The economic environment that manufacturing operators are subject to poses an interesting and perhaps unprecedented market dynamic marked by both challenge and opportunity as companies look to navigate through a liquid, ever-changing business climate driven by continued globalization, technological innovation and a new agenda from Washington. Moderated by Eric Navales, Managing Director, L.E.K. Consulting, the ACG Philadelphia Industry Roundtable facilitated real-time market feedback from an A-Team of seasoned industry veterans who provided insight from the perspective of their respective backgrounds.
Taxes, Tariffs and the Trump Administration
“Wait and see” was Sean Gallagher’s stance on the possible implications of the tax reform and recent tariff developments on domestic manufacturing as it remains prudent for companies to first see which areas of their business will be affected, if any, before making adjustments. Much of the panel echoed the same sentiment, suggesting that the net impact driven by the agenda of the current Administration remains to be seen as the market has not had sufficient time to fully digest and is still in flux in many cases. Kevin Coleman noted that much of the current customer demand has not been brought on by Washington’s policies but rather from a strong recovery in the space, catalyzed by customers who are very confident and extremely bullish. The issue, Coleman explained, is that supply has been unable to keep up with expedited growth in demand, resulting in imbalances in the marketplace which he feels is issue number one in the short to medium term, followed by inflation and tariffs. Despite these imbalances that have surfaced in the manufacturing sector, companies remain trigger-shy when it comes to adding capacity as forecasting the supply-demand curve outside the next two year window becomes increasingly difficult.
Technological innovation and the adaption of such advancements into the manufacturing space is much like the stock market: timing of the position is equally as important as selecting the correct asset. Many operators seem to be fairly risk-averse to the idea of investing in technology prematurely because, as Christopher Lawler noted, “being a first mover is a fairly risky strategy.” As an alternative, many companies are taking a more deliberate, “fast-follower” approach as moderator Eric Navales suggested. While integration of technology can be very beneficial, Sean Gallagher reminded the group that it also requires a fair amount of investment and can be quite capital intensive. All these points are of course moot if companies cannot figure out how to successfully use the resulting data to their advantage. Ted Heininger provided an operator’s perspective on the matter, indicating that while his company has invested in intricate vision systems, the business was failing to utilize the data successfully and has recently hired a software company to gain a better understanding of how to leverage artificial intelligence to make actionable, data-driven improvements.
“The Amazon Risk”
Perhaps the most succinct yet powerful question of the morning came from an attendee who asked “what’s the Amazon risk?” With little hesitation from the panelists, the consensus became clear that this is very much an ongoing concern within the industry think tank. Many of Sean Gallagher’s clients are concerned about what impact Amazon and the digital era will have on their respective businesses, a result which Mr. Gallagher believes will depend on how commoditized a given product is. Continuing on the same sentiment, Kevin Coleman views this as a significant risk for companies offering products close to the commodity end of the spectrum, stating “it’s a matter of when, not if” Amazon will become a threat. Christopher Lawler noted that while differentiation of a product set is important, a more critical aspect to evaluate is the distribution value proposition. For Lawler, not having enough complexity around the interaction between company and customer is a big red flag... Though a given product may be considered differentiated, if customers can find it from another vendor, they will explore that option and price becomes a more significant buying criteria.
The overall takeaway here is a positive one with loosening of regulation making it easier to do business, perhaps even spurring increased demand. It seems customers are more willing to take risks and invest based upon the regulatory climate even if their industry has not had any regulation roll-backs at this time. The key consideration to evaluate is how regulation will change as the current Administration turns over in the next two to six years. As Christopher Lawler stated with fastidious care, “relying on government to be consistent in its application of policy over time is very risky.”
Deal Flow and Valuation
Sean Gallagher and Eric Navales both noted that many operators and private equity funds have gravitated towards an approach focused on adding value through multiple add-on acquisitions rather than the more traditional one-and-done investment model. Gallagher has also observed increased competition as larger funds have had a propensity to move downstream on the enterprise value continuum as they look to smaller deals as possible bolt-on opportunities for their more established, platform brands.
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