By Adam Burroughs on August 19, 2022
Inflation, COVID and supply chain issues are creating significant challenges in the M&A market, says Murphy McCormack Capital Advisors Managing Partner Bob McCormack.
“The supply chain is really impacting the ability for any businesses to execute, even if they have orders,” he says. “And then trying to value a business in an acquisition when you have those challenges, is a real challenge.”
Speaking at the Baltimore Smart Business Dealmakers Conference on a panel exploring the factors influencing buy-side deals, McCormack says when all those macro issues are taken together, they put a lot of pressure on working capital.
“Typically, when you buy a company, you have a targeted net working capital level you expect when you buy that company,” McCormack says. “Well, that net working capital has historically been with 2 to 3 percent inflation rates for 15 years. And so, using a 12-month or 24-month average doesn’t work anymore. Back orders are really challenging that net working capital calculation that you need to have in place post-closing. And also, if you calculated on a 24-month average, now with inflation and supply chain challenges, that’s going to be different, too.”
Less than two weeks after Bortek Industries Inc. closed a deal to acquire Carolina Industrial Equipment Inc. back in December 2021, the company heard from its manufacturers that inventories were going to be low and they’d have limited production spots, all of which was related to the supply chain issues.
“The good news with that was we weren’t the only ones,” says Bortek COO Greg Alt. “Our competitors were in the same situation. So, what we did, we got really aggressive and started placing as many orders as we could trying to do our best to predict what the future was going to look like because in our industry the company that has the equipment is going to win at the end of the day. We needed to place orders in order to get the equipment and be able to deliver it before the end of the year.”
From a longer-term perspective, he says it was important because the company knew that if they had the equipment and their competitors, it would give his company a chance to gain market share. But while equipment sales important, the aftermarket, which represents the parts business and the service business, is what is crucial. He says those who sell equipment end up getting the aftermarket services for the next five to seven years.
Inflation was another big issue. He says when the company’s vendors would announce price increases, his business would try to take advantage of that as quick as they could, passing those increases on to customers at the time because they had vendors that would not announce price increases at all or when they did, they were instantaneous, at a time when the company already had orders placed.
Issues such as the Great Resignation and inflation caused the most notable issues at Quotient Inc., says President Clark Lare. Increasing salaries to stay competitive is difficult for a company that contracts with the government. That’s because the company, in many cases, is working on fixed price contracts, so they can’t go back to the government and renegotiate rates. Typically, those contracts can be as long as five years. And through there can be option years and annual escalations, the company is essentially locked into pricing rates from day one.
Bowie & Jensen Partner & Managing Member William McComas says these macro issues have led to longer exclusivity periods that have come with the tendency toward greater due diligence and more scrutiny of vendor contracts.
“What’s in those contracts?” McComas says. “Is it one of these things where there’s no economic adjustment? If that’s the case, then in buying the seller, you may end up at a point where you’re losing money. So, more focus on that. And also on some of the commodity side — are they pegged to a third-party so that the commodities that are made into the products are escalating?”