PwC’s Q3 M&A Analysis of the Manufacturing Sector

PwC’s Q3 M&A Analysis of the Manufacturing Sector

I have received news of PwC’s Industrial Manufacturing Deals Outlook. I guess you have your good news and your bad news.

From the report’s summary: While disruptive factors are prevailing and point to an economic downturn, many of the positive factors we have highlighted in our previous publications are still relevant in Q3 2019. As stated in PwC’s publication “Winning through M&A in the next recession,” the M&A environment is cyclical and has historically followed economic downturns, as capital available for deals typically decreases; however, the next recession will be different. We believe the downturn will be unlike historical downturns as disruptive economic factors are partially offset by a few positive factors, leading buyers to continue to pursue M&A activity.

Positive factors impacting the deal-making landscape in 2019:

  • Record levels of dry powder from private equity funds and healthy corporate balance sheets coupled with the repatriation of cash for US-based multinationals indicate sufficient levels of capital to pursue acquisitions, which will prevent deal activity from dropping too low.
  • High valuations have been a factor for the decline in deal volume from YTD 2018 to YTD 2019. However, as the economic outlook declines, valuations will likely fall, which will provide opportunities for buyers with high levels of capital. If buyers are aggressive during the downturn, M&A demand should be higher than historical downturns.
  • The prominence of megadeals is reflecting a decoupling of the megadeals segment of the M&A market from the lower-growth global economic environment.

Disruptive factors likely to create a pause in deal making in 2019:

  • The Chinese and US economies are pointing to economic slowdowns. Chinese GDP growth in 2019 is expected to be between 6.2%–6.4%, a decrease from approx. 6.7%–6.8% in 2018. The US GDP annualized growth in 2019 is expected to be between 1.8%–2.3%, a decrease from approx. 3%–3.5% in 2018.
  • Uncertainties as it relates to length of economic slowdowns around the globe, Brexit, and the continued struggles to negotiate trade agreements and tariff concessions between the US and China, remain on the minds of deal makers.
  • The PMI index has dropped to 47.8 at the end of Q3 2019, which is the lowest it has been since 2009.

PwC also captured some quick highlights below:

  • Scale Transactions will Continue to be the Focus for the Industrial Manufacturing Sector
  • Macroeconomic factors – the trade war, slow GDP growth and high valuations – continue to affect the M&A environment across the industrial manufacturing industry.  The latest September numbers from the Institute for Supply Management also showcase the struggle the sector is experiencing with the U.S. manufacturing purchasing managers’ index coming in at 47.8%, marking the second consecutive month of contraction and was the lowest reading in more than 10 years.
  • So far in 2019, M&A activity in the industrial manufacturing industry has been driven by scale transactions, which is primarily focused on product, customer and geographic expansion. We believe this trend will continue into next quarter and 2020. Here’s a breakdown of Q3 2019 M&A analysis of the industrial manufacturing sector:
  • Total deal value declined by 32% to $18.1 billion when compared to Q2 2019. For YTD 2019, the deal value also declined by 16% to $64.5 billion vis-à-vis YTD 2018.
  • Deal volume in Q3 2019 and YTD 2019 declined by 10% and 11% over Q2 2019 and YTD 2018, respectively.
  • There was no megadeal in Q3 2019.
  • All the categories within the sector saw a decline in deal value during the third quarter except the Electronic and Electrical Equipment and Rubber and Plastic Products. However, the Industrial Machinery drove M&A activity with 40% and 35% in value and volume respectively.
  • North America’s deal value significantly declined by 55% in the third quarter compared to the previous quarter, but the region was the most active acquirer with 36% of deal volume, followed by Asia and Oceania.
  • Although there are factors that point to an economic downturn in the near future, we believe the next recession will be different as it pertains to the M&A environment and could potentially lead buyers to continue to pursue deals.

