Wholly matrimony

Whichever way you want to look at them, mergers and acquisitions (M&A) are not what they were. Like a lot of official statistics, those reporting such activity involving UK companies are always on the drag. The latest Office for National Statistics data was published in December and covered the third quarter of 2008 – an update is due next month. It shows that very few UK companies are buying other UK companies, even fewer UK companies are buying foreign companies, and fewer still foreign companies are buying UK companies. All in all over the quarter there were 191 deals worth £11 billion; which sounds a lot until you compare that with the previous quarter's 317 and £34 billion. If you're in the M&A business and take a similar view to Martin Shaw, a partner at heavyweight law firm Pinsent Masons, the Q4 figures don't bear thinking about. "In today's market, apart from disposals to create cash flow for survival, frankly there aren't any deals around. M&A has come to a shuddering halt," he says. "Successful people like [Dublin-based building materials group] CRH would be doing something like 30 or 40 acquisitions a year. That's how it was until the spring/summer of 2008. Now everything's been turned on its head and most manufacturers – particularly those that have been on the acquisition trail and have got large slugs of debt – have got real problems." Shaw has little hesitation in pointing towards the culprits. Because banks are preserving their own capital, they are reluctant to lend more and, as facilities come up for renewal, borrowers are being pressed to reduce their debt. Furthermore, existing facilities that had been syndicated are not being renewed, mainly because overseas lenders have been told by their own home state to withdraw from overseas facility commitments; higher Libor (inter bank lending) rates are putting up the cost of risk; and banks are asking for facility arrangement fees of between 5% and 10% – even for strong companies. Even worse, Shaw describes as "absolutely outrageous behaviour" examples of banks seizing upon trivial breaches of covenants on existing facilities and charging fees to waive them. One company's payment falling due between Christmas and New Year was delayed by one day, incurring a waiver charge of £250,000. Such a tight cash environment means that mergers or acquisitions that might otherwise be advantageous – in terms of the mutually beneficial consolidation of a market sector or reduction through economies of scale achieved by centralising overheads – are often not possible. However, "if a competitor was clearly going into administration, it's just possible that a knockdown price deal might be on the cards," says Shaw. Whether it's mergers, acquisitions or administrations, manufacturers need to watch the companies in their supply chains very carefully and make sure that they have alternative lines of supply in place. It's a view echoed by Brad Brennan, managing director at emergency logistics specialist Evolution Time Critical. The potential for interrupting production is so high that in the automotive industry, vehicle manufacturers are supporting troubled suppliers with faster payments or higher prices rather than risk the consequences of a rushed acquisition. If this can't sustain the supplier's business, then they will support M&A as a far superior option to administration because, if managed carefully, it will ensure continuity. But mergers and acquisitions can be very sudden, he adds, leaving an OEM in the lurch. Brennan says: "If youOre in control with suppliers, talking to them about what's happening – they might be being bought by a company with production being moved to the acquiring company's premises or maybe to a lower cost manufacturing base – at least you know what's going on. One particular OEM customer sent its regular 'milk run' trailer to collect some components from a supplier and the guy was told when he got there, "sorry, we don't make that here any more, that's made in Spain". That's the sort of thing they need to avoid at all costs." So, with the bank vaults locked, is M&A dead in the water? Not according to David Raistrick, UK manufacturing industry leader at Deloitte. "For manufacturers in a stable financial position, the current downturn presents a good opportunity to steal a march on competitors," he says."With conventional finance for M&A effectively off limits in the current lending climate, firms will need to draw on their own resources to beef up their assets.Cash-rich manufacturers with strong balance sheets are now being presented with attractive acquisition opportunities." Martyn Pilley, corporate finance partner at Grant Thornton agrees. "Where there are opportunities for synergistic, opportunistic acquisitions to consolidate your market position, people whoOve got the financial ability are buying each other up; there's an opportunity to add complementary products to the portfolio or to gain market share in their core business," he observes. But there are issues. Pilley goes on: "We're seeing a massive polarisation between the purchasers, who have got money and are under pressure from shareholders not to overpay because it's their perception that this is a buyers' market, and sellers who are still hanging on to what I would call first half of 2008-type valuations." However, the gap is starting to narrow as owner-managers nearing retirement age face the choice of adjusting their price expectations or sitting things out until the cycle turns upwards – perhaps two or three more years, believes Pilley. Both he and PinsentOs Martin Shaw believe some M&A solace could come from a source once, and maybe still, regarded with a scepticism that branded it the 'vulture capitalist' sector. VCs, more properly venture capital or private equity funds, are still said to be available. "The private equity houses are certainly looking at providing debt themselves and it may be that it would be a combined equity investment plus lending from the private equity house. We haven't seen any significant examples of that yet but weOre told that that is a [possible] scenario," says Shaw. Pilley is even more bullish about VC funds and the degree of innovation he's beginning to see in their approach to investment. "If you're a poor business and your bank's running out of patience with you, you're not going to attract an investment anyway. But if you're a good