With the Supply Chain in Turmoil, Deal Making Gets Creative

The tumultuous state of the global supply chain seemed to be a blessing for one American auto parts company. With new cars scarce because of a microchip shortage, demand surged for the sort of aftermarket parts the company made in its U.S.-based factories. It received an unsolicited acquisition offer, hired a banker, and was sorting through multiple competing bids.

Everything changed in September 2021. The one part it purchased overseas–an aluminum casing–became unavailable, and its fourth-quarter sales dropped off a cliff. The deal, which was meant to close by the end of the year, was suddenly on hold.

“There’s not a company in the world that the supply chain problems aren’t affecting in some way,” says Steve Quisenberry, a managing director of the Forbes M+A Group, which represents the parts maker. “In the fourth quarter, we’ve had to become very creative at deal-making.”

Lower middle market advisors in many industries are scrambling to adjust their bids and offers as their clients cope with scarce parts, clogged ports, and the shortage of people willing to work in the shipping industry.  

Deals have hit snags because of complex chains of dependencies that few understood. Take resin, for example, sticky substances that are critical to the manufacture of a cornucopia of modern products–toys, packaging material, paint, building supplies, laser printer toner, and plastic straws, to name just a few.

“Just having product to ship is a differentiator,” says Darren Williams, the head of the industrial practice at Origin Merchant Partners. The resin shortage, he said, forced PVC pipe makers to put customers on allotment, even as they raised prices by five times. 

“One of my clients strategically kept a one year supply of raw resin on hand at the onset of covid to satisfy their manufacturing needs,” Williams says. “They were able to replenish throughout the last two years (albeit at increasing prices) and were able to increase market share because their competitors could not supply due to their just-in-time inventory policies.”

Indeed, buyers who before the pandemic may have put a premium on companies with the leanest operations—asset-light, low inventory, flexible labor force, and so on—are now seeing new value in companies that have a cushion against disruption.

One winning sector, Williams points out, has been construction equipment rental, even though it is capital intensive. That’s hardly a surprise, with new dump trucks and backhoes back-ordered by 12 to 18 months. “Revenue, profitability, and valuations for those companies are at all-time highs,” he says.

The shipping and logistics industry, of course, is doing very well overall, but there is a lot of variation. Demand has been especially strong for cold storage, needed both for food and vaccine shipments. But trucks that deliver cars to dealers are sitting unused.

Supply chain issues are forcing a consolidation among smaller trucking companies, even though most are having record years, says Beau McGinnis, a senior analyst at The Tenney Group, a firm that specializes in the transportation and logistics industry.  There is a shortage of new trucks and a corresponding increase in the price of used rigs. Many long-distance drivers, meanwhile, have joined the great resignation, choosing other work that keeps them closer to home.

Amid these pressures, McGinnis says, trucking companies that hadn’t considered M&A are exploring deals. Some, having made it through the tough times of Covid, want to get out while the industry is doing well. Others are looking to buy companies to get access to the equipment and drivers they need. 

“There are people who have not done a transaction in the 20 years they had their business that are now opening their eyes to acquisitions,” McGinnis says. “They say this is a way to grow and add capabilities we don’t have without the risk of doing it ourselves.”

Financial buyers are also increasingly attracted by the surge in activity at logistics companies. Before the pandemic, private capital focused on acquisitions driven more by technology than hard assets, such as third-party logistics and last-mile delivery companies, says Nicholas Somos, an investment banker with Left Lane Associates.

“We’re seeing search funds and other private equity companies coming back to the market and saying,  ‘Maybe we’ll tolerate a little bit of CapEx on an asset-based trucking company or a hybrid third party logistics company with assets because of the strength of the industry,’” he says.

Even when there are interested buyers, deal terms have become more complex. It’s hard to reach an agreement using the typical middle market structure—expressing a bid as a multiple of trailing twelve-month EBITDA—when the last year’s earnings may have been depressed or inflated by the supply chain turmoil.

“Buyers don’t want to pay at the peak,” McGinnis says. “They see that companies are having record years, and they don’t want to pay an EBITDA multiple on the last trailing 12 months because that’s not what things will be like going forward.” 

One solution has been to base the purchase price on an average of the last two or three years. Another is to use an earnout structure.

“Buyers say, ‘Hey, you’re doing great, producing more EBITDA than you ever have. We’re happy to pay you on that, but you need to do it again next year,'” McGinnis says.

While some sellers balk at earnouts, he adds, others see it as a worthwhile tradeoff. “If it’s a difference between getting paid $20 million in cash or getting $25 million with an earnout, a lot of people are willing to wait a year to go to the beach house and hang out with their grandkids.” 

All the forces pushing up all deal values—low interest rates, public market valuations, and so on—have allowed some sellers to receive excellent terms even when they have been hit by supply chain slowdowns. One of them is the auto parts company that thought it would have to delay its sale when it was hit with a shortage of aluminum casings. By the end of the year, several buyers returned with aggressive bids despite the supply constraints.  

“The auction process drove the value higher because strategic buyers wanted the company and its brand,” Quisenberry said. The winner “will make a significant capital investment that will allow the company to produce all its components in the United States.”