Executive summary

Worldwide cross-sector deal value decreased 13% from YTD 2018 to YTD 2019, while deal volume remained flat at a 1% increase during the same period. Consistent with cross-sector worldwide, Industrial Manufacturing value has decreased 16% from YTD 2018 to YTD 2019. The primary driver of value decline is related to the 11% decrease in deal volume during this period, which is reflective of some of the lowest quarterly activity since Q1 2014.

Consistent with the trend noted in our Q2 2019 publication, year-to-date activity has been driven by scale transactions, which are primarily focused on product, customer, and geographic expansion. The decrease in deal volume is a result of macroeconomic factors such as the lingering trade war, anemic GDP growth around the world, and high valuations. While overall deal value has seen a decline, the aggregate value of the top ten deals year-to-date has remained stable at $30.3 billion YTD 2018 and $31.4 billion YTD 2019. As such, these macroeconomic factors have not deterred deal makers from turning to M&A to meet their strategic objectives.

Trends and highlights

  • In Q3 2019, the total deal value declined by 32% to $18.1 billion when compared to Q2 2019. For YTD 2019, the deal value also declined by 16% to $64.5 billion vis-à-vis YTD 2018.
  • Similar trend can be seen in terms of total deal volume. Deal volume in Q3 2019 and YTD 2019 declined by 10% and 11% over Q2 2019 and YTD 2018, respectively.
  • Average deal size declined by 15% to $83.6 million in Q3 2019 compared to Q2 2019. The average deal size also declined by a mere 2% to $93.7 million in YTD 2019 vs. YTD 2018.
  • Out of the top ten deals in YTD 2019, four deals took place in Q3 2019. These four totaled up to ~$9.3 billion, and accounted for more than 50% of the total deal value for the quarter.
Global Industrial Manufacturing Merger and Acquisition Activity Recedes

Global Industrial Manufacturing Merger and Acquisition Activity Recedes

Merger and Acquisition (M&A) activity in the industry segment I cover seems to have been hot for some time. I, along with others dependent upon the strength of the industry like say magazine media companies, view market consolidation as having the potential for decreasing revenues. Fewer companies makes for a less vibrant marketplace. Just take a look at the size of the magazines covering controls and automation these days.

Although this report covers a much broader segment than controls and automation, I always study the quarterly PwC M&A report carefully. And here is Q3 2018.

Global industrial manufacturing M&A results for Q3 2018 experienced a significant pull back in deal value from the Q2 2018 historic high with aggregate disclosed value of $11.7 billion, which is a 73% decrease quarter on quarter and a 52% decrease compared to the three-year quarterly average. The most recent quarter is directionally consistent with the 42% decrease seen in global cross-sector M&A deal value from Q2 2018. Since PwC’s last publication, the US administration has taken steps to implement tariffs on imported goods and a trade war has ensued. The uncertainty around how this will affect the M&A landscape more heavily weighed on industrial manufacturing than other sectors this quarter.

Looking at deal volume, there were 477 deals announced in Q3 2018 compared to 612 deals announced in Q2 2018, a 22% decline. The three-year average number of announced deals was 624 to which the 3Q 2018 results represent a 23% decline.

Worldwide cross-sector and industrial manufacturing deal making had been humming along with five and four consecutive quarters of deal value growth, respectively, prior to Q3 2018. The question remains if this contractionary quarter is the beginning of a trend or just a pause in action resulting from uncertainty in the economic, regulatory, and political environments.

Key trends/highlights

  • Total aggregate disclosed deal value sank 73% to $11.7 billion in Q3 2018, a 52% drop compared to the three-year quarterly average of $24.2 billion and a 73% decrease from Q2 2018 of $42.9 billion.
  • Total deal volume decreased to 477 deals in Q3 2018, a 23% drop compared to the three-year quarterly average of 624 deals and a 22% decrease from the 612 announced deals in Q2 2018.
  • There was $78.9 billion of deal value announced for the first nine months of 2018 compared to $60.4 billion for the same period of 2017, a 31% increase.
  • There were 1,738 deals announced for the first nine months of 2018 compared to 1,906 deals for the same period 2017, a 9% decrease.
  • A $1.2 billion merger was the largest deal announced in the quarter.
Purchasing Manager’s Index Still Looking Strong

Purchasing Manager’s Index Still Looking Strong

We have a new manufacturing sector economic activity report from the Institute for Supply Management—The Purchasing Manager’s Index—showing continued solid growth in the segment.

