In our column in the January, 2007, issue of AD&P, we offered a leverage strategy that suggested re-deployment of a supplier’s plant and real estate assets to modernize those assets, or to convert the real estate to a more profitable purpose (see: How Real Estate Can Help Competitiveness). A deeper look at this strategy seems more appropriate than ever, in part because plant, property and equipment are among the largest assets sitting on a supplier’s balance sheet and thus they must be highly efficient financially as well as operationally in order for the company to be competitive and profitable. The other reason to examine plant and property is that real estate can be a formidable source of much-needed cash, particularly now in the midst of global customer requirements and investment demands.
If, for example, a supplier has sales of $200-million and real estate and plant assets estimated at $50-million, one cash-generation strategy is to construct a sale-leaseback plan wherein the company sells the real estate, then leases back the assets most relevant to their operation. The rent charges the company will then incur will depend upon factors such as creditworthiness, life of the lease, nature of the business purpose, and, of course, location. But in return the company has sale proceeds in the tens of millions to realize as a new source of cash. This cash can be used to invest in the business, increase R&D, or to pay dividends to shareholders. The logic here is to put proceeds to work to generate liquidity for new investment or simply to pay a higher return on invested capital (ROIC).
Another strategy, as Jack Buchanan, CEO of Blue Bridge Ventures, has suggested, might be to couple the cash with accelerated tax incentives and modernize by creating state-of-the-art plant facilities to be more competitive in emerging global markets. “The advantages, besides becoming more globally competitive, is to increase financial leverage and special efficiencies, reduce operating costs, and many times become more eco-friendly in the process,” says Buchanan. Buchanan knows what he speaks of, having purchased a Lear plant in Walker, Michigan, in late 2006, and he now is working through the process of re-structuring the plant assets to increase their efficiency and marketability. “Skinning or dismantling a building is risky but many times necessary to avoid functional or economic obsolescence. A supplier needs to sometimes consider reformulating the plant or real estate in order to create value.” Buchanan has transformed the Lear plant from a single-use operation to an asset that now houses two Tier I suppliers with other manufacturing tenants slated to come aboard soon. “Assets don’t always have to be glued together, and there is value to be realized in knowing that,” he says.
Conventional theory tells us that owning our real estate assets is beneficial because, historically, they will always generate greater value over time. But there is real danger if a supplier has no vision or a separate strategy for the real estate, plant, and properties held on the balance sheet. Whether it is residential property or an industrial plant, people assume the values will always go up. But often, especially in an industry such as automotive facing a jarring down-cycle in North America, future values are unknown. Worse, if the plant is functionally obsolete or suffers an environmental hazard due to chemical spills or industrial waste, there may be little or no market for the property under any conditions.
The key is to have a real estate exit strategy in place and to be prepared to shed a plant or property before you reach the “missed opportunity” or “no opportunity” scenarios. Sale-leaseback or outright sale could be the right alternatives, as stated previously, or there could be benefit in finding a joint venture (JV) or development partner. Using a JV partner may create flexibility in ownership, or the potential to convert the building to a “Class A” property to recognize future gains. If you are a distressed supplier, Buchanan suggests a real estate strategy to generate cash and as an alternative to taking on greater amounts of debt to fund growth. He recommends considering a plan to separate plant and property assets from equipment assets in order to avoid the look of a “fire” sale. “The last thing a supplier needs is a vacant building as a result of a forced or unforced plant closure. In that case, the supplier faces carrying costs such as utilities and taxes with little chance of rental income or re-use potential. And if you do move the property, you may only realize nickels or pennies on the dollar.” The most critical issue of all—in determining a strategy—is asking whether you are really building equity as you hold onto a property, or is your true value below market, at book, or even below book?
A CFO of a mid-sized Tier II supplier I recently spoke with confirmed his company’s need to close a plant in California and, while it was necessary operationally and strategically to dispose of the assets, the additional benefit was that proceeds from the sale paid off most of the company’s bank debt and, as a result, significantly strengthened the company’s balance sheet. Because this company took a proactive approach, there were strategic bidders in the process that created higher prices. In addition, fortunately for this company, the overall real estate markets in California are currently much more robust than, say, Michigan or other Midwest states, so higher values were obtainable for the real estate. However, similar results could be obtained in non-California locations. The company now uses the strong balance sheet and financial position as a major competitive advantage in the marketplace.
Over the course of ownership, proper planning can enable a company to generate annual double-digit cash-on-cash returns on properties, plants and real estate. Selling the property may allow you to capitalize on an active office market in the area, or other commercial or industrial growth segments. Moving the real estate off the balance sheet or transforming the plant and property can create greater flexibility, leverage, and, best of all, a new source of cash. And, in these complex times of global competition, locating cash is a strategy worth considering.