The combination of a healthy stockpile of dry powder for LBO funds, a moribund economy and a shortage of strategic buyers has buyout pros licking their chops as momentum swings their way in the race to acquire sound manufacturing companies.
There’s no question that manufacturing has several hurdles to clear in the months and years ahead. Like most cyclical industries, it has been hurt by the economy. But given today’s low valuations, as well as the other factors mentioned above, LBO pros are taking a hard look at this sector. According to Buyouts, worldwide the manufacturing sector has already seen almost $7 billion worth of control transactions during the first quarter of 2003, including the recently closed $4.73 billion deal for TRW Inc.
“This is a great time to buy, and LBO shops are the buyers of choice,” said Tim Wilding, a managing director with CIBC World Markets and the head of the firm’s industrial growth investment banking group. “These businesses are being sold at relatively attractive valuations, and activity should increase in the U.S. and overseas.”
The $325 million public-to-private acquisition of bankrupt steel maker LTV Corp. by WL Ross &Co. is a prime example of a sagging industry’s lowered valuations leading to an acquisition. (In fact, the purchase price on that deal is actually less than the amount the company was paying in interest payments on its debt each year.)
Manufacturing is certainly one of the most complex and wide-ranging sectors on the buyout community’s radar screen. In the broadest of industry definitions, Ben & Jerry’s is lumped in with the likes of U.S. Steel, which makes for an assorted mix of companies. The eclectic nature of the sector forces buyout pros to look beyond EBITDA and hone in on what makes a target a promising business.
“When it comes to EBITDA and purchase multiples, manufacturing is the least applicable sector,” said Joe Massoud, managing director with The Compass Group, which last month recapped existing platform company CPM RosKamp Champion, a manufacturer of agricultural-related machinery. “The focus should be on capital expenditures and operating cash flow when targeting manufacturers.”
In heavy manufacturing, such as Alcoa and International Paper, the amount of capex is equivalent to anywhere from 7% to 12% of revenue. In consumer manufacturing, companies such as Philip Morris and Campbell’s have lower cap ex costs, ranging from 1% to 4%, but spend much more on marketing to keep their brands in front of consumers.
In order to stay competitive, LBO pros agree that a manufacturing company must undergo costly and perpetual upgrades, while maintaining the lowest possible cost structure. “They need to exhibit continuous cost improvements to remain competitive, or else that manufacturer will fall by the wayside within three or four years,” said Bob Cummings, a managing director with Wind Point Partners, which has done over a dozen manufacturing LBOs in recent years. In February 2002, Wind Point spent $165 million to acquire Ames True Temper, a maker of long-handled garden tools sold to big box home and garden retailers.
MW Manufacturers, a maker of window and door products, recently changed hands from one buyout shop to another in January. After seven years of ownership, Fenway Partners sold MW to Investcorp for $188 million (see Buyouts, 2/3/03). According to Greg Smart, a managing director at Fenway, MW’s cash flow from operations tripled during Fenway’s involvement, and including the original purchase price in 1995, the buyout shop invested nearly $55 million in material and design upgrades, which Smart said directly affected company growth.
Upgrading also means strengthening your Web presence, although most buyout pros seem far less excited about the Internet’s impact on manufacturing today than they did a few years ago. “People saw it as a panacea…[especially] when the Big Three automakers invested in Web integration,” said J.G. “Pete” Ball, founder and principal at Crossroads LLC.
Today, most manufacturers still view the Web as important, but their expectations have become more pragmatic. Most see the Internet primarily as a method of cutting costs and achieving efficiency, as opposed to a revenue-generation tool.
“Manufacturing companies haven’t seen any substantial increases in income for quite some time, but any margins they do see have come from the cost-cutting side – not from price increases,” said one managing director at a major investment bank. “Look at GE’s annual report – they mention improvements on the cost-cutting side and how much business they still do on the web. Yes, [the web] was a big push, and it may not be the focus anymore, but it’s still an essential element.”
Until there is an economic upturn, corporate parents will continue to tighten their money belts and trim the fat associated with non-core assets. That means more divestitures of manufacturing companies.
“Things are gearing up, especially in the chemical industry,” said Wilding. “Big companies have earmarked 2003 as the year to sell non-core assets, because many of them have been holding out for an economic recovery that hasn’t appeared. They just can’t wait any longer.”
British Petroleum’s chemicals division, which raked in approximately $12 billion last year, recently announced it is looking to sell its specialties intermediaries unit. Earning $300 million in 2002, the unit is just a small slice of the entire chemicals division, but would amount to an LBO in the upper reaches of the middle market.
Goodyear is another well-known manufacturer seeking to carve out its non-core chemicals business. With annual revenue of more than $750 million, an auction could send the price skyrocketing out of the reach of most strategic buyers, leaving the LBO community as the last man standing.
Another possible buyout target is Dupont’s fibers activities unit, which makes polyester and nylon fibers and posted $6.5 billion in revenue last year. When the company first announced it was looking at strategic alternatives regarding the unit, there was talk of doing a carve-out divestiture or a spin-off IPO. And despite what one investment banker calls “a significantly deteriorated profitability,” some say the unit may be undervalued enough to draw the interest of the heavy hitters of the LBO world.
One of the larger and more complex recent deals is Northrop Grumman buying TRW Inc. and carving out its auto unit. In March, after 18 months of wrangling, The Blackstone Group came to terms with the defense conglomerate, paying $4.73 billion (see Buyouts, 3/17/03). In one of the more complex manufacturing deals completed of late, Northrop actually negotiated to spin off TRW’s auto unit before Northrop actually owned TRW.
An Area of Struggle
Looking ahead, the continuance of war and a dragging economy will make life difficult for all manufacturing companies, although some subsectors will have it worse than others. Heavy manufacturing (makers of equipment and machinery designed to manufacture additional products) is one area that is expected to remain depressed. “It’s going to be a slow environment for the next 18-24 months,” said Massoud. “LBO shops need to be wary of the false start, and refrain from getting excited when they see upticks in business.”
In the aerospace, automotive and computer sectors, manufacturers will seek longer-term relationships with suppliers, but to foster those they’ll have to show they’re financially viable and have staying power. “We saw that in the aerospace industry 10 years ago, in the auto industry a few years ago, and now in the PC industry,” said Crossroads’ Ball. “A more intimate relationship along the value chain…is a major force.”
All the while, more and more manufacturing jobs are heading overseas, as fiscally strapped corporations want to achieve lower labor costs. “There’s more of it moving offshore…to China…and to India,” said Ball. “India is strong in software development and telephone call centers, and has great capacity for manufacturing.”
But it’s these same challenges that are prompting corporations to shed their manufacturing divisions, which means buyout firms should see plenty of opportunities.
“It’s a challenging environment,” said Stewart Kohl, a buyout pro with The Riverside Company. “We are all waiting and watching for corporations to open the spigot. Consumers, not corporations, have been moving the economy along lately, but at some point the corporations will begin to spend money [on improvements], and then it gets interesting.”