Industrial Manufacturing: Building a Competitive Recovery - Part III: Is Vertical Integration the Right Solution to Ease Supply Chain Woes?

Welcome to Cherry Bekaert's Industrial Manufacturing Podcast. We're excited to continue our latest series titled Building a Competitive Recovery, where we will discuss the challenges of this COVID recovery landscape and provide strategies to position your company for future success.

HOST: MATT BRADY: I'm Matt Brady, leader of the firm's Industrial Manufacturing Industry Group. Today I'm joined by Jeff Bangston, leader of our Deal Advisory Services Group. Jeff joins me to discuss part three of our series on the pros and cons of integration and overall M&A activities for your business. Welcome, Jeff.

JEFF BENGTSON: Thanks, Matt. Glad to be here.

HOST: MATT BRADY: Happy to have you. Based on the environment, you're a busy man, so let's just dive in. What are the general industry trends you're seeing that are driving M&A demand specifically for industrial companies?

JEFF BENGTSON: I think pandemic-resilient businesses are in high demand. Travel, hospitality, and entertainment have been most affected by COVID, but manufacturing companies that supply and support real estate, construction, and digital services continue to grow and be in high demand.

Since the onset of the pandemic, we've become more reliant on digital services with working from home, remote schooling, and virtual meetings. All of this depends on reliable, high-speed technologies. If you have a manufacturing company supplying those industries, you're in high demand.

Second, there is plenty of capital available; that has been the case for the last five or so years. There has been pent-up demand post-COVID, where many middle-market firms were uneasy doing deals in 2020. Now it's like putting the accelerator to the floor to get deals done.

I sort of break it down between sell-side deals and buy-side deals. On the sell side, more owners are wanting to sell in 2021, very much because of impending tax increases under the Biden tax plan. Combine that with all the capital looking for good deals, and that explains why there's so much activity.

Moving capital gains rates from about 20% to the 40% range, increasing individual income tax rates from 37% to 39.6%, and raising corporate income tax rates are motivating sellers on the sell side.

On the buy side, I break it into private equity and manufacturing clients. Private equity continues to invest in new platforms but is doing significant add-ons to existing platforms. In a typical year I might see three or four add-ons for a platform; this year we're seeing many more, for some clients, 20 to 25 add-ons.

Not only do we get new platforms to do diligence on, but they're adding many deals on top to improve overall margins. For example, one large automotive accessories platform has invested over the last five years and done at least 15 add-ons this year.

The sellers in the lower middle market were selling through distribution channels, which took a good amount of margin out of the business. The large platform buys these companies and deals direct with the manufacturer, eliminating the middleman and increasing margins. That's one reason they can pay higher multiples.

Another example is manufacturers selling through e-commerce platforms like Amazon, Home Depot, PayPal, and eBay. When you add a new product line and already have infrastructure in place, you can gain scale, eliminate inefficiencies, reduce owner compensation in lifestyle businesses, obtain better freight rates when bringing full containers from overseas, and remove redundant sales and marketing functions. These changes juice margins for new platforms.

HOST: MATT BRADY: It sounds like COVID added fuel to an existing trend, and capital availability became a primary driver. I hear product diversity and market saturation are also factors that lend themselves to industrials looking to grow.

JEFF BENGTSON: Yes. Supply chain is part of it. Companies want to cut out the middleman. That has been a trend for some time. Private equity sees industries ripe for consolidation and pursues synergies by combining companies.

HOST: MATT BRADY: Has that trend been accelerated recently?

JEFF BENGTSON: It has been accelerated, particularly as businesses seek to manage tax law changes between now and year-end.

HOST: MATT BRADY: If you were advising industrial clients on what to think about or focus on for the next 12 months, whether they're buy-side or sell-side, what would you say?

JEFF BENGTSON: Everyone is scrambling to get deals done by year-end for obvious reasons. If you can save 20% on a transaction, it's a no-brainer. If you're on the buy side and want to get deals done, it's a great time because sellers want to close by year-end.

The biggest challenge is that accounting firms and attorneys are overwhelmed; we're part of the bottleneck because there are so many deals. Right now we're three to five weeks out on new projects because we can't physically handle more.

HOST: MATT BRADY: That's probably true for law firms and other advisors as well. Time is of the essence.

JEFF BENGTSON: On the sell side, with this influx of sellers matched with enormous capital and dry powder, it's a great time to sell your business. Multiples are high. I've seen some large deals in healthcare with substantial numbers. As part of a business owner's retirement strategy, I can't think of a better time to sell than right now.

HOST: MATT BRADY: That's a big consideration for many owners, the tax savings and the high demand. This topic could run hours, and there are pitfalls without good planning, but you've provided a clear picture of the landscape and what's driving demand.

JEFF BENGTSON: Sure.

HOST: MATT BRADY: For our listeners, we hope this brief conversation gave you a sneak peek at the deal landscape and some ideas for short-term actions. Additional guidance on this topic, including the case studies highlighted by Jeff and performed by our Deal Advisory Services team, can be found in the related guidance section of this podcast page. Also please visit cb.com/backg for more.

We hope you tune in for the rest of our series on Building a Competitive Recovery. In part four we will focus on the benefits New Markets Tax Credit (NMTC) can bring to your growth strategy. In part five we will review tax strategies available to offset some of those expansion costs.

In previous parts of our series, we discussed using digital strategies to optimize supply chain, and in part two we focused on the impact of international tax changes and what those tax law changes might do to your supply chain. Thank you for listening, and Jeff, thanks for joining us today.

JEFF BENGTSON: Thanks for having me. Have a good day.