Trends in Manufacturing M&A: Supply Chain Dynamics, Labor Challenges, and The Future of Automation

Manufacturing in the United States is currently experiencing a major revival. In addition to stimulating a healing economy, the resurgence of onshore manufacturing is also creating tremendous opportunity for investors targeting the space. While all of this paints an exciting picture for the future of the manufacturing industry, it’s not without its challenges. Supply chain disruption, labor shortages, and pricing increases are major hurdles that both manufacturing operators and their financial sponsors will need to clear. 

In this week’s virtual roundtable, six lower middle market deal professionals sat down to discuss these major trends in manufacturing and how they will impact the M&A economy. 

Thank you to the below Axial members who participated in the discussion: 

Jessica Ginsberg, Director of Business Development, LFM Capital

Dan Eisemann, Senior Vice President of Corporate Development, Fairfield Maxwell

Craig Korte, Director of Business Development, Industrial Opportunity Partners

Scott Mitchell, Managing Director, SDR Ventures

Stephen Raymond, Managing Director, The DAK Group

John Slater, Managing Director & Advanced Manufacturing Team Lead, FOCUS Investment Banking

Video

Audio 

Show Notes 

Introductions 00:00 – 5:22

Supply chain dynamics and pricing increases 6:25

• Scott Mitchell, SDR Ventures: Currently working with a pallet manufacturing company that was selling pallets for $10 a piece in January and now it’s up to $40/piece; people need to move goods, so the prices are able to continue to creep higher
• Lumber prices have likely peaked and are starting to correct 
• Steve Raymond, The DAK Group: They’re currently in the market with a building products manufacturing business that is a large consumer of steel; has had a big impact on both the company and the sell-side process
• Prices of steel are at a record high and delivery times for raw material are delayed 6+ months
• Consumers are delaying purchases based on increased price and delivery times
• Has also impacted the margin profile because YoY numbers don’t line up
• Dan Eisemann, Fairfield Maxwell: Invested in a pebble pool tile manufacturer; last year was a great year to be in the swimming pool business, so revenue is up significantly
• That said, a lot of the materials need to be sourced from around the world, and getting shipments from China is becoming increasingly difficult and shipping rates have gone through the roof
• Getting materials is tough enough, but then having to price the products is another issue entirely; there was a question as to whether or not to call the increase a tax or surcharge, or just to call it the new price
• Distributors and construction firms will buy it because the demand is there, so the business has settled for the placeholder name of “additional tax”
• Craig Korte, Industrial Opportunity Partners: IOP has 10 active portfolio companies right now; most are selling intermediate goods (selling to other manufacturers), and generally there has been pretty good success in passing along the price increases that are occurring in the supply chain
• It’s helpful that prices for everything are going up — it’s not just one sector — and it’s something that is well publicized, so people don’t question it
• Some businesses are trying to wait out the price increases, so some of IOP’s portcos that sell into manufacturing plants are seeing pauses on orders
• Dan Eisemann: Labor is another discussion in and of itself, but since labor is currently so expensive due to the shortages, that can make price increases in materials seem like a drop in the bucket comparatively
• John Slater, FOCUS Investment Banking: Working with a custom high-precision metal fabricator right now, and during the pitch meetings, questions were less about the price increases, and more about availability
• Supply chain disruption is absolutely as important as price when you’re seeing lead times of 3-6+ months beyond what they normally are

