With strong growth in merger and acquisition (M&A) activity, particularly in the middle market, many business owners have to consider whether a transaction makes sense for their company in today’s environment. For example, an acquisition strategy can be a great way to supplement organic growth and create incremental value for a company. However, the sale of a business to another strategic partner or financial party like a private equity firm can be an excellent way for a business owner to generate cash. We regularly run across companies in the auto space that are small to midsized and might be family owned that are working on the development of a succession plan. More often than not, business owners do not have a person they want to leave the business to so they turn to a merger or acquisition as a solution. A successful transaction provides growth opportunity and/or incremental value to an acquirer, while meeting the liquidity needs of the seller.
However, there are many critical success factors for a merger-and-acquisition transaction that must be considered by both the buyer and the seller. A successful transaction is influenced by many factors some that can be controlled and others that cannot:
- Operations: The operational fundamentals of an automotive supplier are critical to maintaining financial performance, generating growth and creating incremental value. Breakdowns in a company’s operations can lead to lost production, missed deadlines, poor launches, customer and supplier anxiety, and financial distress. Companies with strong operating fundamentals therefore tend to receive higher relative value during an acquisition.
- Strong financial performance and projected growth: Companies that have demonstrated consistent historical financial performance, including revenue and earnings growth, stable or expanding margins, and effective cost control, tend to receive greater interest and higher relative value from potential acquirers. The ability to accurately project future financial performance is important because future revenue and earnings are what the acquirer is ultimately purchasing.
- Exposure to commodity pricing: In today’s volatile commodity markets, raw material price changes (e.g., steel, resin, etc.) can have a dramatic impact on the financial performance of an automotive supplier that is exposed to commodity price changes. The ability to mitigate the effects of such price changes (e.g., hedging contracts) or to pass cost increases to customers can have a significant impact on valuation.
- Platform exposure: Growth projections can be dramatically impacted by the specific platforms served by a supplier. For example, suppliers to relatively new and/or highly successful platforms often have stronger and more stable projected growth compared to suppliers on mature or less-successful platforms. Companies have to target the growth programs they want to be on and focus their efforts on winning that business.
- Diversification: In any form, diversification provides stability, reducing the volatility of its future financial performance. If a company’s revenue is spread among multiple customers and/or platforms, the loss of a single customer and/or platform will have a relatively minor impact on performance. Too much exposure to domestic OEMs has hurt many suppliers, while others with a mix of Japanese business have grown in this automotive environment.
- Cost and quality: Suppliers that understand their true cost for producing components with an accurate burden allocation and that consistently improve their quality will be the best positioned for the future. Additionally, those that manage their supplier base to the same standard will have a significant competitive advantage over the competition.
- Mission-critical supplier: OEMs and Tier 1 suppliers are looking for suppliers that provide something specific and unique to differentiate themselves. Those suppliers that provide highly engineered components or a specific process will be better positioned to receive the highest level of value. Innovation and research and development is the most important element that best in class OEMs and Tier 1s are looking for to separate themselves from the rest. They want suppliers that invest in them in terms of technology and they will, in turn, invest in them.
- Capacity utilization: Utilization can be a key factor impacting financial performance and opportunities for growth. Suppliers with a significant amount of available capacity are often not generating sufficient revenue to cover their fixed costs, resulting in poor financial performance and therefore lower relative value. Suppliers in this situation should focus on maintaining quality and maximizing their capacity to its highest and best use. But often, rationalization is necessary and companies have to be willing to make those necessary reductions.
- Loyal, experienced employees: An experienced and loyal employee base tends to increase productivity, improve quality, reduce the chances of work stoppages, and reduce the overall cost structure of a company. Training is a critical element to the success of the best companies today. Management focused on supporting the team to the goals of the company are essentially focused on growing the business.
- Experienced management team: Strategic and operational leadership are critical components to success. Suppliers with leadership provided by a group of knowledgeable managers, rather than just one individual, are better positioned to handle leadership transitions. Leadership is one of the key differentiators for best-in-class companies, and with a strong team, the value of the company increases. Customers, suppliers and employees all favor a company that maintains focus during transitions, particularly after a merger or acquisition.
- Strong customer relationships: Customers value suppliers that not only meet their needs, but also proactively manage their relationships. Suppliers that offer additional services enjoy strong customer relationships and often get a first look at new business opportunities. This better positions them for long term growth particular with thriving customers.
Successful mergers and acquisitions aren’t easy to achieve. However, acquirers and sellers can improve the chances of consummating successful M&A transactions by focusing on what they can control. These factors guarantee nothing, but ignoring any of them could bring about an unfavorable outcome. The industry will continue to see more activity in this area and it is important that companies learn from the mistakes made and focus on successful transitions in the future for long-term survival.