March 7, 2013
Interviewed by: David Snow
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America’s Manufacturing Revival

The U.S. manufacturing sector is being transformed and The Carlyle Group is confident the revival will continue. In a fascinating interview with Privcap, Brian Bernasek, Managing Director in Carlyle’s U.S. buyout practice, describes drivers of change in the U.S. energy market and Chinese labor market. He also details his work on two of 2012’s largest deals–the $4.9-billion acquisition of DuPont’s Performance Coatings business (renamed Axalta) and $3.46-billion buyout of Hamilton Sundstrand.

The U.S. manufacturing sector is being transformed and The Carlyle Group is confident the revival will continue. In a fascinating interview with Privcap, Brian Bernasek, Managing Director in Carlyle’s U.S. buyout practice, describes drivers of change in the U.S. energy market and Chinese labor market. He also details his work on two of 2012’s largest deals–the $4.9-billion acquisition of DuPont’s Performance Coatings business (renamed Axalta) and $3.46-billion buyout of Hamilton Sundstrand.

America’s Manufacturing Revival: A conversation with Brian Bernasek of the Carlyle Group

What’s driving the renewed interest in American manufacturing?

Bernasek: Well, I think one of the big reasons is the opportunity of the energy sector that’s available across the industry. You know, there’s an opportunity to benefit from the equipment used to extract and explore for natural gas and oil. And there’s an opportunity in the transportation of that natural gas and oil. And that not only is an opportunity for the manufacturers of equipment, the manufacturers of transportation, but it’s lower-cost fuel to be used in our facilities and plants in the U.S. So you see that in industrial plants that provide, make glass, that make aluminum, that make metals. It’s a big raw material, is energy costs, and those lower costs make American manufacturing more cost-competitive than they would have been at any other time.

So that’s one key driver that we’re seeing, and we see it across our portfolio. We can see it across our opportunities. You know, for example, we see it in Allison Transmission, a business that we own that manufactures transmissions across the landscape, from on-highway vehicles to transmissions that are used in the fracking side of the equation in the oil and gas industry. And we see good growth and good opportunity in that fracking equipment. We see it in our rental-equipment business at Hertz and HERC. That business is doing very well in places, in the tar sands and fracking environments throughout the country. So we see it in the way of equipment, and we see it just in services around that industry.

We also see, have seen, a real change in labor in that opportunity over the last several years. You know, Chinese labor historically was always thought to be a really rich opportunity for manufacturers—lower wages, opportunity to benefit from that and on the cost side. Now, given the fact that in the last five to ten years you’ve seen nothing but accelerating wage growth in China, and you’ve seen the counter to that in the U.S.—and when you factor in transportation costs and you factor in those higher labor costs in China, manufacturing in the U.S. is cost-competitive as it’s ever been.

So both of those trends, I think, are key drivers for us. I think there’s also, you know, there’s plenty of challenges with government or on the fiscal side. That’s something we could spend a great deal of time talking about. But there also is a general sense that people want U.S. manufacturing to do well. And that’s a big change than where things were two or three years ago. Now, there’s some policies that make it difficult for that to work to the extent that we’d like to see happen, but there is a sense that we’d like to see a strong U.S. manufacturing base. And that can do nothing but help.

Carlyle closed several large manufacturing deals in 2012. Can you describe some of them?

Bernasek: Sure, sure. Well, there were two transactions. One was the Performance Coatings business of DuPont, and that was around a $5 billion transaction. And the other was the acquisition of Hamilton Sundstrand from United Technologies, around about a $3.5 billion transaction. And each of those are different, but they’re also the same in a lot of ways.

For one, we had a macro view that we saw opportunity on the industrial side of the equation and an opportunity in the U.S. and globally for labor reasons, for the energy reasons, for a number of growth opportunities that we see in an industrial sector. And from a macro perspective, we were comfortable with the opportunity where we sat in the economics cycle and where the growth opportunities were.