Primary drivers of pricing increases & the impact of inflation 15:00

• John Slater: Hearing much more about labor shortages than materials price increases; employers are giving raises immediately after hiring folks because they are so desperate to keep them around
• Dan Eisemann: Shipping costs are also a huge driver, particularly if you have to import critical materials
• China snapped back a bit sooner, so a lot of shipping vessels were heading there and China is now taking up a lot of the shipping capacity
• Scott Mitchell: If you think of the supply chain like a hose, there was a big kink in it caused by COVID (plants shut down, people were delaying orders due to uncertainty) and when you unkink the hose, there is a bit of a delay before the water flows again
• We’re playing a bit of catch up right now as the market normalizes
• John Slater: Over the past 23 years, we’ve developed a “just in time” economy
• When you study economics, curves are smooth, but that’s not how it plays out in the real world
• If you have one item that is disrupted, it can affect and entire market (ie: what is occurring in the housing market due to lumber prices)
• Craig Korte: These are systems that didn’t have a ton of slack in them, so when you get changes in demand the way we’ve had recently, it’s hard to increase capacity quickly enough
• Commodity prices should start to normalize as manufacturers come back to 100%
• It is currently the wild west when it comes to freight; it’s not just the pricing of freight, but it’s the work you have to do to get things moved
• Businesses that used to talk to 2-3 carriers now need to talk to 10 to try to find a decent price

Labor shortages and hiring & retention challenges 21:42

• Labor is one element of inflation that may not be coming back anywhere in the near future
• Jessica Ginsberg, LFM Capital: 100% agree on the labor side; so many of LFM’s portfolios are in things like machining and metals, and the struggle to find skilled or qualified welders is huge, and there’s the added stress of then losing them to another factory down the street for $1/hr more, so there’s a lot of creativity needed for retaining employees
• Have found some success in creating tiers; an employee starts and will be on the bottom tier, and if they show up every day for a month, they can move up a level, etc.
• Craig Korte: Wage rates are advertised by billboard, and it’s become commonplace to be “ghosted” by employees; they’ll show up for a few days and then disappear, never to be heard of again
• Newer facilities that didn’t have an established workforce and non-union facilities are seeing things like 200%+ turnover this year
• Jessica Ginsberg: When you factor in the need to train every new employee, it is even more of a challenge
• Some of the businesses are needing to think about things like finding a group of welders in one geography and bussing them to another geography where they’re needed; things that you’d never need to think of in the past
• Dan Eisemann: Even with higher wages, it’s just as hard to find the bodies
• Jessica Ginsberg: COVID taught us that we want to have the fewest bodies on the floor so they can be spaced apart, and that encourages automation
• The labor issues continue to hammer home the need for automation
• LFM’s portfolio company Eckhart is a business that sells a “factory of the future” product where they look at your existing facility and they design and implement an automation/robotics plan and their backlog has grown exponentially in the recent months

A deeper dive: just-in-time manufacturing 26:25

• Craig Korte: There’s not a fundamental question behind the style of manufacturing that we’ve become accustomed to, rather there is just more of an emphasis on safety stock and questions around the supply chain model
• Steve Raymond: The political climate is affecting businesses’ level of comfort with having their materials and their supply chains so far from home, in places like China
• Scott Mitchell: OEMs are going to continue to look for cheaper solutions internationally, but if you’re at lower volumes for more specialized parts, there is more consideration around reshoring
• What’s most likely to happen, is that businesses who were left in a lurch with no backup plan will be more likely to put in a plan B that has stateside operations 
• Dan Eisemann: Fairfield Maxwell hasn’t had any conversations about upending their models based on what’s happened, they’re more in a reactive role right now and figuring out how to address the gaps that they’ve seen
• Since the China tariff proceeded COVID, there was a little bit of lead time for people to start to readjust prior to the pandemic
• Just-in-time manufacturing is not gone, it’s just not as just-in-time as it used to be
• Scott Mitchell: If you think back to when we ran out of toilet paper at the beginning of COVID, people got a whiff that something was happening and began hoarding toilet paper, which ultimately created a major supply issue. The same thing happened in manufacturing.

