After a substantial decline in 2013, merger and acquisition (M&A) activity in manufacturing grew in 2014, and is expected to continue to do so in 2015. Strategic buyers and sellers in this industry should waste no time preparing.
The 2014 increase in M&A was driven by both strategic acquirers and increasingly active private investors, as well as the natural aging population of manufacturing founders and owners.
Strategic acquisitions, which increased 13% in 2014, include both public and private companies. These buyers are usually interested in growing capacity, capabilities, or market. Private investor acquisitions, which increased 11% in 2014, include both private equity and venture capital buyers. Historically, many private investors have been less active in the manufacturing industry due to a lack of operational experience or capabilities.
One of the reasons for the uptick in manufacturing M&A activity is basic economics. As revenue and profits are growing for potential sellers, they are more interested in making a sale in the hopes of an increased valuation based on improved performance. Buyers, at the same time, are feeling more confident as the economy returns to stronger and more stable growth, and as a result are more interested in making a purchase.
The industry is also dealing with a disproportionately aging workforce. The average age of a highly skilled U.S. manufacturing worker is now 56, and many owners and executives are older. Having spent their career building a company, these individuals are now at an age where they are ready to retire, but many of them need the profits from the sale of their business in order to do so.
Key Manufacturing Areas to Prepare for a Transaction
In addition to traditional accounting and financial due diligence involved in an M&A transaction, the manufacturing industry has several other unique dynamics that should be considered prior to a sale. Failing to consider these dynamics may negatively impact the value of the deal, or increase the likelihood of a derailment late in the transaction process.
· Operations – To appropriately address operational concerns that could impact a transaction, it is critical to consider how a buyer might view these issues. Manufacturing facility arrangement and organization LEAN practices, health and safety, and capacity-impacting space constraints (or excesses) are just some of the issues that a buyer may view as a considerable potential future liability or expense.
· Raw Materials/Inventory – The total quantity of stored raw materials and work in progress (WIP), as well as inventory turns based on sales activity should be calculated and analyzed. A comprehensive finished inventory aging assessment is also a strategic effort that should be completed in preparation for a transaction. (This is especially important for perishable products.) Typically buyers like to see 60% of inventory move in less than a year, 30% of inventory move in 1-3 years, and no more than 10% of inventory stored for 3+ years. It is also important for a seller to share a thorough understanding of the supply chain.
· Profitability – Strategic manufacturers will also assess their complete product portfolio – including product line profitability. The most effective profitability analysis, given today’s technology-heavy manufacturing processes and complex business overhead costs, will include not only traditional parts and labor, but also things like sales, general and administrative (G&A), and customer service costs. Product distribution channels should also be assessed for issues and opportunities.
· IT – Sellers should be prepared to describe the strengths and weaknesses of all of their technology systems. Areas to investigate include: process reporting, data collection, storage, and security, the age of all hardware and software (including applications and personal computers), database structure and usage, networks and servers, communication tools, e-business capabilities, etc. IT issues are particularly important to the private investor who may be pursuing a buy-and-build strategy (purchasing multiple manufacturers and combining them to achieve value-added efficiencies or scale). Any one of these IT issues could result in at best a delay in integration with other systems and at worst cripple and kill an investment.
· Management/HR Diligence – Given the labor challenges the manufacturing industry faces, management and talent issues are of particular concern. Communication is key to ensuring that all employees feel valued before, during, and after a transaction. Aside from a founder or owner, private investment buyers might find it important to develop relationships and form agreements with other experienced key staff as a part of the transaction. A cultural comparison is a good idea for strategic buyers who need to know how employees at an acquired company will fit into a new parent organization based on its values and behaviors.
Whatever the reason for a potential sale or acquisition, buyers and sellers will find 2015 to be an increasingly competitive year for M&A. Successful manufacturers will likely find themselves in the crosshairs of both strategic and investor-led interest. Whether executives and owners are contemplating a sale for the first time, or have considerable experience, completing a transaction without proper industry-specific preparation, including operational, inventory, IT, and talent-related groundwork, will be a challenge.
Consulting Partner, Joanne Baginski, CPA, leads the transaction services group at EKS&H and can be reached at 303.740.9400 or firstname.lastname@example.org. Audit Partner, Kreg Brown, CPA, leads the manufacturing client industry group and can be reached at 303.740.9400 or email@example.com.