May 17, 2013
Interviewed by: David Snow
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Deal Flow in a Competitive, Tech-Infused Market

Why are sellers selling in the revitalized U.S. manufacturing sector? And how are PE firms helping these companies use technology to improve operations and groom themselves to be acquired by a larger company? In Part 3 of a series, Don Charlton of Argosy Private Equity; Anand Philip of Castle Harlan; and Steven Menaker of RSM discuss seller motivations; tech impact; and exit opportunities.

Why are sellers selling in the revitalized U.S. manufacturing sector? And how are PE firms helping these companies use technology to improve operations and groom themselves to be acquired by a larger company? In Part 3 of a series, Don Charlton of Argosy Private Equity; Anand Philip of Castle Harlan; and Steven Menaker of RSM discuss seller motivations; tech impact; and exit opportunities.

Deal Flow in a Competitive, TechInfused Market The New US Manufacturing Opportunity

David Snow, Privcap: We’re joined today by Don Charlton of Argosy Private Equity; Anand Philip of Castle Harlan; and Steven Menaker of RSM. I’d like to talk a bit about the private equity space for manufacturing as manufacturing is you know, I guess begun to enjoy a renaissance. Are there more private equity firms bidding for properties in the manufacturing space broadly defined? And is this sort of increasing the competitive dynamics of doing deals in manufacturing? Maybe starting with Anand?

Anand Philip, Castle Harlan: Well that is a little bit of a tough question because we, we like to say that a lot of what we do is proprietary, and 80 percent of what we, we look at about a thousand deals a year to set the baseline expectations. But about 80 percent of those have a proprietary element to them, either where there is no banker, broker or investment book involved at all. But a higher percent than the, that 20 percent is that proprietary is, will be closed that ends up being proprietary. So about half of what we close has no specific process involved and didn’t have other bidders involved at the point where we were involved with the company. But you are seeing in the other 50 percent a competitive element, and there are other firms out there chasing these properties. You also have the corporates that I talked about who have cash on their balance sheets that in certain instances would be very interested. The interesting thing about corporates is that they are much less willing than financial buyers to do the clean up work. They are willing to pay a higher multiple for a pristine company because they, they’re not set up to make all the changes that we are. They want to have much more of a plug and play type of operation. And some one of the opportunities in private equity is to be able to get a company that needs to be improved in the manner we’ve talked about. And at that point it becomes much more attractive to a corporate buyer.

Steven Menaker, RSM: I think there is people who know that there is money, dry powder sitting on the sidelines, and so as the sellers take it to market they know that there is an attractive field. And I think we’ve seen in most

cases there are competitive bidding processes that go on and I think the investors know that they have to either play or they’ll go on to the next one.

Don Charlton, Argosy Private Equity: I think a lot depends on the size, again you’re doing much larger deals than we’re doing. We’re doing you know, lower middle market deals, so below five million, you know, usually it’s going to take a lot of work. So you’ve got  to have, as a firm you’ve got to have the resources and network of contacts whether they be internal or external to put those value creation methodologies in place. You know, kind of five to seven, you know, five to ten, you know, tends to be competitive, and then once you kind of get over ten million, at least in the lower middle market it is very competitive. You know, sometimes at an auction process it’s a feeding frenzy because there are just not that many good companies that, that have achieved that scale in the marketplace.

Snow: Well that’s good from an exit perspective right, so if you are the owner of, or you’re created a pristine business it sounds like there are more opportunities than ever to, to change the ownership of, or find a new owner for your business.

Philip: Absolutely and in, in the past few years alone we have sold over a half dozen companies to strategic buyers, and so that speaks to the ability to change some of these companies. The other thing is in 2012 in anticipation of changes in capital gains you saw a lot of buyers chase companies where the sellers were running for the exit. And if you are, if you are an entrepreneur who built a company up over 30 years and the majority of your net worth is tied up into that one investment a difference in capital gains between 15 percent and 23.8 percent is very dramatic to you. And so we, we saw a lot of deals attempt to be closed, but surprisingly not as many closed as we would have thought. And we’re, we’re still investigating why that’s the case. But it wasn’t as much of an activity was we could have hoped. And that being said we were the beneficiary on both the buying and the selling side. So we bought in the last quarter of the year a large oil and gas company that we carved out from a public business for just about a billion dollars. And on the selling side on the last week of the year we sold one of our portfolio companies in the auto aftermarket segment for a very attractive valuation of over three times our money. So we were the beneficiary on both sides, but just in terms of the absolutely amount of deal flow it wasn’t, it was good but it wasn’t as robust as we would have expected for a one time anomalous type of event.

Menaker: I think you had some companies depending on the cycle that they were in were not performing well leading up to the slow down, maybe in perhaps 2012, didn’t end as strongly as it may have started so the values weren’t there, companies were a little bit less excited. But I know that probably Don from your perspective there might have been more of the add on environment where the small bolt on was ready to do something because of the attractive tax rates, easier to get it done. We had one client that was able to close a deal on December 31st simply because you had that motivation to get it done.

Charlton: And it was material differences, you look at those tax rates and the difference in cap gains alone could be real money to these owners. So we saw a lot of deals cued up, we didn’t see as many get done as well. So I think it kind of bodes well for Q1-­‐Q2 with a little bit more certainty in the tax structure, with the laws passed. I think we should see hopefully a robust first and second quarter here.

Snow: Final quick topic and that is, I think a lot of people you know, who are maybe not in manufacturing see it as a place of very mature businesses. Where you know, buyout firms prowl, but are there a lot of growth equity, sort of very entrepreneurial-­‐driven, maybe even technology-­‐driven opportunities taking advantage of the new technologies and maybe even new data capture opportunities? Are you seeing those kinds of deals in the market?

Charlton: We have looked at a few deals of companies that provide infrastructure to manufacturers. Mainly in the ecommerce areas, so let’s just say it’s a niche product where they were a distributor and built up a large base of employees who knew the products. And then built up the infrastructure to handle higher volumes. It serves as a great venue for manufacturers to find new channels. A lot of times manufacturers don’t know how to sell online. So we’ve seen a few companies in that space which I think will continue to grow.

Menaker: Technology isn’t a critical factor in technology, maybe it doesn’t always take that central point because it is the equipment ultimately and the people that drive it. But being able to use the data to drive sales activity, costing activity is an important part, and I think we’ve seen that in almost all the deals that we participate in and our clients that we work with. An increasing emphasis on IT and IT related projects to make sure that they’re getting the information they need.

Philip: Just one example we were a few weeks ago at a manufacturing company, and in the control room where they can watch each one of the machines operate because this company is on hundreds of acres of operations and so in the control room they, they can see how

everything operates. And they mentioned that now on their iPhones they have the ability to download an app, which while they’re sitting at home or outside the country on travel, they can actually watch those machines. And if you are the, the head of manufacturing you happen to be traveling and you see something that, you know, is off on a scale somewhere you can call the guy in the control room and have him actually make a change. So it’s interesting that in a very old world industry you can apply new technologies.

Menaker: It just takes a little bit longer to start but I think they will embrace it.

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