New ways of looking at US manufacturing and industry

By Joseph Huffsmith and JB Cherry, One Equity Partners

While investments in dynamic industries such as healthcare and technology capture the imaginations of LPs and receive the lion’s share of media headlines, old school industrial manufacturing – especially in the US – is often an afterthought. The decline of American manufacturing is an old trope, which cites cheap overseas labor, an efficient global supply chain and limited opportunity for growth domestically. Opportunities in American manufacturing and industrial businesses remain vibrant if investors adopt a global perspective and think carefully about the role they can play in GPs’ portfolios.

When considering why manufacturing remains ripe for PE investment, it helps to think about the US economy as two barbell ends, each full of large, global corporations. One end is the consumer-facing portion, comprising restaurant chains, retail groups and consumer goods conglomerates. At the other end lies heavy industry: raw material providers like mining and energy companies, infrastructure services and materials, and heavy equipment makers.

In between lie numerous mid-market, business-to-business companies making up supply chains to these global companies. We believe opportunities abound for PE firms that can identify and back manufacturers to make them more important to global customers.

While the “global economy” is frequently discussed, covid-19 brought about logistical and supply chain challenges, driving the point home for many in a new way, exposing vulnerabilities and demonstrating critical roles played by domestic manufacturing businesses that are reliable partners to global enterprises. That’s one reason the construction of new manufacturing facilities in the US grew 116% over the past year, according to Dodge Construction Network.

Private equity can bring capital to fuel growth, a strong network of connections and deep operational expertise that can help small and medium-sized manufacturers achieve scale to become reliable and versatile partners to large global companies.

Identifying potential

Finding the right manufacturers to back is, of course, a critical puzzle piece for private equity firms. One area to examine is the company’s customer base. A major challenge for many manufacturers is customer concentration, whether they are dependent on one or a few customers for most of their revenue.

If the revenue concentration is from a global manufacturer that trusts and relies on them, it can bolster the investment case. Manufacturers need to do a lot correctly to win and retain business from major global customers who can be extremely demanding. If a manufacturer earns that business, they can secure strong gross margins and a reputation for reliability they can take to other global companies.

Location, location, location

M&A is another important component of investors’ playbooks. Acquisitions focused on expanding manufacturers’ geographic footprints can be meaningful. Helping manufacturers to build out supply network and achieve greater production flexibility worldwide is a critical role PE investors should play.

Especially post-pandemic, this flexibility can be key for large, global customers who are seeking certainty even more than pricing power. They want partners who have multiple production facilities to avoid bottlenecks from port overcrowding or travel restrictions; who can maintain production volumes because they have strong relationships in multiple regions; and are able to maintain pricing by minimizing tariff impact.

We recently merged an agricultural components manufacturer with a large presence in the Americas and Europe with a business that has complementary products and footprints in Europe and Asia. The combined company can serve global customers locally in the regions they operate with redundant global operations, should supply chains need to adjust.

Surviving consolidation

Large, global companies are also looking to increase efficiency by reducing the number of suppliers they must manage. The traditional use of M&A to increase diversification is still a key strategy, but it is sometimes less about entering new end markets and more about serving a broader range of needs with existing customers.

Acquiring and integrating businesses with complementary products and services can result in increased wallet share with existing customers without added expense required to grow the customer base. In addition, the ability to provide customers with multiple offerings creates stable customer relationships.

An example of this strategy is an investment we made in a piping system components maker that bought five complementary businesses during our ownership. While these acquisitions were about adding more products to sell to more customers, the strategic achievement was much greater.  Acquisitions allowed the company to manufacture in multiple locations and source from more providers, both in the US and abroad, eliminating a vulnerability that might have knocked them out of consideration for large customers with global presences. Following the acquisitions, the company’s customers had more assurance that they would receive products on time, regardless of political and economic volatility.

The pandemic demonstrated that the need for strong manufacturers that can be reliable partners for global enterprises is bigger than ever, and so is the opportunity for PE to play a transformative role in building these businesses.

Joseph Huffsmith is managing director and JB Cherry is senior managing director at One Equity Partners