower and income taxes and capital spending a little higher, Reliance nonetheless paid down debt—reducing its debt-to-capital ratio to 23.8% from 33.6% at the end of 2002—and still generated new record earnings of $205.4 million, or $6.21 per share. “Life was good,” Hannah says.
Life is so good that Hannah fields a steady stream of phone calls, letters, banker presentations and other requests from companies that want to be part of Reliance Steel & Aluminum.
“It seems we’re on everyone’s list. I’m proud of the reputation that we have in the industry,” he says. “It has allowed us to get into the great position of being the acquirer of choice out there.”
“Dave Hannah is an excellent leader, the key person in taking the company to the size it is today,” says Yvonne Varono, who follows the company for Jefferies Group Inc., an investment bank that focuses on mid-cap companies. “Reliance has one of the best management teams in the metals service center and processing space. They have done an excellent job of balancing control from top management with an entrepreneurial spirit at the facility level. They pick and choose companies that fit well with Reliance.”
So, how does Reliance achieve top profits while consuming a steady diet of lesser companies? Hannah says it’s a relatively simple formula built around tenacious application of time-honored business fundamentals: Reduce risk and expand growth potential through diversification of products, customers and geographic markets. Manage working capital through higher inventory turns (5.7 turns for Reliance in 2005 compared to the recent industry median of 4.4 turns) and accounts receivable reductions. Choose to maximize operating profit as the No. 1 priority, turning away unprofitable business and reducing headcount and other expenses rapidly if times call for it.
“We’re not smarter than anyone else,” Hannah says. “We just do a few simple things, and that makes our companies bigger, stronger and more profitable businesses today than when we acquired them.”
Arnold Tenenbaum, who retired in 2003 as president of Chatham Steel Corp. of Savannah, Georgia, agrees. Tenenbaum sold Chatham, the family business, to Reliance in July 1998.
“Happily, Reliance was the winner of the process,” says Tenenbaum, who ran the company as a Reliance subsidiary for five years. “They keep the pressure on you, and while it’s not a cakewalk working for them, they do what they say they will, and they give you all the space you need to succeed.”
One big reason why Reliance succeeds, Tenenbaum says, are the opportunities to discuss best practices and solutions with his peers. “It absolutely works,” says Tenenbaum. “We talked about common threads in the business that affect us all. We built relationships and found ways to solve problems.
“Dave Hannah hung the moon, in my opinion. He’s a marvelous facilitator with just the right mix of involvement and standing off to the side. His integrity is as high as it can be, and he combines that with a wonderful way of working with people and analyzing issues. It’s his instinctive reactions to situations that have been very good for Reliance and everyone who is part of the Reliance family.”
Hannah, 54, was trained as an accountant, with a bachelor of science degree in business administration from the University of Southern California. His first full-time job was with Ernst & Whinney in Los Angeles, where in 1973 he was assigned as an auditor to the Reliance account. There, he met two mentors: William T. Gimbel, CEO of the company from 1964 until 1994 and an MSCI President’s Award winner, and Joe D. Crider, the longtime Gimbel associate who was CEO from 1994 until 1999 and who remains as chairman.
“They ran Reliance better than a lot of other public companies that I was assigned to as an auditor,” Hannah says. “Bill Gimbel’s family owned a majority of the stock, but Bill didn’t run Reliance like it was his personal thing.”
Although Hannah had no real metals background, Gimbel needed a CFO for his growing company and made it clear that Hannah wouldn’t have to be the CFO forever. So, at age 29, Hannah took the plunge and moved from a downtown L.A. high-rise to a cramped service center-style office at the company’s world headquarters in industrial Vernon, just down the road from Earle M. Jorgensen’s offices. Gimbel and Jorgensen were “buddies and competitors,” Hannah recalls, one reason why the marriage of their two companies now seems so natural.
Forward asked Hannah to discuss his career and how he keeps Reliance at the top of its game.
