Portfolio: CHAMP Ventures and H-E Parts

Fortescue Metals Group is the largest player in Western Australia's iron-ore rich Pilbara region, producing 155 million tons of the metal each year. The company has ridden the wave of the resources boom. When Fortescue was founded in 2003, the country's total ore output was 180 million tons. The major change agent is emerging markets demand, notably from China where Fortescue's iron is used to forge the steel that underpins industrialization and urbanization.

Miners are not the only beneficiaries of this phenomenon. Fortescue operates two hubs in Pilbara and H-E Parts, which is owned by Frontenac of the US and CHAMP Ventures of Australia, recently signed a five-year contract to service the trucking fleet for one of them. It involves providing wheel-end repairs for a 120 vehicles that carry loads of 240-300 tons. The trucks' rear wheels come under particular stress and require rebuilding every two-and-a-half years. Fail to do this properly and projects fall behind schedule.

"They need to have the truck maintenance organized so they are doing all major components within a reasonable timeframe," says Ian Olivieri, managing director and head of Australia at H-E Parts. "They don't want to have the wheels done one month and then the engine or transmission the next month. There requires quite a lot of planning and monitoring of the trucks' condition."

CHAMP's involvement stems from a move to expand H-E Parts from the Americas into Australia. Chicago-based private equity firm Frontenac bought the business - then known as Dom-Ex - from its founding family in 2006. The goal was to create the leading supplier of after-market parts and reconditioned parts and equipment to off-highway customers. Consolidation through M&A was always going to be a significant part of the story, given the still fragmented nature of the industry.

Olivieri was the first to come on board in Australia, shortly after H-E Parts bought its first business in the country. He previously spent more than 20 years with original equipment manufacturer (OEM) Komatsu, latterly as Australia managing director.

Oliviera was tasked with overseeing existing businesses and finding new M&A opportunities, but Frontenac wanted a local private equity partner as well. A local accounting firm put together a limited auction process and CHAMP quickly emerged as the preferred partner, completing the investment in December 2008. The private equity firm could point to a substantial track record of investments in mining services, with the likes of Amdel, APB and Gecko Systems.

"We didn't have any exposure to the H-E Parts product range as such, but we had exposure to the miners and mining contractors, and through that we could understand the value proposition H-E Parts brings," says Gareth Banks, managing director at CHAMP.

Divided responsibilities

Frontenac and CHAMP own 80% of the company between them. The Australian firm paid an initial A$22.5 million ($21 million) for a significant minority stake of approximately 30%. The remainder of the equity is spread across company management and the owners of several acquired businesses who rolled over their interests in order to participate in future upside of the business.

Annual revenues are split approximately 50-50 between the Americas and Australia. Frontenac takes day-to-day responsibility for operations in the Americas while CHAMP oversees Australia, and the two investors work together on group-level and strategic issues.

The vast majority of H-E Parts' business involves providing new, remanufactured of refurbished components and related services and engineering solutions for hauling trucks, excavators and crushers. Clients include all of the major miners in Australia, North America and Chile - from BHP Billiton to Barrick Gold Corporation - as well as a host of mining contractors. The company also has several smaller business lines, including new and used equipment and on-site services.

A miner buys a truck from an OEM such as Caterpillar, Komatsu, Sandvik or Metso with a three-year warranty period. Once this expires, the miner may continue using the OEM for replacement parts or switch to an independent provider like H-E Parts.

"Mines often enter into a maintenance contract with an OEM after they buy a fleet of trucks and this could last four or more years," Olivieri adds. "It was a very popular approach until cost pressures began to build again, at which point the miners became more entrepreneurial about how they manage their equipment."

The H-E Parts value proposition might not simply be charging a lower price for replacement parts than an OEM; the company's 650 staff includes a sizeable engineers that works on technical solutions to reduce wear and extend component life across an entire fleet. H-E Parts operates on a contract basis or has ongoing relationships where it is embedded in a customer's maintenance cycle.

Revenues have jumped from $100 million when CHAMP first invested to $250 million today, but this increase must be viewed in the context of growth achieved through acquisitions that complement significant organic expansion. According to Banks, in 2014 the company is exhibiting a double-digit rise in pro forma revenue from the previous year. There have been eight acquisitions globally and three in Australia, paid for through a combination of additional equity contributions from the investors and debt.

Strategic M&A

Targets are identified based on the additional geographical exposure they bring to H-E Parts and creating a product portfolio that captures the largest possible share of clients' spending on parts and related services. High-cost maintenance areas for trucks include the engine, rear wheels, transmission, suspension and radiator cooling system.

