United States

Q2 2019 Industrial Products Industry Spotlight



For investors targeting the IP space, the question of paramount focus is how long the US plans to pursue its current course on trade with China. Some investors—following one set of assumptions around tariffs—entered due diligence at the end of 2018 only to find that additional tranches of tariffs can significantly complicate the valuations process for some prospective targets in manufacturing. Deal closing times have slowed as a result, and many deals have been halted altogether, weighing on the volume of completed deals in the IP space through H1. “Some investors have found themselves in a difficult position because all of a sudden an important product got hit with new tariffs with a 10% to 15% impact on the target’s margins,” said Hong Nguyen, director of transaction advisory services for RSM. Meanwhile, some manufacturers have suffered a double-whammy impact, as the expanding set of tariffs hit both a product they buy and a product they sell. These developments complicate an environment in which it has become harder to achieve a full level of understanding about a target’s business operations, especially early in the review process, creating additional risks when submitting an initial bid.

Big picture

US tariffs on $250 billion in goods shipped from China continue to weigh on dealmaking in the industrial products (IP) space, but secular factors have also contributed to the decline in deal volume of late. With the current economic recovery likely topping out in Q3 2018, trade policy has only added to an already competitive environment for investors targeting IP plays.

However, some financial sponsors and strategic acquirers are struggling to get past the first round of increasingly crowded bidding processes even as more ambitious IP bets remain stalled until a clearer picture of the macro environment emerges. All the same, most manufacturers have arbitrated means to pass costs down the supply chain, depending on their industry and the arrangement they have with a customer. In some instances, the complete cost increases from tariffs have been passed onto the customer. Particularly in the automotive sector, clients serving one of the North American auto majors report that supplier arrangements with some original equipment manufacturers continue to prevent pass-through strategies from completely diluting their margins.

Looking ahead

Given the significant level of capital chasing fewer quality targets in the IP space, competition among investors for quality assets remains as stiff as ever, with some investors hunting for new assets and eventually reporting an inability to spend their money. According to Nguyen, tariffs have a more negative impact on the IP business, with few able to capitalize on the potential benefits touted by current trade policies. Investors thus far have often sought ways to mitigate the impact of US and China trade tensions on the operations of prospective targets during diligence. Transaction multiples should remain at historically elevated levels through H2, despite concerns about the macro environment. Consequently, clients can continue to expect multiple phases in completing a project, extending time to close as multiple parties are involved, which creates a lengthier and more constrained review process.

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