United States

Manufacturing slowdown will create opportunities for private equity firms

INSIGHT ARTICLE  | 

After enjoying several years of solid growth, the manufacturing sector is poised to see a slowdown.

Transaction professionals predict there to be growth in the manufacturing sector, but at a slower pace than the past two years, according to the latest reading of the Mid-Market Pulse (MMP). The MMP, published by Mergers & Acquisitions in partnership with RSM US LLP, is a forward-looking sentiment indicator that monitors M&A professionals’ expectations for merger and acquisition activity within the middle market over the coming three- and 12-month periods.

Both the three-month and 12-month outlooks showed expansion in the manufacturing sector, but were lower than the overall M&A industry scores for the same time periods. Additionally, U.S. durable-goods orders fell 5.1 percent signaling that the manufacturing sector is slowing.

There are many global economic factors playing a role in the slowdown in the manufacturing sector. “Global and domestic growths are contracting,” says Joe Brusuelas, RSM’s chief economist. “The dollar is appreciating and it’s hampering growth. Commodity prices have also collapsed. There are overall challenges facing growth in all sectors, including manufacturing.”

It’s important to note there are exceptions for some manufacturing companies. For example, the auto industry continues to be a bright spot in the economy and in the manufacturing sector. Sales of automotives have doubled since the recovery began in 2009, with U.S. car sales levels not seen since 2005. Manufacturers supplying the auto industry have benefited tremendously. “We are producing as many automotives as the supply chains can handle. That sector is bifurcated in this sense,” says Brusuelas.

Additionally, the slowdown isn’t all bad news. As a result of the slower growth, private equity firms believe that by the middle of 2016, it will be a good time to pick up manufacturing assets. In fact, according to the MMP, 54 percent of dealmakers believe they will be completing more manufacturing deals in August 2016 then they did in August 2015.

Slower growth will likely result in lower valuations for manufacturing companies, which is a score for private equity firms who have been struggling to win deals in the ultra-competitive market environment. According to S&P Capital IQ’s LCD unit, U.S. buyout firms paid an average of 10.3 times EBITDA for their purchases in 2015. That surpasses the 9.7 times EBITDA seen in 2007.

What’s more, as private equity professionals look to the future, they see benefits of owning manufacturing assets. Many believe the energy sector will see a resurgence, which will boost manufacturing long term. Other dealmakers say the slowdown in China will also give the U.S. manufacturing companies a boost long term.

“China is a big factor. The country is on a long-term rebalancing. They have hit a wall in terms of growth and they want to focus on domestic consumption. They have a classic oversupply problem and their market is becoming more mature,” says Brusuelas. Indeed, China is experiencing change. Wages are increasing, there are demands for social change in the workplace and there is an emerging middle class with new purchasing power. These dynamics are playing a role in the shift away from U.S. manufacturing in China.

“Overall manufacturing activity has slowed down, but as values come down the M&A middle market is expected to be pretty active. The goal for private equity firms will be finding assets at the right valuations and not overpaying.

The recent financial markets’ volatility has heightened the risk of overpaying as concerns over the strength of the U.S. economy have risen,” says Richard Albano, a transaction advisory services partner, with RSM.

Steve Menaker, national industrial products practice lead for RSM, adds private equity firms will likely be interested in manufacturing companies that supply the aerospace, building products and automotive industries. “We are seeing private equity firms engaged in these sectors, especially the auto sector as auto sales soared with over 17.5 million new cars sold,” says Menaker. “The challenge will be pricing as successful companies have pushed up the pricing and competition for growing companies is intense.”

Car manufacturers have been steadily increasing their production in the United States. The result is creating manufacturing opportunities for U.S. companies. For example, Volvo Cars is expected to start producing cars in the United States by 2018. The company is currently building a factory in Charleston, South Carolina. This is the first time the Chinese-owned automaker will have an assembly plant in the United States. This comes on the heels of Volkswagen announcing plans to expand its Chattanooga, Tennessee-based plant and German automaker BMW’s $1 billion investment into its South Carolina plant, which increased its capacity by 50 percent in 2015.

Aerospace companies are also expanding in the United States. At the end of 2015, Hamburg, Germany-based Airbus opened its first civilian aircraft factory in the United States in Mobile, Alabama.

“These companies want suppliers close to the plants to reduce lead times and provide great flexibility if changes are necessary. This move for proximity will create opportunities for growth. Both strategic acquirers and private equity firms are interested in owning these assets. This is a trend that is expected to continue,” says Menaker.

Private equity firms are already buying manufacturing assets since the start of the new year. In January, SEA Equity bought Dycem, a manufacturer of nonslip and contaminate-controlled flooring used by many industries including hospitals to aerospace companies. The company has locations in the United States and the Philippines. Private equity firm CI Capital has started snapping up manufacturing companies as well. The firm, which owns Tech Air, a Danbury, Connecticut-based distributor of specialty gases and related welding supplies, completed acquisitions of New York-based Ravena Welding Supply and Texas-based Hereford Welding Supply. Lastly, Kansas City-based DIT-MCO International Corp., a manufacturer of wire testing systems for aircraft, was acquired by private equity firms, Capital for Business and Sage Capital.

Albano expects more deals from private equity coming down the pike when valuations decrease further. “Private equity firms are not willing to pay at this level so the strategic acquirers can be more effective right now,” says Albano. “Also, private equity acquirers may start looking at lower-quality assets with lower valuations where they can provide operational expertise to drive value.”

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