The U.S. manufacturing market is heading in the right direction once again -- and that might be enough to draw back investors like Riverside Co.
As recently as 2006, Riverside -- a Cleveland-based private equity firm -- did almost 60 percent of its deals in manufacturing. But by last year, that number had dropped to 23 percent and it’s only at 16 percent so far in 2012, senior adviser William Seelbach said at a May 31 manufacturing conference in Cleveland hosted by the National Association for Business Economics.
“In the last year or two, our interest in manufacturing has waned due to better fits in health care, education and training, software and franchising,” said Seelbach. “But there could be a resurgence of manufacturing in the U.S. because of low natural gas costs and the return of business from China.”
The re-entry of firms like Riverside could be a plus for plastics processors and other types of manufacturers, especially since Riverside has never been shy about making deals — and lots of them. The firm has been involved in 300 transactions since being launched in 1988. Its current portfolio includes more than 80 companies, with 14,000 employees and total sales of $3.2 billion.
Riverside currently owns two plastics-related firms: PVC window extruder Sunrise Windows Ltd. Of Temperance, Mich., and medical injection molder Coeur Inc. of Lebanon, Tenn. Riverside bought Sunrise early last year and has owned Coeur since 2008. Riverside also has sold three plastics-related firms in the last four years.
Seelbach said Riverside likes to invest in “little leaders,” meaning companies that rank in the top three in a niche or industry that Riverside knows well. The firm tries to steer clear of firms that make heavy equipment or that do commodity or contract manufacturing.
“There’s only a few industries we don’t like, such as automotive or real estate,” Seelbach said. “We’re basically industry agnostic.”
Right now, Riverside is sailing through a post-recession mergers and acquisitions market that — while improving — still contains some hazards.
“We saw a lot of manufacturers go out of business or shed product lines [during the recession],” said William Hartmann, chief credit officer of Key Bank in Cleveland. “The ones who made it through are really good operators.”
Hartmann added that Key Bank — one of the 20 largest banks in the U.S., with more than $90 billion in assets — “has seen some really interesting companies emerge, where they take old machinery and bolt on new electronics and come up with efficient operations.”
But at the same time, he said that many manufacturers are going through a “generational transition” and that “a lot of them who made it through [the recession] are exhausted.”
“They did things [during the recession] that they never wanted to do,” Hartmann explained. “They let go employees, cut customers — it wasn’t a lot of fun.
“So now some of them are saying ‘If I get a good price [for my company], I’m out of here.’ A lot of them don’t have a son or daughter interested in the company.”
That mindset also leads to little reinvestment in the business.
“When you go through that, you’re not investing in new machinery or new workers,” Hartmann said. “You’re just trying to get through it and get the best price. Once that happens, we’ll see a tremendous amount of activity.”
There’s also been some inactivity on the buyer side, according to Hartmann. “Many companies are sitting on large amounts of cash,” he said. “There’s tremendous liquidity and the number of loans is going down. Companies are only making small investments in machinery or buying product lines from competitors that failed.”
Another challenging issue has been a lack of stability in prices for industrial real estate. “It’s a very uncertain market, especially because in a lot of these cases the business is 50 or 80 years old, and real estate constitutes a lot of the value in small manufacturing,” Hartmann added.
Business sales also could be prompted by small business owners having to adjust their lifestyles. “A lot of these guys had two homes and a lot of them had their own airplanes,” Hartmann said. “Now they’re having to adjust to less take-home pay.”
Another positive outlook came from William Strauss, a senior economist with the Federal Reserve Bank of Chicago.
“I’m exceedingly optimistic in regard to manufacturing,” he said. “Manufacturing productivity has been improving at a 6.5 percent annual rate since July 2009, and we’ve recovered 75 percent of the drop in output since the recession.”
“The manufacturing sector continues to reinvent itself. I truly believe the recent collapse is cyclical not structural.”
But Straus also pointed out that only about 20 percent of manufacturing jobs lost during the recession have returned — and that manufacturing now makes up less than 10 percent of U.S. jobs, after peaking at about 33 percent in the 1940s.
Part of that decline can be chalked up to productivity gains from increased use of computers and automation, he said. The same amount of production that required 1,000 workers to complete in 1950 could be done by only 170 workers in 2010.
The M&A field for mid-market companies — those with between $5 million and $50 million of earnings before interest, taxes, debt and amortization (EBITDA) — also continues to evolve, according to Ronald Kahn, a managing director with financial firm Lincoln International in Chicago.
“There’s quite a bit of capital available for middle market companies,” he said. “We’re seeing more money from private equity and publicly held business development companies. And more than 70 percent of all mid-market loans in 2011 were provided by non-bank institutions.”
This available money looking for a home — as well as the comeback in manufacturing — also appears to be driving market prices up, according to Seelbach at Riverside.
“Deals that were selling for 6-7x EBITDA two years ago now are getting 8-10x for companies of similar quality,” he said. “That’s supply/demand of normal macroeconomics. And there’s more demand right now.”