Manufacturing companies have become attractive acquisitions for both strategic and financial buyers. Many buyers view the sector as one where the U.S. is undergoing a renaissance and the long-term trends bode well for it. Any manufacturing company therefore attracts a good deal of interest when it comes on the market.
Despite all of this though, valuations can vary widely among manufacturers due to a variety of factors. Why one firm commands a multiple of 7 times adjusted EBITDA and another only 4 times is often due to the nature of their businesses. In our view, the five most important factors affecting valuations for manufactures can be defined as follows:
1. Does the company make products or provide a contract service? Companies that make products with strong brand names and good competitive positions in the market will command better valuations than those that provide strictly contract manufacturing services. While not always true, those whose products have good margins will see this.
2. Are clients diversified and do they operate in attractive markets? The biggest concern buyers often have with small manufactures (and even large ones for that matter) is that they have too much client concentration or their clients serve markets that are not attractive. It is not unusual for us to see manufactures who have most of their business tied up with 2 to 3 end-users. This negatively affects valuations and possibly the manner in which an acquisition is paid for. Sellers may have to contend with deferred payments that are subject to adjustments depending upon what happens with revenues.
3. Is the manufacturer dependent on one or two suppliers? Much like customer concentration risks, a business can also have supplier risks. If a manufacturer is too dependent on one or more companies that supply materials or services and they can’t be easily replaced, then this will be a problem.
4. Have necessary investments been made in equipment and technology to remain competitive? Buyers will frequently analyze a company’s capital equipment purchases (CAPEX) over the years to determine if they have adequately invested to remain competitive and that the CAPEX is reflected in the financials of the firm. If a company has been generating good earnings without doing this, they will often conclude that these earnings are illusory.
5. Has the company developed a good management team? A company that is not solely dependent on the owner, either for running it or for managing customer relationships, is going to be one that commands a higher valuation. Buyers want to know there is a good team in place to run the business. It is also very beneficial to have well developed management systems, particularly in accounting. But this is usually the case for companies with good management.
If you are an owner, think about what you can do to improve in these 5 key areas. It will pay off in the long run.