business who could use money for expansion but, again, the bank's not co-operating, that [VC investment] is an option that should not be discounted," he says. VCs are either having to sit on their funds and not invest at all, or invest for lower returns – perhaps backing an MBO purely for equity or maybe looking to joint venture with a corporate group that would like to sell a non-core division in its entirety but is prepared to instead sell a stake to the VC and back that subsidiary's management. Two of the still acquisitive manufacturers Works Management tracked down owe a good deal to private equity. Precision Technologies Group (PTG) claims to be one of the two largest remaining UK machine tool manufacturers. It was formed in September 2006 when two individuals and an investor got together to buy grinding specialist Jones & Shipman, then rotor and gear specialist Holroyd from Renold plc. The strategic intent was to form a machine tools group with what PTGOs COO Tony Bannan calls "a central niche market focus – not your standard machine tools but something a little bit special". The first motivation for the purchase was purely one of availability at a sensible price, says Bannan; it was "ideal for exploitation because they'd underperformed for a long time and the versatility and flexibility that a small group could bring to it would give them the best chance of success". All that was needed was "some capital, some focus and the creativity," adds CEO Stephen Lord. In little more than 12 months, the business had been turned around and in August last year hit the acquisition trail with the purchase of the prestigious Crawford Swift and Binns & Berry brands, and the launch of J&S Remanufacture to design and build new machines and re-engineer large existing machines at its Rosemount Works in Elland, West Yorkshire. It was a move that allowed PTG to exploit opportunities in the large capacity machine tool sector and, as Lord puts it, "has spread the risk in times like this so the business is very well positioned today". Separation Operationally, when PTG makes an acquisition, "we almost put it into an isolation ward". As it becomes strong enough to fit within the PTG ethos – the last one took six months – it is brought into the main fold of the group. That may mean taking out non-complementary products – optimising an underperforming brand effectively, not cherry picking bits of it, Lord insists – and realising the upside of implementing the group's ERP system. "We take legacy systems out immediately upon acquisition." Group turnover this year is expected to be £30 million. It's been profitable since its conception and is growing in profitability despite the way the markets are. And it's still looking for acquisitions. Current such activity is about identifying strong, underperforming complementary brands. "There are lots of opportunities now and they're growing on a daily basis." As for funding, Lord says: "The shareholders are very much forward thinking and are retaining the profits weOre making in the business for potential acquisition activity; they have also offered, if required, to provide funding to supplement the retained earnings." COO Tony Bannan says: "We've got two or three more in the pipeline; it's a big opportunity for the obvious reason that businesses are becoming available, so it's not something we're slowing down on." An example of market consolidation via acquisition on an even larger scale can be found at Braintree, Massachusetts-based Altra Industrial Motion, a multinational manufacturer of clutches, brakes, gears and couplings with 40 product lines and production facilities in eight countries, including the UK. Craig Schuele, vice president marketing and business development, is in charge of seeking out and managing the purchase of new acquisitions. Altra was initially formed by a private equity group, incorporating the power transmission division of Colfax and Kilian Manufacturing, a spin off from Timken. Now, it is a fully-fledged public company. Two years ago, it acquired five power transmission brands from UK-based Hay Hall, a purchase that gave Altra a bigger stake in Europe and the UK. "It really allowed us to globalise sales and marketing," says Schuele. More market-consolidating acquisitions, mainly in the US, followed – the small motion control group Bear Linear in 2006; TB Woods and All Power Transmission in 2007 – as sales grew from $300 million in 2004 to well over $640 million now. There's a five-part philosophy, "a very disciplined core strategy", behind the acquisitions, Schuele explains. Each of them, he insists, must strengthen Altra's product portfolio, be accretive to group earnings in a manageable time frame, be capable of leveraging fixed costs, expand the company's global footprint, and make products and serve markets that the group understands. Financing the deals can come from a number of areas, including issuing bonds or, for smaller bolt-on acquisitions, "we just use cash". Rather than getting into an auction for an acquisition target, Altra believes in developing relationships with the company, avoiding situations where the price ratchets up. "Overpaying means that the company comes under a lot of financial pressure after the purchase," Schuele says, "and you don't want to damage the company or damage established customer relations by taking out cost too aggressively." While the ultimate aim is increased sales and profitability, purchases have not included substantial plant rationalisations so far. "In the long term, we are interested in building expertise and manufacturing excellence. When we acquire a company we look for synergies – cross-selling opportunities, where products can be sold into new markets; and for new solutions, how we can leverage the existing infrastructure to increase the sales of that company. We have a global sourcing office which often brings substantial benefits in terms of purchasing raw materials and components more competitively." A key tool Altra applies to its new companies to improve productivity quickly is its own brand of lean manufacturing – the Altra Business System – which, it says, leads to improved profitability. On the subject of future acquisitions, Schuele says: "There is plenty of space within the market to expand; long term there are a wealth of power transmission companies that fit all our criteria fully for potential future acquisitions."