Sometime in mid-2021, just as U.S. markets and consumers alike were looking forward to the end of COVID restrictions and a corresponding rebound in the economy, global supply chain issues suddenly emerged as one of the lagging indicators of the COVID recession.
How it Happened: The COVID Supply Chain Crisis
When the pandemic first hit, governments worldwide closed their borders and ordered business shutdowns in key industries, slamming the brakes on the production of goods. But where industries continued operating, COVID-related employee absences slowed production, further exacerbating shortages. Then in Spring 2021, the much-anticipated lifting of COVID restrictions was postponed after new COVID variants struck. Consequently, consumers who had saved up for summer vacations channeled their unspent funds into increased holiday spending, pushing prices higher.
The resulting supply chain crisis, visually embodied by the container ship that got stuck in the Suez Canal in March 2021, disrupted business and industries worldwide and has led to changes in long-established methods of doing business.
In past decades, industries reduced expenses by off-shoring production to third-world countries and using just-in-time inventory management, postponing large purchases until shortly before they were needed. Lower warehouse-storage costs left more money available for the bottom line and correspondingly increased stock values.
The supply chain crisis revealed unanticipated weaknesses in the system.
Now that overseas partnerships have been shown to be less reliable, many companies have begun on-shoring production and distribution, moving their facilities closer to customers. The notion of vertical integration has also become more attractive as industries seek to lower their costs and improve the reliability of parts delivery.
More Investment in Supply Chain Businesses
The new focus on logistics and transportation has caught the attention of investment firms looking for M&A targets. As pent-up demand and rising fuel prices force companies to spend more on transportation and distribution, this sector of the economy has become more attractive to investors. As a result, private-equity firms have begun increasing their investments in supply chain businesses, including warehouse automation and other logistical operations affected by shortages, all of which were previously taken for granted. Private-equity firms have recently invested three times as much into this sector as in 2020. According to PitchBook, firms invested $9.1 trillion into the supply chain sector between January and May 2022 alone.
The additional focus on the supply chain aspect of business is affecting company valuations, with investors asking questions like
- How resilient is this company?
- How agile and nimble is it in coping with unexpected outside factors?
During the most recent earnings call for the Motley Fool financial investing and advice company, Vic Richey of ESO Technologies, a software technology manufacturer, said that supply chain issues have led to record levels of backlog and even past-due backlog, mainly in ESO’s utility and aerospace businesses. Richey said his firm is still not sure when the situation will clear up, but “We are doing everything in our power to get customers the products they want when they want them.”
Saleel Kulkarni of Bain & Co., which advises private-equity managers, recently told the Wall Street Journal that his company is seeing private-equity firms investing in areas like warehouse automation and other areas related to logistical operations that are suffering from labor shortages and are thus good targets for growth.
However, such investments remain niche because they will never have the same capacity for rapid growth that makes the tech and healthcare sectors so attractive to investors.
Impact on Working Capital
Changes caused by supply chain shortages have affected how industry treats working capital as part of the M&A process. Working capital are the funds and liquid assets on hand to continue operations for the near future. It is a key component of M&A deals because a buyer needs to be sure a company has enough money in the bank to continue operations as it transitions from seller to buyer.
The amount of working capital on hand has historically been a factor that went into negotiating the deal. It has now become less so, as businesses find themselves channeling more funds into inventory to compensate for long lead times caused by supply chain shortages. They know that being able to supply what the customer needs when they need it is crucial to maintaining good customer relations, and they are willing to pay higher prices to keep key parts in stock.
M&A advisors say that after some initial confusion, buyers now understand the current environment and are taking this into account when negotiating.
Structured Sales
Record product backlogs have complicated M&A dealmaking because customers are placing extremely large orders to compensate for expected shipment delays. This has unsettled standard methods of estimating company valuations. Without any precedent for how this will affect valuations, sellers turn to the structured-sale process, listing companies without a price and waiting to see what offers come in. The resulting range of price offers gives sellers some idea of how much their firm is worth, while also giving them several good offers to choose from.
Michael Callam is president of Gertsburg Licata Acquisitions. Contact Mr. Callam today at mcallam@gertsburglicata.com or (216) 573-6000 x7003.
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