Q: HAVE YOU EVER ACTUALLY MANAGED A SERVICE CENTER?
A: Bill and Joe sent me out to run our carbon flat roll operation here in L.A. I did that for a little more than a year, just to try to get some sense of what it was like. It was an eye-opening experience. It’s not easy to run a service center. I got a real appreciation for what our managers go through. Our business is, to a great extent, unpredictable. We don’t have now, and we didn’t have then, a lot of large OEMs or big manufacturing activities in Southern California. It’s really a job shop and fabricating community. And as a result, the short lead time, quick order turnaround and next-day delivery concept were what we had to do well to be successful.
Q: WHAT FUNCTIONS ARE CENTRALIZED AT RELIANCE?
A: When you’re running one of our locations or one of our companies, you are essentially an independent business unit. We do have some things that are centralized, but the typical centralized things like purchasing and even regional processing are not the way that we run our businesses. They do their buying; they have local authority to make decisions with respect to their customers. They collect their receivables, and once the money comes in, it comes in here. But operationally, we are very decentralized.
The centralized items include things like cash management, internal controls, insurance, some accounting, some benefits and sometimes IT.We’ve done a lot of acquisitions, but we still get asked the question, “How are you going to fold things together, and what kind of integration issues are there going to be?” All of that kind of thinking creates anxieties for people who work for the acquired company. The vast majority of the time, we don’t push things together, and operationally, there’s virtually no integration. The biggest area of synergies is in the back office kind of stuff that’s invisible to employees for the most part. Insurance, benefits, those kinds of things that the more you buy, sometimes, the cheaper it gets.
Q: WHY NOT PURCHASE METALS ON AN AGGREGATED BASIS TO TAKE ADVANTAGE OF YOUR SIZE IN NEGOTIATIONS WITH MILLS?
A: We do get the benefit of our size. Our corporate job is to make sure that our key suppliers in all of our products recognize the total buying done by the entire Reliance family. They don’t treat these individual businesses like individual businesses. They aggregate our individual purchase orders, and it all becomes part of Reliance in their eyes.
We don’t expect that we’re buying better than everyone else; we just don’t think we’re buying at a deficit to anyone else. So we do get the benefit of our size even though we buy locally.
Many times, the benefit of a solid relationship with your supplier is not just price. It’s that service aspect. When material was tight in the early part of 2004, we got what we needed. If we hadn’t had the relationships that we have, or probably been the size that we were, that would not have happened.
Q: HOW DO COMPANIES THAT YOU BUY TURN INTO HIGHER-PERFORMING RELIANCE SERVICE CENTERS? WHAT NUMBERS DO YOU TRACK ON A REGULAR BASIS?
A: The saying around here is “Let the bottom line speak for itself.”
You have to view that in the context of the economic environment. We are probably more proud of what our businesses did in 2001, 2002 and 2003—the three most difficult years that any of us had ever seen—than we were of our performance in the great environment of the last two years. What we did was position ourselves to take advantage of that kind of great market where prices were up, demand was up and there were material shortages.
In the very difficult environment of the years before that, all of our businesses made money. An important part of our business strategy is to have a wide diversification of products, customers and geography because that helps us to be less cyclical. Even so, we had never seen a time when pricing and demand for all of our products in all of our geographic areas was going down at the same time.
On a regular basis, we focus on only a handful of things. We look at sales, and although we look at volume, we don’t focus on it because we’re a profit-oriented company, not a tons-oriented company.
The most important thing we talk about to the people who run our businesses is gross profit. We just believe that we deserve to be paid for the service that we provide, and we have to have the discipline to lose an order.
Q: GROSS PROFIT IS A BIG CATEGORY. HOW DO YOU BREAK IT DOWN?
A: Closely related to gross profit is inventory turns. It’s closely related because if you have too much inventory, you feel more compelled to take an order with low margins just to reduce your inventory. If you don’t have too much inventory, then you can be more selective in your sales.
