The manufacturing sector has historically been a key area of focus for private equity (PE) firms that invest in mid-market UK companies. The Centre for Management Buyout Research reports that 420 buyouts of UK manufacturing businesses have taken place since 2010, at a cumulative value of £29.2bn. In each year of the last decade, manufacturing ranked in the top three sectors nationally, in terms of total number of PE-backed acquisitions.
Inevitably the Covid-19 crisis poses questions of this long-standing relationship between PE investors and mid-sized UK manufacturers. Many PE firms had already begun pivoting towards the technology sector and the lockdown-induced rise in remote working will only accelerate this trend. Many manufacturers, by contrast, were adversely affected by lockdowns and may continue to suffer productivity constraints in the medium term due to ongoing social distancing requirements. An industry-wide shift away from sole-sourcing could also increase supply chain costs, further eating into gross margins and deterring investors.
However, we believe that demand from manufacturers for PE financing will remain strong. Moreover, we see the appetite of specialist investors to back UK manufacturing businesses persisting in the long term. That is not only despite Covid-19, but in some cases because of it. The transformed market landscape will allow PE investors to demonstrate the value of their financial and operational support, while also causing the leading players within different manufacturing sub-sectors to differentiate themselves as viable investment propositions.
PE’s value-add during Covid
One competitive advantage enjoyed by PE-backed manufacturers manifested itself in the early days of the pandemic. Similar to how manufacturers with operations in Asia could better anticipate the impact of the UK lockdown and more quickly reorganise their processes in a Covid-compliant fashion, PE owners offered highly relevant experience. Manufacturers could draw on the collective knowledge of investment teams that were seeing a range of situations across the sector and had supported dozens of businesses through prior economic crises. These teams were able to pool both best practice and prior experience to advise on critical issues like short-term cashflow management and managing relationships with lenders.
For example, in March we tasked dedicated teams with working through new policy developments, such as furlough. In a fast-moving and uncertain environment, this allowed us to advise each of the CFOs of our investee companies on how to engage with these schemes, freeing management to focus on other pressing issues. Similarly, our team worked with each of our portfolio companies to ensure they had access to liquidity throughout the initial shock. Without this pooling of resources and the readily available expertise of an investment team already familiar with the business, this support would not otherwise be available to a mid-sized manufacturer.
Manufacturing firms should also realise greater long-term value from PE ownership following the crisis. The entire purpose of private equity as an investment approach is to provide patient capital to businesses throughout the economic cycle. While it is a natural human reaction for business-owners to batten down the hatches and wait for better days to invest, PE firms have access to capital and a long-term investment horizon. Their portfolio companies should therefore be able to continue investing in their systems, sales, distribution and back office, equipping them with the tools to thrive when the market recovers. The benefits of this through-the-cycle investment are particularly pronounced in a capex-intensive industry like manufacturing.
This investment in portfolio companies extends to funding ‘bolt-on’ acquisitions – a classic PE tool for supporting growth. The current volatile environment has created fertile grounds for this tactic, by illustrating the benefits of scale to many smaller businesses and thereby increasing the number of receptive acquisition targets. In manufacturing specifically, there are many small but high-potential businesses with pent-up demand to service but without the working capital to take on increased order flow. Partnering with a larger manufacturer seeking acquisitions, as those backed by private equity invariably are, offers a natural route to accessing capital and funding growth.
We therefore expect the Covid-19 downturn to simultaneously create winners within each manufacturing sub-sector, demonstrate the potential benefits of PE ownership and give rise to market conditions ripe for consolidation via a ‘buy-and-build’ strategy. While it will undoubtedly be impacted by the pandemic, the dynamic of PE firms funding the growth of some of the UK’s leading mid-market manufacturing businesses looks set to continue into the future.