The two acquisitions completed last year - both in the Americas - fell in line with these two broad strategic objectives. Morgan served to strengthen the company's customer networks in Canada, Chile and Peru, particularly in brakes, clutches and hydraulics. Meanwhile, the purchase of B&G Machine, one of the leading engine manufacturers in the US, allowed H-E Parts to extend its services to cover nearly all industrial diesel engines.

The company's initial M&A activities in Australia in 2008 - wheel-end supplier Birrana and crusher parts manufacturer CME - opened up a new market but also introduced capabilities that benefit operations as a whole. "Birrana specializes in rebuilding the rear wheels of Caterpillar haul trucks, which is the second-highest cost area of maintaining a truck after the engine," Olivieri says. "The trucks had earlier been plagued by some short-life issues and Birrana solved them. Now the company is contracted to most of the major mining houses directly as well as having a good share of the contracting market."

The other Australian acquisition was a smaller trading business with bases in Kuala Lumpur and Shanghai that serve as staging points for selling crushing and processing equipment into the Asian market as well as for managing relationships with parts manufacturers in the region.

CHAMP and H-E Parts continue to look for M&A opportunities, although they are likely to focus on product rather than geographical expansion, with hydraulics a particular area of interest. "Ian brings the operating perspective and his network and then we have our own network of intermediaries and other business owners," Banks says. "If anyone is looking to sell we can capture that."

CHAMP works with the company on post-deal integration and in each of the three cases it has proceeded reasonably smoothly. A greater challenge is presented in cross-selling initiatives, whereby existing products are marketed to newly-acquired customer bases. For example, US-based Crown was bought a few months after Birrana, in part because its product line is similar but where the Australian company focuses on Caterpillar trucks, Crown caters to Komatsu vehicles. Now Birrana and Crown technologies are sold to customers in the Americas and Australia.

These synergies are lucrative but realizing them takes time. "It is part of the value trade of putting businesses together," Banks says. "You have the technical knowledge within the group but you still need to sell the customer and it is not an instantaneous decision. You have to demonstrate credibility in the new product area."

Cost and scale

The location of H-E Parts' physical infrastructure mirrors that of the clients it serves. In an Australian context, this means covering the major mining basins of the Hunter Valley, Bowen Basin and Pilbara. The company usually does not maintain a presence at each project; rather it must be able to deliver to the miners' logistics centers. For example, the logistics hubs for Pilbara are in Perth.

The huge investment in mining over the last five years as the China-driven boom took hold has required more excavators, trucks and crushers to dig, transport and process larger amounts of iron ore. To put the expansion in context, overall exports of metal ores and minerals came to A$91.3 billion in 2013, nearly twice the 2009 figure. H-E Parts' addressable market has inevitably expanded. The company is less exposed to the commodities cycle because business is driven by production volumes, not capital purchasing.

Indeed, demand is expected to remain robust as machinery put to work during the investment part of the boom enters the post-warranty maintenance period that H-E Parts serves. With commodity prices now falling from their earlier peak, the company is also seeking to position itself as a lower-cost alternative to OEMs as miners trim the fat.

The majority of Fortescue's revenue comes from customers in China and the company projects that continued economic growth, though not as heady over the coming 10 years as in the previous 10, will support increases in steel production requiring higher levels of iron ore imports. However, Fortescue also pledged in its 2013 annual report to search for ways of driving costs down further. This includes pursuing operational efficiencies, which among other things, may involve outsourcing equipment maintenance to lower-cost providers.

"When all is good the pressure is on production and filling trains and filling ships. When the prices come off, as they have since October 2012, the pressure is on filling those trains with the least amount of cost they incur," says Olivieri. "There has been a real shift in the last 18 months."

Another factor working in H-E Parts' favor is that while its customer base is relatively concentrated, there are few rivals of genuine scale beyond the OEMs. The company is therefore able to approach the large miners and contractors and present them with a package of solutions covering a variety products and brands. The smaller, single-product providers that proliferate in Australia, usually serving an individual basin, do not have this luxury.
The private equity investors have no immediate plans to sell but there is a sense that scarcity value might make the business more appealing to potential buyers. Previous CHAMP portfolio companies in mining services have been exited through IPOs and trade sales.

"Many of the strategics who are potential buyers might have other exposure to the mining sector and the cyclicality of the capital cycle, but it is difficult to get exposure to the more sustainable after-market side because there aren't any businesses of scale globally," Banks says. "But if we had another 10 years we could continue on the current acquisition path, so there is a private equity secondary angle too. Someone could continue on this journey and use H-E Parts as a platform."

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• Topics
• Australasia
• Industrials
• Buyouts
• Buyout
• Australia
• Commodities
• CHAMP Ventures
• buyout