A deeper dive: labor supply 31:35

• There is the idea that high labor prices are here to stay, versus the idea that raw material prices are more transitory 
• Craig Korte: Labor was a major problem for manufacturing businesses before COVID — it’s hard to get good people and have them stay with you when you’re in a job environment that is not as cushy as most
• COVID pulled a lot of people away from their jobs for a period of time, and now you’re having to win those people back without the same “perks” that other markets can offer; hours are long, there’s not always air conditioning in the summer, a lot of the jobs are in  smaller towns where the demographics aren’t hugely desirable 
• Now manufacturers are competing with companies like Amazon who are able to hire the same subset of employees and pay up and offer perks
• Jessica Ginsberg: It’s similar to the loss of teachers: more teachers left the education field post-COVID because it was a harder and less desirable job, and people are now seeing they can try new things 
• Scott Mitchell: COVID shined a direct light on some of the increasing inequities between the haves and the have nots, and people are reevaluating 
• SDR is working with a plumbing company based in Denver that now has a national recruiting strategy; you never used to have a recruiting strategy for blue collar labor where you’d try to pull people from different states
• Steve Raymond: That’s something that is similar across industries and isn’t specific to blue collar workers; the sub-30 year olds in every field are so much more willing to move across the country because it’s now a lot more about quality of life than just a job

A deeper dive: automation 41:55

• Dan Eisemann: Fairfield Maxwell has a business with a quarry in Mississippi and it’s not the easiest place to find labor to begin with, and you need a lot of overtime; additionally, there are a lot of steps to get material out of a quarry pit.
• Because of all of those things: there was a good return to putting money into automation for this business
• Machines are more reliable, you don’t have to worry about retaining them, and they can do things faster and more efficiently in a lot of situations.
• The business is automating a portion of the stations at this one quarry and will use it as a test case to see if they’d like to roll out automations to other stations and locations
• In order to do this, the business had to go back to the bank, because it was a $2M plan
• Expecting a 2-3 year payback period
• Jessica Ginsberg: Automations projects could be multi-million dollar plans, or they can be much smaller than that
• Sometimes robotics are taking over human roles, other times they’re just making it faster/easier/safer for employees

How does all of this affect deal dynamics? 48:26

• How does all of the above impact pricing, structure, complexity of underwriting when buying companies?
• Craig Korte: One thing that IOP will look at more than ever as they look at businesses: how does their equipment stack up against the competition?  
• Jessica Ginsberg: A greater focus on geography and the ease (or lack thereof) of recruiting into that geography
• Supply chain also matters more today than it did a few years ago: is there a diversification of vendors? Are raw materials coming from China or Taiwan versus domestic? — getting the right answers to those questions is more important than it used to be.
• Scott Mitchell: SDR is under letter with a business in the refrigerated trailer space and they’ve been growing nicely and have strong demand, but now they’re hearing that their manufacturers are pushing out to 2022, which makes timing of a deal hard
• John Slater: One of the main drivers that FOCUS is seeing is supply-chain resilience. This is making businesses much more attractive.
• Craig Korte: While there isn’t anything else new that IOP is looking at in terms of their diligence process —  just the increased scrutiny around some of the previously mentioned items — they are still extremely bullish on American manufacturing
• There’s a ton of opportunity here, and manufacturing is coming back to the U.S.
• It’s very much a seller’s market, whether the buyers like it or not

The return of manufacturing to the United States 55:55

• Craig Korte: It does look like there are longer-term trends that imply that over the next 20 years there will be a significant amount of manufacturing that is brought back stateside
• However, it’s OEMs that really drive this, not lower middle market companies; OEMs are the ones who will need to bring back huge factories
• Jessica Ginsberg: There is hope as an American that we can continue to invest in these US-based manufacturing companies to better ourselves and the geographies where these businesses exist, but right now, it is more based on those hopes than any firm political climate
• Dan Eisemann: Operating companies are looking for a good quality product at a great price. If there is an American company that can achieve both of those things, that’s great, but ultimately something needs to have both of those things. 
• Scott Mitchell: Mexico and South America are going to be creating some diversity that is a bit closer to home and a lot of OEMs are going to be looking for onshore “safety valves”