Inventory is one of the most manageable assets that we have. When people in our industry get hurt, usually it’s because they have made a bad inventory decision.
Last year, there was way too much inventory on the carbon side in our industry. In mid- to late-2004, prices rocketed upwards. There were some perceived shortages. So when there were some import offerings at mid-year, a lot of service center operators bought heavy. That material was delivered in the late third quarter right through the first quarter of 2005.
People stopped buying from the domestic mills because they had a lot of this imported material coming. The domestic mills reduced prices. Now, you’ve got a situation where prices are going down, there’s too much inventory on hand and there’s panic, because the last thing you want is too much inventory at a high price. A lot of people got hurt because of that.
Q: YOUR OPERATORS ARE TOLD TO BUY WHAT THEY NEED AND NO MORE?
A: We stand in front of them and tell them. We tell them on the phone. We have two managers’ meetings a year, where we get everybody together and tell them. It takes time for people to get comfortable with the fact that they don’t have to have three months’ or four months’ worth of inventory in their warehouse. If they align themselves with reliable suppliers, they don’t have to take that inventory risk.
In 2005, we turned our inventory 5.7 times as a company. That’s an average of 2.1 months of material on hand. If we had turned 4.7 times, or on average, 2.55 months on hand, we would have carried about $93 million more material on average. We think we can do better than 5.7 turns a year.
We have some service centers, mostly in the real commodity products like carbon flat roll, that had double-digit turns last year. One in Colorado in carbon bars and tube had 11.5 turns; one in carbon plate and structurals with a little bit of flat roll, in New Mexico, turned 10.2 times. It depends on the nature of the business. We have a service center in Los Angeles that does a lot of work in wide flange beams and heavy structurals that will turn in the 2.5 to 3.5 range, and we think that’s OK, given the business.
If we have some people that turn inventory six times, and someone in another place that buys from the same suppliers, with the same product base, and that turns only four times, we’re going to sit those two operators next to each other, so that one can learn from the other. In our industry, the rule of thumb was that you bought for a quarter, and that is for four turns. A lot of owners, when we acquired their companies, felt good when they walked into their warehouse and looked at a lot of inventory. We look at that as money sitting on your floor that we can use for growth.
Q: WHAT OTHER MEASURES DO YOU TRACK?
A: Inventory and accounts receivable are the two largest elements of our working capital. So we watch accounts receivable, days of receivables. Last year, we reduced receivables outstanding to 40 days from 41 days in 2004.
We watch expenses as a percent of sales. Headcount is the largest component of our operating expenses at about 55% of the total. So when you think about expense control, you have to have your arms around your headcount.
Why did we make money in 2001, ‘02 and ‘03? It’s because we managed our working capital, so we created a tremendous amount of cash flow. And then, the biggest thing we did was reduce expenses very quickly. During that three-year period, we reduced our workforce by more than 20%. It wasn’t an edict from the corporate office. Some of our businesses reduced workforce 50% or 60%. As business began to fall, we simply asked our managers for their plan to deal with it.
Because of that, we were able to make some very good acquisitions that were a major reason why we had the results we did in 2004—because we were well-positioned to take advantage of the market when it started to improve.
Q:HOW DID YOUR REACTION TO THE DOWNTURN DIFFER FROM WHAT YOU MIGHT EXPECT FROM A TYPICAL SERVICE CENTER?
A: Very few businesses pay as much attention to inventory turns as we do. They don’t focus on maximizing gross profits like we do. And they don’t focus on personnel.
We understand that. These businesses are important members of their local communities. They didn’t want to have the reputation of laying off people. When things got tough, they just hunkered down and made the best of it. They didn’t go into the mode we would go into—a focus on expense reductions.
