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September 2010 
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Challenges And Opportunities In The North American Manufacturing Sector |
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Pauline Renaud, May 2009 |
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Page 2 of 2 |
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As result, carmakers are left with a few options to try to restructure their businesses. In the short term, they can shut facilities, wok out interim support systems for the supply chains and dealer networks stressed by the uncertainty in the sector and negotiate government participation. But automakers also need to implement operational and administrative restructurings. They are, for example, advised to retool and rationalise the damaged brands in the case of North American companies, reconfigure the product offering and production capabilities to match consumer demand and preferences and prepare for the coming technological transformation in the nature of personal transport, among other solutions.
Besides the difficulties associated with the implementation of cost-cutting measures, several other challenges have arisen for troubled companies in the manufacturing sector. Firms that depended on continued sales growth and profitability to service high levels of debt will need to restructure these debt obligations, says Mr Loughlin.
Some companies that are still viable, but over-leveraged, may still be able to reorganise and therefore survive. But for many other businesses, “refinancing debt is very challenging, if not impossible in the current credit environment,” notes Mr Loughlin. “Therefore, a substantial percentage will find it very difficult to avoid formal insolvency. Key challenges will include raising the required financing to allow the company to operate, while going through a formal insolvency or Chapter 11 proceeding. Raising financing for debtor-in-possession (DIP) facilities in the current US credit environment is very difficult.”
Indeed, DIP financing has become increasingly expensive and is only offered on shorter terms, while being accompanied by higher rates and fees. “There will be a rise in formal insolvencies, but not until the valuation valley is reached, since DIP funding has contracted, and formal filings need credit in the system in order to exit by sale or a funded financial plan,” explains Mr Besant. “Hitting the valley floor in asset deflation will allow for a more reliable short-term liquidation and long-term valuation analysis, which provides a floor for the easing of credit for DIP, exit finance, and distressed M&A.” But some experts suggest that there are likely to be more DIPs that force quick sales or are used as ‘loan to own’ strategies. Under such a strategy, a private equity firm extends credit, or acquires the debt of a borrower, with a view to converting its debt position into a controlling stake, often through bankruptcy.
Opportunities on the horizon
On the bright side, the current economic downturn and lack of liquidity will provide some investors with excellent M&A opportunities, when the financial and credit crisis eases. Sophisticated acquirers, such as private equity firms and hedge funds, are increasingly making investments in distressed companies, due to the low indicative trading value of debt. And this is likely to increase, as the price of deals will get more attractive. “Private equity firms appear to be entering the distressed debt-investing arena in a meaningful way, using loan to own strategies,” confirms Mr Loughlin. “Private equity firms have billions of dollars to invest in the right situation. They can also protect their own instruments by making ‘bolt on’ acquisitions at good values to drive profits and avoid covenant defaults.” In bolt on acquisitions, the acquisition will fit naturally within the buyer’s existing business lines or strategy. But PE funds are not resistant to the financial crisis and some of them are running into difficulties, particularly regarding their access to financing and issues with their existing portfolio companies. Therefore, the impact of PE firms within the sector in the long term remains to be seen.
Private equity aside, healthy trade buyers can also benefit from the opportunities in the distressed manufacturing sector. One company’s problem can become another’s chance to buy at bargain prices while adding revenue streams, developing new product lines or expanding its geographic coverage. “Those companies with strong balance sheets and cash flows can take advantage of what is likely to be a buyers’ market,” says Mr Sprayregen. Indeed, consolidation across the manufacturing sector is somewhat inevitable. However, Mr Sprayregen points out that, “necessary consolidation may be delayed by the enormous uncertainty in the industry and by the ordinarily large up-front cash costs of achieving synergies in consolidations, as those may be challenging to fund up-front in the current environment.” He adds that such transactions will be “dependent on the strength of the acquirer – specifically, their access to cash – due to the scarcity of credit and financing options in today’s markets. These types of plays will be longer term plays, as buyers will need significant staying power in such situations, to get to the time of economic recovery – whenever that happens.”
Nevertheless, the outlook is grim in the short to medium term regardless of the angle. According to a recent study by PricewaterhouseCoopers, US-based industrial manufacturers are expecting an average negative revenue growth over the next 12 months. Demand is the overwhelming concern, as oil and energy prices have plunged and are therefore no longer a major drag on growth. But for cash-rich companies and investors, there are golden opportunities. This has been highlighted in the study, which reveals that the number of manufacturers planning M&A activity remained constant at 32 percent in the last quarter of 2008, compared with the previous quarter. An increase in cross-border transactions is also expected, as regional consolidation may be reaching its limits in a number of industries. Ultimately though, there is still hope, with many believing that the manufacturing sector will pick up in the next two years, returning M&A levels back to normal.
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