I also received an analysis from PwC’s Bobby Bono. His remarks are interesting including events in Washington that could change the rules of the game.

Long experience tells me that little that goes on in Washington significantly affects the economy. Presidents run for election on the economy, and are sometimes elected on it, but most of the time market forces and technology changes render their efforts dead on arrival. An exception, as Bono points out, could possibly be a trade war instigated by Trump. So far, all his tweets seem to be more geared toward getting people to the negotiating table (his forte, I guess), than in any unilateral action. Regardless, the underlying economy still looks strong. We can only hope.

In brief:

  • New Orders, Production, and Employment Growing
  • Supplier Deliveries Slowing at Slower Rate; Backlog Same
  • Raw Materials Inventories Growing; Customers’ Inventories Too Low
  • Prices Increasing at Faster Rate; Exports and Imports Growing

The report:

Economic activity in the manufacturing sector expanded in March, and the overall economy grew for the 107th consecutive month, say the nation’s supply executives in the latest Manufacturing ISM Report On Business.

The report was issued today by Timothy R. Fiore, CPSM, C.P.M., Chair of the Institute for Supply Management (ISM) Manufacturing Business Survey Committee:

The March PMI registered 59.3 percent, a decrease of 1.5 percentage points from the February reading of 60.8 percent. The New Orders Index registered 61.9 percent, a decrease of 2.3 percentage points from the February reading of 64.2 percent. The Production Index registered 61 percent, a 1 percentage point decrease compared to the February reading of 62 percent. The Employment Index registered 57.3 percent, a decrease of 2.4 percentage points from the February reading of 59.7 percent. The Supplier Deliveries Index registered 60.6 percent, a 0.5 percentage point decrease from the February reading of 61.1 percent. The Inventories Index registered 55.5 percent, a decrease of 1.2 percentage points from the February reading of 56.7 percent. The Prices Index registered 78.1 percent in March, a 3.9 percentage point increase from the February reading of 74.2 percent, indicating higher raw materials prices for the 25th consecutive month. Comments from the panel reflect continued expanding business strength. Demand remains robust, with the New Orders Index at 60 or above for the 11th straight month, and the Customers’ Inventories Index at its lowest level since July 2011. The Backlog of Orders Index continued a 14-month expansion with its highest reading since May 2004, when it registered 63 percent.

Consumption, described as production and employment, continues to expand, with indications that labor and skill shortages are affecting production output. Inputs, expressed as supplier deliveries, inventories and imports, were negatively impacted by weather conditions; Asian holidays; lead time extensions; steel and aluminum disruptions across many industries; supplier labor issues; and transportation difficulties due to driver and equipment shortages. Export orders remained strong, supported by a weaker U.S. currency. The Prices Index is at its highest level since April 2011, when it registered 82.6 percent. In March, price increases occurred across 17 of 18 industry sectors. Demand remains robust, but the nation’s employment resources and supply chains are still struggling to keep up.

Of the 18 manufacturing industries, 17 reported growth in March, in the following order: Fabricated Metal Products; Plastics & Rubber Products; Computer & Electronic Products; Paper Products; Printing & Related Support Activities; Nonmetallic Mineral Products; Transportation Equipment; Petroleum & Coal Products; Wood Products; Machinery; Chemical Products; Textile Mills; Electrical Equipment, Appliances & Components; Furniture & Related Products; Miscellaneous Manufacturing; Food, Beverage & Tobacco Products; and Primary Metals. The only industry reporting a decrease during the period is Apparel, Leather & Allied Products.

Bobby Bono, PwC’s U.S. Industrial Manufacturing Leader, offers the following analysis.

