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Private Equity Trends and Implications on the Manufacturing and Wholesale Distribution Industry


3/17/14

The private equity (PE) industry, after years of lackluster performance driven by the financial crisis has returned to pre-crisis levels of activity. Last year, the industry experienced its most successful fundraising year since the onset of the economic downturn, and transaction activity continues to gain momentum. PE firms are placing an even greater emphasis on exit strategies, and a strong pipeline of deals for the first quarter of 2014 already exists.

The manufacturing and wholesale distribution (M&WD) industry, also hard hit during the downturn, entered 2014 on a similarly sound footing.  Fourth-quarter output recorded its largest increase since mid-2010, and manufacturing demand generally appears solid.
 


Both Healthy, PE Firms Eye M&WD

In light of the positive outlook for the M&WD industry, has PE interest in these types of firms increased, and has this affected the pipeline and outlook for investment? It appears so.

As a case in point, one leading middle-market PE firm with industrial manufacturing as its core investment focus is witnessing an uptick in PE interest in manufacturing companies. The sectors poised for the strongest level of growth in 2014 include medical instrument and supply manufacturing, aerospace and defense, and natural gas and electricity distribution. Investment interest in these sectors is closely tied to the broader market. Those sectors showing solid performance in the overall economy are receiving very high valuations, with significant interest from PE investors.

Reed Anderson, Director with investment bank Houlihan Lokey and head of the firm’s Industrial Distribution practice, maintains that 2014 is slated to be a notable year for mergers and acquisitions in the distribution sector. While the actual number of PE transactions declined from 2,459 in 2012 to 2,124 in 2013, Anderson foresees a surge in supply as it relates to deals this year. “A number of PE deals are reaching their point of harvest,” he says. “Although 2013 was a bit slower, in 2014 we are starting to see companies that were not ready in previous years now reaching the inflection point where it makes sense to consider an exit. Owners are asking, “Given current valuations, is it the right time to sell? Am I taking on too much risk if I hold this business longer term?”

Anderson notes that many distribution businesses are in a strategic position in today’s market. “Strategic buyers are flush with cash and looking for ways to grow their business,” he says. “Organic growth rates are not what they had been previously, and companies are looking for growth today through acquisitions.”

On the PE side, there is an abundance of capital and M&WD is a favored sector for investment. Businesses with downside risk protection, specifically maintenance, repair, and operations (MRO) companies, are especially desired because they cycle less than do new product manufacturing companies.

Competition Leads to Attractive Valuations

A key issue facing the PE industry in 2014 is increased competition for quality deals. There is a large amount of capital available for acquisition and investment from a range of capital sources including PE, lenders, and strategic acquirers. This climate has led to exceedingly attractive valuations in the M&WD industry. Anderson concurs, “Auctions are incredibly competitive today.  Buyers are aggressive across the board.”

Competition for PE deals from nontraditional players such as hedge funds and mezzanine lenders is also on the rise and may increase as new federal regulations squeeze regulated banks with tighter lending rules. Given the improved market conditions in 2013 and 2014, hedge funds, mezzanine lenders and less traditional financing sources continue to grow in size and power and continue to pursue strategies that can generate ever-higher returns. 

Private equity activity surrounding add-on transactions continues to grow, accounting for 53% of all PE buyout deals in 2013, a record high. The number of add-on deals surpassed platform buyouts for the first time in 2013. The fragmented nature of the M&WD industry, which comprises a fair number of smaller niche companies, allows for an abundance of add-on acquisitions. Given that PE firms will look at substantially smaller companies for add-on acquisitions than they would for platform investments, the market is ripe with opportunities. What is paramount for PE firms when looking at an add-on is whether a synergy exists and if the opportunity presents efficient use of management’s time. Anderson agrees, “The key is closing at an attractive valuation in addition to working with the right people.”

What Does CohnReznick Think?
The PE and M&WD industries are each poised to make solid gains in 2014. Flush from a successful fundraising year, the PE sector is on the rise, and experts expect that many of the attractive investment targets will come from the equally surging M&WD industry. Competition in this space is fierce. With strategics and nontraditional players competing aggressively against PE firms to land quality deals, valuations in the M&WD are already reaching exceedingly attractive levels. Companies considering a buyout should understand what each prospective acquirer or investor brings to the table in addition to cash, as well as the best options for closing at the most attractive valuation.

Contact

For more information, please contact Alan Wolfson, Manufacturing and Wholesale Distribution Industry Practice Leader, at 646-254-7416, or Jeremy Swan, Principal, Private Equity and Venture Capital Industry Practice, at 646-625-5716.

To learn more about CohnReznick’s Manufacturing and Wholesale Distribution Industry Practice, visit our website.


This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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