It takes time to make change. Managers don’t do things because we tell them to. We have a great deal of information within our company now. We can show them results in the same formats from other companies in our family, numbers that they know they can rely on. Before, if I own a business and you own a business, and we’re talking about how much money we made or how many times we turn our inventory, we may lie to each other. Now, when we put up the numbers, all determined in a consistent manner, they see real, reliable data, and they are more apt to ask, “How did you do that?”
Remember, many times people can maintain a very comfortable lifestyle. Their business is making money, and they have all the things that they might want. There’s no pressure for them to get aggressive on improvements. There’s a lot of human nature involved.
Q:WHAT OTHER KINDS OF SITUATIONS DO YOU LIKE OR AVOID?
A: We basically buy and sell on the spot market. It works for us. No customer is more than 1.5% of our revenue, so when we purchase material, we don’t know where it is going.
If you’re tied into contracts, you may see your material cost going up, but you may have a fixed selling price with a customer. You sit there and watch your profit margin being squeezed. If you have a large contract buyer, it’s very difficult to get into a dispute with them. We’ve seen it over and over again, where customers will force their service center supplier to reduce their contract price. You’re kind of damned if you do and damned if you don’t.
When you do a large-volume contract business, typically the cheapest price wins. We don’t expect to be the cheapest price. We expect to be the best value when you consider service and quality.
We also have a lot of locations with a distinct product focus. For example, here in L.A., we have seven different businesses with seven different names that specialize in seven different product groups. We could have one name and put everything in one facility. We might utilize our equipment better and reduce people to a certain extent. But we think we would lose more business by doing that than any benefit that might come from cost savings. With a narrower product focus, we really can be a specialist in the market for each product, with equipment and procedures dedicated to processing and shipping that material.
Q: WHY HAS THERE BEEN SUCH AN EMPHASIS ON ACQUISITIONS AT RELIANCE?
A: We don’t feel we can grow internally at the rates necessary to be a successful public company. We have to supplement that internal growth by acquiring other companies. We try, over the cycle, to grow our top and bottom lines in double digits, with a goal of 15%. That’s what you have to do for the market to recognize you and reward you with a good multiple.
EMJ is the largest transaction that we’ve ever undertaken. It is a solid, well-managed company that fits very, very well with us. There’s a great fit and compatibility with management—we grew up down the street from one another. There’s very little overlap in products. They are in specialty long products, bars and tubing that we just aren’t in. Geographically, their real strength is in the Midwest, where we are weak relative to the size of the market. That’s the best opportunity for us to grow. We don’t have anything in Canada or New England, and they have operations in both areas. It all fits.
Q: WHAT HAS BEEN THE IMPACT OF SUPPLIER CONSOLIDATION ON YOUR BUSINESS?
A: We see it as a positive development. We like to operate in an environment where prices are higher as opposed to lower. Consolidation among suppliers has resulted in a level of discipline in pricing that we have not seen previously.
Last year, when prices were going down, there were production cutbacks and rescheduled maintenance outages by the mills because they didn’t want to flood the market, which would have driven prices down further. That’s evidence that there is more discipline at the supplier level in pricing that we did not see in the past. Fewer players with larger market shares mean more discipline.
Q: ARE YOU WORRIED ABOUT THE FUTURE OF NORTH AMERICAN MANUFACTURING?
A: There is a concern. Without customers, we’re not here. But I have faith in the business community. They are resourceful, and I don’t think business owners will let our manufacturing base be destroyed.
Here’s a good example: Our company grew up in the job shop community. We didn’t have a lot of large OEMs, and we have fewer now than we did 20 years ago. We did have a substantial aerospace market in southern California—McDonnell Douglas, Lockheed, Northrop and a fairly substantial shipyard business in San Diego on up to Santa Barbara.
We were concerned when the aerospace business started to go away. But the job shops that served that industry were resourceful. They shifted from aerospace to other businesses, such as transportation, semiconductors, energy and alternative energy, and electronics. They lost their customer base, but shifted over into new ones.
It wasn’t an option for them to close up or move their business elsewhere. They did what they needed to do.