A private equity firm bought a $30 million steel service center in 2022. The financials looked strong: 8% EBITDA margins, growing revenue, reasonable leverage. Within 12 months, EBITDA had dropped to 3%. The acquirer had not understood that the seller's margins were inflated by a steel price spike. They paid a multiple on peak earnings that was really a multiple on unsustainable margins. The business was not broken. The purchase price was wrong.
Normalize for the Steel Price Cycle
This is the single most important step in evaluating a steel service center, and the one most often done poorly. Steel prices are cyclical. HRC has ranged from $400 to $1,900 per ton in the last five years. A service center's revenue, gross margin, and EBITDA swing dramatically with steel prices even if the underlying operational performance is constant.
To get a true picture, normalize EBITDA across a full price cycle. Look at 5 years of financials minimum. Calculate margins during the trough (2019-2020), the spike (2021), and the normalization (2022-2024). The trough margins tell you what the business earns in a bad market. The spike margins tell you nothing useful. The normalized average across the cycle is what you should base your valuation on.
Inventory Valuation Traps
The balance sheet shows $8 million in inventory. What is it actually worth? Check the aging. If 20% of inventory has not moved in 6 months, that material is worth significantly less than book value. It might be obsolete grades, widths that nobody wants, or remnants that will eventually be scrapped.
Check the valuation method. LIFO versus FIFO makes an enormous difference in a volatile price environment. A LIFO-based inventory valuation during a rising market understates the inventory's replacement value. A FIFO-based valuation during a falling market overstates it. Restate the inventory at current market value regardless of the accounting method to understand the real asset value.
Do a physical inventory count. Do not trust the system. Walk the warehouse with someone who knows the product and count the bays. In our experience, the physical count is within 5% of the book value about half the time. The other half, the variance is 8% to 15%, always in the wrong direction.
Customer Concentration Risk
If the top customer represents more than 15% of revenue, you have concentration risk. If the top three customers represent more than 40%, that risk is severe. Understand the nature of each major customer relationship: is it contractual or transactional? Is the relationship with the company or with a specific sales rep? What happens if that sales rep leaves?
Talk to the top 10 customers as part of due diligence. Not the ones the seller hand-picks for you. Ask: how long have you been buying from them? What would make you switch suppliers? What do they do well? What do they do poorly? The answers will tell you more about the business's sustainability than any financial model.
Equipment and Facility Assessment
Steel processing equipment has long useful lives but significant replacement costs. A slitting line that is "fully depreciated" on the books might work fine for another decade, or it might need a $200,000 rebuild next year. Have an equipment specialist assess the condition of every major piece of equipment: slitters, shears, cut-to-length lines, cranes, forklifts, and scales.
The building matters too. Industrial buildings that house steel operations take a beating. Floor loads, crane loads, and forklift traffic wear out floors, columns, and roofing faster than standard industrial use. Get a structural assessment, not just a property inspection.
The People Factor
In a service center acquisition, you are buying two things: inventory and relationships. The relationships live in people. The sales team knows the customers. The warehouse team knows the operation. The owner knows the mills. If key people leave after the acquisition, the value you paid for walks out the door.
Identify the critical people (usually 5 to 8 individuals in a mid-size service center) and structure retention incentives before closing. The cost of retention bonuses is small compared to the cost of losing your top sales rep and their $5 million book of business three months after you write the check.