Let the China/Taiwan Distribution War Begin

You could have missed the news. A terse, four-paragraph statement from Avnet Inc. (NYSE: AVT) announced its decision to acquire two small Taiwanese electronics component distributors, setting the stage for the inevitable consolidation of the China market. The two companies Avnet bought are quite small, but the implication of the transaction, for what has now become the biggest geographical market for the component distribution business, is enormous.

The acquisition positions Avnet squarely in the backyard of WPG Holdings (Taiwan: 3702), the largest component distributor in Asia and the company its biggest global competitors will have to displace in the region to maintain (regain?) their leadership positions. By acquiring Prospect Technology Corp., a $157 million revenue company, and fellow Taiwanese company J.C. Tally Trading Co. Ltd. ($90 million in 2010 sales), Avnet clearly signaled its intention to fight as hard for the China manufacturing region market as it did on the way to vanquishing most competitors in North America and Western Europe.

Mergers and acquisitions activities fascinate me, and I must admit to having been impressed by how distributors have done it so successfully over the last ten years. I would not underestimate the significance of the Taiwan invasion by Avnet if I were running the opposition in Taiwan or China.

Look at the history of Avnet and its biggest US competitor, Arrow Electronics Inc. (NYSE: ARW). Within just one decade or so, both companies have eliminated most of their biggest local and European rivals through acquisitions and by moving resolutely into their home turfs, leveraging advantages gained over years of hardscrabble existence and determination to assist customers with high-value offerings wherever, and whenever, their services were required.

The J.C. Tally and Prospect Technology acquisitions are only the latest in a long string of deals Avnet has made in recent years. The company has been quietly tacking on local Asian distributors to its wings over the last five years and has bought businesses in Australia, China, France, Japan, India, Indonesia, North America, Latin America, Turkey, and Vietnam in the last four years as part of its internationalization efforts. (For a complete list of Avnet's acquisitions over the years, click here.)

Still, the Japan-Taiwan-China axis represents the greatest growth opportunity for Avnet, hence the latest acquisitions. The region also presents great challenges to the company as it seeks to ensure WPG does not establish a stranglehold on the market in the world's most populous country.

Over the last five years, both Arrow and Avnet have expanded operations in China with local presence in the country and in Hong Kong and Taiwan. In its last fiscal year ended August 3, 2010, Avnet increased its sales from Asia-Pacific to 25 percent of total revenue from 21 percent in the prior year and 19 percent in fiscal 2009. The company's electronics marketing division, which accounts for the bulk of its sales and markets components as well as design services, increased sales in Asia more than 20 percent in fiscal 2010 to $3.9 billion and continues to spearhead Avnet's growth efforts.

Avnet's growth strategy for Asia goes beyond simply making acquisitions, however. The company has increased design chain services in the region, especially in China, where it offers "a host of technical design solutions in support of the sales process of complex products and technologies," according to its fiscal 2010 Securities and Exchange filing.

I mentioned challenges to Avnet's expansion efforts in Asia above and cannot help but return to the subject. WPG's growth over the last five years has been phenomenal. The company quickly overtook all contenders to become the biggest component distributor in China as manufacturers moved operations to the region. Leveraging its knowledge of the territory, local connections, and first mover advantage, it has set itself on a path to displacing rivals to become the world's No. 1 distributor this year, or by next year.

In the eat or be eaten world of components distribution, Avnet has had no other choice but to strike hard and deep into territories the competition would rather keep to itself. Its action, and similar actions from Arrow and the other major distributors, including Future Electronics and Digi-Key, will start an inevitable race to consolidate the market. WPG itself may have by now grown too big to be an acquisition target, but all other players in the region are fair game when Avnet and Arrow roll into town.