The PMI manufacturing index decreased 1.5 points, but remains high at 59.3; prices reached their highest level in 7 years ahead of a potential trade war

The ISM Purchasing Manager’s Index (PMI) for manufacturing survey dropped 1.5 points to 59.3 for the month of March 2018.  While a significant drop from last month’s 60.8, last month was the highest the PMI reached in the last 14 years and March remains above the 90th percentile of PMI reports since 2000.

The continued positive economic environment has led to supply constraints and a buildup in the price index, which now stands at 78.1, its highest level in 7 years.   Price increases occurred across 17 of 18 industry sectors in March as New Orders also dropped 2.3 points.  While the full impact of tariffs and a potential trade war have not set in, some companies are beginning to see signs across select commodity prices and concern around overall global demand rise.

But with any change in rules, businesses need to learn what those rules are, how they will impact their business, and then how to adjust. Most manufacturers already build locally. There have been so many changes already in American regulations that they long ago realized it’s best for their business to build for American sales in North America, and to build for European sales in Europe to meet demand. It’s not 100% local but it’s heavily weighted. Manufacturers want to be close to their customers.

How businesses adapt to the new regulations will speak to their inherent strategy.  If they weren’t as flexible as they should have been, this may be a challenge. Commodity prices often move more than 10% in a year, so this tariff is not that different from that. It’s actually more predictable.

Global Industrial Manufacturing Merger and Acquisition Activity Recedes

Industrial Manufacturing Trends for 2017 from PwC

My friends over at the PwC industrial manufacturing practice have taken a look at 2017 industrial manufacturing trends. The report was composed by Marian Mueller, Bobby Bono, Steve Pillsbury, and Barry Misthal. I will summarize here. Check out the link for more in-depth discussion.

I think they have nailed most of the ideas coming up. Some of these will be difficult for suppliers to either swallow or develop. Likewise, customers may not always like increased connectivity back to the supplier. Pay for performance, so far, has not been a winner. Customers begin to think they are paying too much if performance really does increase. Then they want to go back to a fixed price <sigh>.

Six Industrial Manufacturing Trends

1. Leverage data and analytics in a new business model

By upgrading their technical capabilities, industrial manufacturers can bundle a variety of services enabled by connectivity and data, replacing the increasingly outmoded model of selling one big complex machine under warranty and a service agreement for maintenance and repair.

2. Innovate pricing

As technology begins to alter the relationship between industrial manufacturers and their customers, the traditional pricing model for the service contract must be changed as well, from pay-for-product to pay-for-performance. Condition-based maintenance, driven by predictive and interconnected industrial technology, will become commonplace. This should translate into fewer visits from repair technicians. As a result, customers will naturally expect more favorable terms, which can be facilitated by sharing risk.

3. Develop strategic partnerships — carefully

Industrial manufacturers must become more active players in the technology ecosystem, seeking expertise outside the industry in order to develop equipment connectivity, data analysis, and software development that are beyond their current abilities. For example, recognizing that it cannot grow the ecosystem alone, at least one major industrial company has aligned with a wide range of technology firms to create a dedicated cloud-based platform that can run industrial workplaces. Leaders have to balance the practice of close collaboration with strategic partners against the need to stay flexible in contracting and partner selection, all while maintaining their hold on their markets.

4. Mine operational data

If connected machines — the primary components of IoT — are to be the backbone of industry in the near future, industrial manufacturers will have to figure out how to manage the data coming from an avalanche of sensors, integrated equipment and platforms, and faster information processing systems. There is a critical need to hire people who can mine these bits and bytes of information and work more closely with customers to use the data to improve equipment performance and open new revenue streams. Indeed, the anticipated efficiency returns from digitization over the next five years across all major industrial sectors are substantial: nearly 3 percent in additional revenue and 3.6 percent in reduced costs per year, according to a recent PwC survey of companies.

