Ready for a manufacturing M&A boom?

Increase in deals signals the need to be prepared

Manufacturers appear poised to continue their strong performances throughout 2015. That makes the sector a prime target for M&A — for both buyers and sellers.

Figure 1: Mergers or acquisitionsHalf of manufacturing executives report that M&A is important to their company’s strategic vision, according to Grant Thornton LLP’s Value-Adding Strategies survey. Moreover, four out of five manufacturers have completed an M&A deal in the past five years.1

It doesn’t hurt, either, that M&A activity is strong in other sectors, too. Scott Sperling, co-president of private equity firm THL Partners, says deal volume hit an eight-year high in the first quarter of 2015, as the cost of transactions remains low and companies chase growth.2  

“Manufacturing executives are proactively exploring M&A,” says Ed Kleinguetl, Grant Thornton LLP managing director, Transaction Advisory Services. “They’re not waiting for an opportunity. They see that multiples and debt limits are high right now, so they are more deliberate in finding partners that fit their core strategies.”

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Avoiding common M&A mistakes
Also contributing to the uptick in M&A is a mountain of private equity capital. Undeployed private equity capital, or “dry powder,” reached $1.2 trillion in 2014.3

In a robust economy, buyers are on the lookout for growing businesses that complement or extend their market reach. Sellers, on the other hand, hope for maximum long-term returns while protecting their legacies. With capital readily available, it’s an M&A match made in heaven.

Time to deal?
Is now the right time for your organization to pursue M&A? Proactive CFOs use a range of objectives to confirm whether a deal makes sense.

On the buy side, common objectives include:

  • Support corporate strategy: Does the deal contribute to the corporate mission and/or enhance company brand?
  • Expand into new markets and customers: Does the deal grow the corporate footprint and provide access to new domestic and international markets or distribution channels?
  • Increase operational capacity: Is there an opportunity to integrate similar operations to handle increased demand?
  • Boost operational capability: Does it introduce new skills and technologies?
  • Expand intellectual property: Does it offer access to patents and trade secrets?

On the sell side, objectives typically include:

  • Divestiture: Does the sale streamline cost structure by shedding assets no longer core to the company mission?
  • Exit strategy: Does the sale offer an attractive option for key stakeholders to exit at a time that internal succession options are untenable or undesirable?
  • Partial or complete liquidation: Does it maximize return on assets in a healthy market?

Figure 2: Primary objective of M&AAmong these possibilities, Grant Thornton’s Value-Adding Strategies survey found that two objectives take precedence among manufacturers as M&A drivers: expanding market or brand (62%) and international expansion (44%).

Finding a suitable partner

Deal-savvy CFOs should seek a “three-level-down” perspective of a target company to get a perspective on intangible but critical factors that can do a lot to determine whether the deal and integration are likely to proceed smoothly:

  • Start at the top to determine if the owner or senior executives will retain the same passion with which they’ve led the company to date.
  • Interview supervisors and managers who know the company’s operations. They can help identify customers, suppliers and employees who should be retained.
  • Talk with employees about safety practices and labor turnover to get a sense of a company’s culture.

Figure 3: Suitable partner

But CFOs don’t stop there, since many other factors that make or break M&A must be resolved before closing a deal. They also need to take a close look at:

  • Business practices: Comparable operations practices and standards make integration simpler and faster.
  • Business systems: Incompatible technologies add substantially to integration costs.
  • Market/customers coordination: The company must determine which contracts and pricing will take precedence after a deal is completed to minimize customer disruption.
  • Supply chain optimization: Mismatched supply chains and procurement practices lead to inefficient inventories and operations.
  • Reallocation of assets, capacity: Optimizing a combined network of plant assets can deliver significant value. On the other hand, some jurisdictions offer incentives to retain legacy facilities.
  • Reallocation of workforces: Although many executives focus on consolidating employees in fewer locations, retaining separate facilities while standardizing business practices may deliver better results.
  • Accounting and administrative issues: Many integrations flounder on insufficient documentation, unrecognized tax liabilities or disputes among new owners.

The CFO’s critical role in closing the deal

The CFO should lead the M&A plan from the start through the closing of the deal (e.g., negotiation tactics, tax-advantaged strategies, optimal deal timing), taking the following into careful consideration:

  • Financial due diligence
  • Transfer of assets and liabilities
  • Earnout provisions
  • Business system/IT due diligence

A successful deal always starts by getting your own financial house in order. This includes up-to-date financial statements, a review of customer and supplier contracts for covenants that may affect a deal, restrictions or encumbrances on assets, and tax liabilities.

“The most effective CFOs are focused on understanding process as well as technical matters,” says Chris Schenkenberg, partner, M&A Tax Services, Grant Thornton LLP. “They make sure that M&A due diligence is rigorously executed in the context of current tax and regulatory environments. This is vital because U.S., state and international taxing jurisdictions have become increasingly aggressive over the last 10 to 15 years, making tax compliance complex for companies of all sizes.”

Most M&A due diligence initiatives project corporate performance improvements. Unfortunately, few live up to their billing.

“Examine estimates of post-merger synergies with a skeptical eye,” says Kleinguetl. “This is where deals typically fail to deliver. The leaders of one company believe they can suddenly fix the problems of another and then fail to achieve those unrealistic goals.”

Plan for integration early

In deals that succeed, CFOs plan for integration prior to completing due diligence. Why? First, a solid integration plan identifies issues that require attention in the purchase agreement. Second, early work on integration will foster open communication (as appropriate) to employees, customers and suppliers about the pending deal.

To make this happen, leading CFOs establish protocols for reporting on integration objectives and milestones. Successful integrations can take months, depending on the size of the deal. CFOs must have a reporting process that allows them to carefully assess progress across multiple functions (IT, finance, operations) and intervene quickly if things go awry.

“Once you close a deal, you’ve got about 100 days to form the new organization you envisioned and capture the synergies you projected,” says Kleinguetl. “After 100 days, everyone goes back to business as usual, so that anticipation of change and momentum need to be set in motion rapidly and sustained early on. Speed is critical — speed over perfection.”

CFOs need to be at the forefront of spotting M&A opportunities and guiding the actions to support informed and effective decision-making and, ultimately, deal-making.

Your competitors are looking at growth through M&A. Are you?

1 Value-Adding Strategies survey, Grant Thornton LLP, Autumn 2014.
2 DiChristopher, Tom. “Why M&A is on a tear in 2015,” CNBC, May 20, 2015.
3 Berry, Freya, and Schuetze, Arno. “Flush with cash, private equity faces $1 trillion headache,” Reuters, Feb. 25. 2015.