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US-China tensions add extra layers to manufacturing deals

As the US and China trade conflict rolls on, uncertainty around tariffs and how they impact bottom lines is adding an extra level of complexity to transactions in the manufacturing sector.

Mergers and acquisitions (M&A) in the manufacturing sector can be complicated at the best of times – but the US-China trade war is providing another potential obstacle for dealmakers to negotiate.

More than a year after the US first imposed additional tariffs on goods imported from China, many businesses are still trying to work out the best strategy for dealing with them amid a sea of questions.

How do you ‘share the pain’ down the supply chain? How much can you pass on to the ultimate users of your products? Can you realistically shift production out of China to another jurisdiction? How is China going to let the yuan decline against the US dollar? How might competitors counter your strategy?

For manufacturing M&A deals, there is another emerging query: how do I demonstrate the impact of tariffs on my sustainable economic earnings?

“It slows business down,” says Bill Chapman, Partner at Baker Tilly in the US, on the rolling impact of the US-China situation.

“With a 25 per cent tariff, if you were to eat the whole thing  — and nobody would ever do that, but it’s worth thinking about as a worst-case scenario  — your operating margins would have to be north of 30 per cent, or else you’d be going out of business in a hurry.

“It’s not just the buyers  who are worried. I’ve been working on a deal with a private equity fund that owns a platform company that has its consumer products manufactured in China.

“They are buying two bolt-on businesses and both [deals] have stalled. And they have stalled because the lenders are nervous because there are just too many variables to assess to get comfortable

“The concern is now, how am I going to get repaid in this dynamic environment? If you keep getting margin compression because of tariffs, how do I know you aren’t going to be in default? 

“How the deals are getting financed is one of the big questions, let alone how you are going to manage your vendors, customers, and the ultimate consumer.”

Despite some of the pressures exerted by the cross-Pacific standoff, Chapman says the market generally continues to be a robust one – particular for buyers with an eye for a bargain.

“In the middle market and lower middle market we’re still seeing a lot of activity,” Chapman explains.

“However, the  quality of the sellers has declined some, because I think a lot of the higher quality stuff has sold already or the potential seller has made the decision to hang on because it’s too early to sell. 

“Additionally, I think some companies are slimming down a little bit and the larger organisations are trying to shed some non-core assets. 

“We’ve seen more large carve-outs in the past 18 months than I have in a long time. I think people are anticipating a slowdown and are trying shed non-core assets. When is the next recession coming? That’s a question I think a lot of people are asking.

“The assets changing hands might be seen as small and non-essential by the seller, but a private equity fund might be more nimble. They will believe they can identify issues where there is fat that’s never been noticed before.”

Chapman regularly sees technology playing a part in manufacturing deals. Sometimes that means one business acquiring another to get ahead by acquiring operations with more sophisticated technology it doesn’t believe it can develop itself.

“That strategy can work but I still think you need to supplement it with your own R&D efforts,” Chapman explains.

“If you’re buying something you don’t understand, you’re just biting off more than you can chew.”

Sometimes, however, it’s a lack of available information or the poor quality of data that hinders or kills a transaction.

“The biggest complaint I have is that you find entrepreneurs viewing accounting and systems as a non-value-added cost,  and not a strategic component of their business,” he says.

“They tend to maintain that philosophy until it is too late. They don’t upgrade and they neglect their systems and their books and records are not very good. 

“I’ve seen this more and more frequently, where systems are antiquated. And it’s incredibly difficult to extract data.

“The neglect of systems and financial and operational data reflects poorly on management, because the buyers are thinking, how have you been managing this? How have you been able to control your business without good data?

“It’s a cliché, but it still holds true” You can’t manage what you can’t measure. And certainly, if you can’t prove it, you can’t sell it.”

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William Chapman

Baker Tilly United States

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