5. Decide what intellectual property to share and what to develop

Many industrial manufacturers find it difficult to manage digitization and big data analytics because their internal IT systems are so unwieldy. As company operations have grown more complex, expanding into new global markets and product lines and integrating newly acquired firms over many years, the old enterprise resource planning (ERP) systems that were meant to drive efficiency and coordination have proliferated into a tangled mass of disparate networks.
Industrial manufacturers must begin the process of overhauling their IT systems, creating a completely new architecture that can serve as the backbone for internal and external technology initiatives. In this new approach, it is imperative that IT systems communicate throughout the organization with standardized protocols.

6. Create strategies for talent development and retention

In the digitization sweepstakes, industrial manufacturers often find themselves at a disadvantage when trying to attract and retain talent. For example, in the U.S. many of the best and brightest STEM (science, technology, engineering, and math) students would prefer to work in Silicon Valley, where innovation is on the menu for breakfast, lunch, and dinner, rather than in the stodgier old-world locales where many industrial manufacturers have their plants and headquarters.

Succeeding in challenging times

The next wave of leaders in industrial manufacturing will build an ecosystem that capitalizes on the promise of analytics and connectivity to maximize efficiency for themselves and their customers.

Global Industrial Manufacturing Merger and Acquisition Activity Recedes

Industry 4.0 Survey: Building the Digital Enterprise

Are we getting beyond the speculation and hype of ideas such as Industry 4.0 and digital manufacturing? This latest survey and study by PwC (www.pwc.com/industry40) reveals that executives anticipate benefits from investments within two years.

pwc-industry-40-survey-2016

PwC says its 2016 Global Industry 4.0 Survey is the biggest worldwide survey of its kind, with over 2,000 participants from nine major industrial sectors and 26 countries. It goes to the heart of company thinking on the progress of Industry 4.0. The study explores the benefits of digitising the horizontal and vertical value chain, as well as building your digital product & service portfolio.

Industry 4.0 at a glance

“We include a detailed description and definition of Industry 4.0 in the main global report on the survey.” Digitisation and integration of vertical and horizontal value chains, digitisation of product and service offerings, and the development of new digital business models and customer access platforms are driving Industry 4.0 adoption.

Digital Enterprise From the Study

Behind the scenes of the world’s leading industrial products companies, a profound digital transformation is now underway. Companies are digitising essential functions within their internal vertical value chain, as well as with their horizontal partners along the supply chain. In addition, they are enhancing their product portfolio with digital functionalities and introducing innovative, data-based services.

  • Industrial manufacturing companies plan to invest 5% of annual revenue in digital operations solutions over the next five years. And they are setting themselves ambitious targets for the level of digitisation and integration that can be achieved.
  • Many companies are already producing machines to deliver on the vision of the connected factory, using the power of the internet to link machines, sensors, computers, and humans in order to enable new levels of information monitoring, collection, processing, and analysis. This is adding to the products and services that companies can offer their customers, helping them work in collaborative ways in the design of future machines and their digital environment to boost performance.
  • A number of technologies, including robotics, cobotics, 3D printing and nanotechnology, have direct relevance for many industrial manufacturing applications while other technologies, such as augmented reality, can enable manufacturers give customers realtime information and training at the point of use.

Some of these developments are maturing now. Others remain for the future. The rate of adoption of Industry 4.0 technologies by industrial manufacturing companies is accelerating fast.

The digitisation, integration and automation opportunities offered enable companies to collaborate both internally and across their value chains in ways that can provide a step change in productivity as well as design and build quality. And they are opportunities that are increasingly important as companies seek to stay relevant as the era of digitally connected smart infrastructure develops.

Analysis

The point that fascinates me is the speed of adoption. It was only three years ago when I was introduced to the “hype” of Industry 4.0. Then followed speculation and hype. Typical technology curve, I think.

However, most of the technology existed. It just took the foresight and will to begin and the intelligence of implementation. Ways to increase sales and reduce costs both contribute to profitability. Maybe the strategies and technologies behind Industry 4.0 and Internet of Things and digital manufacturing actually will help us cross the next manufacturing divide.