We also saw very good micro opportunities in each one of these deals that were attractive to us. Both of the businesses have great market positions and unique products that are highly differentiated and just very hard to replicate. In the case of Hamilton Sundstrand, they make pumps that are based in large part on aerospace technology that’s just very difficult to replicate [in] the very niche markets where they have great positions. In the case of the Performance Coatings business, there are some 40,000 different shades of color that this business provides to the auto sector—to paint cars and refinish cars that are damaged, to finish up brand-new cars. And that’s a competitive advantage. It’s just hard to replicate. So you had those differentiators, to start with. 

We also very much liked the free cash flow in each of those business, which makes it… It’s right in the middle of our wheelhouse to have businesses that are strong, free cash flow generators. We’re very value-oriented in our investment approach and like to take good businesses and make them even better, which is what we can do with each of these, too, from a Carlyle perspective specifically.

There are other things who think the same thing as we do on those, that would recognize the differentiated products, would say, “We love free cash flow, but why Carlyle?” Why were we able to do something different with those? In the case of Performance Coatings, we had a strong thesis and approach in that there was a real cost and opportunity in the business—an opportunity to make the business better by running it more efficiently and attacking some growth markets and emerging markets that we thought we could help at Carlyle in that, given our global presence.

And with Hamilton Sundstrand, what investment thesis drove your interest in the sector and, ultimately, the company?

Bernasek: Sure. Well, we had a baseline view and a macro view that there was… We were in a good spot in the economic cycle, for one—in the industrial cycle, for one. We saw that the base of the business in the U.S.—about 50 to 60 percent of the business—is in core U.S., small part in Europe, at some point in Australia. That core market had good growth trends—40 percent of the businesses in emerging markets—where we saw that there was a real opportunity to grow, and that that’s an area where we wanted to leverage. Also, importantly, about 40 percent of the business is in energy, oil and gas, petrochem markets, which we see good growth, given the trends in natural gas and the trends in oil.

Were deals of such size difficult to finance?

Bernasek: Well, I think there’s clearly a demarcation in size that allows you to get some financing that you might not be able to. And when you get to this size transaction, you’re attractive to a different audience. And so that will clearly…is easier to get that scale done at a certain level, in terms—better terms and better pricing. Having said that, we ended up doing a lot better in December, in January, when we ultimately financed both of those deals, than we thought we would in the summer, speaking to the strength of the financing markets in the last six months, which are really, you know, as strong as they have ever been and including, you know, the 2005–2007 time frame.

Given the current economic conditions and political environment, what are your expectations for 2013?

Bernasek: You know, it’s going to be a very interesting year. I think, you know, on the positive side, we see good trends in our housing-related businesses. We see good trends in our energy-related businesses. We see some slowdown in a couple of spots. In short, it feels kind of like what you’d expect at a zero-to-two-percent GDP environment: little bit up, little bit down. Some places are winning, and some places are losing. You’ve got really robust financing markets—again, as strong financing markets as we’ve seen in a decade; and we saw some pretty good financing markets in that decade. And you have companies with a lot of cash who would like to do M&A and utilize the cash.

And then you also have a number of investors—personal investors as well as institutions—who would like to put money to work in the equity markets. And that all sort of circles around a place where it ought to be a pretty good deal environment. There ought to be an opportunity to get comfortable around where businesses are going to perform, where there’s some stability in cash flow that you can get more confident about leveraging those cash flows and pricing and valuing those.

You hate to point to the one thing that everybody talks about, but everybody does talk about the fiscal issues and whether that is sorted out. But I think if that is, continues to be, a kick-the-can approach, and we have the environment that we have now, which is probably as benign as we’ve had in some time, it’ll probably be a pretty robust year.

Carlyle’s co-CEO, Bill Conway, recently said he was “bullish” about investing in America. What’s driving that optimism at the firm?

Bernasek: We do believe in investing in the U.S. We put our money where our mouth was on that last year, and I expect that we’ll continue to do that for a lot of the reasons that Bill articulated in his note: robust financial markets, the rule of law, the energy sector and energy growth, the recovery in the housing market. Those are all reasons to be bullish on America over the medium to long term. What we have, times when it’ll be a little bit difficult—I suspect we will—but ups and downs. But in the long run and the medium run, we see real opportunity.

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