Are UK manufacturing M&A trends about to turnaround?

The overall data is pretty gloomy. It tells us that the UK manufacturing “deal scene” has seen a decrease in transaction volumes over the past year.

But Luke Morris, Corporate Finance Partner explores if there are now signs of a bit of a turnaround?

I say decrease in volumes overall because, interestingly, deals in the sector which we ourselves handled held up well last year. However, I must confess that there was a stark reason for this: our particular focus meant that our clients saw significant interest from overseas investors and we were able to help them complete on several large, and rather complex, cross-border transactions. Foreign interest in UK manufacturing businesses has remained strong, it’s even grown I would suggest, despite the overall picture.

So why, now, signs of a turnaround overall?

Well, for one, private equity seems to have woken up from a slumber period, and whilst it has retained a focus on strategic investments in sectors like technology and healthcare there are indications of more creative funds now looking outside of the norm. Particularly in the types of deal they will consider at and the way in which they can be financed.

One fund I was speaking with recently is focused on sustainability and eco-friendly acquisitions, because that is what their Limited Partners want. They are pushing for consolidation of advanced manufacturers fitting this bill in order to improve processes, encourage new ideas, drive economies with technology, and deal with skill shortages and succession issues. All sensible stuff so far.

But where they differ is in that they are what I would call a “1980s Stanford Business School Search Fund”: they want to buy an existing, typically stable (but not necessarily growing), business to run and scale.

The term, “scale up” seems to have reappeared in the lexicon.

Such funds understand that the lower mid-market is not, and never will be, “Perfect Manufacturer Limited”, but it could become more so (with work). They understand that this work will ultimately drive them value.

Watch this trend as I expect more of it: clever entrepreneurs with institutional-backing becoming first-time hands-on CEOs by acquiring established businesses, offering a quicker and less risky path to business ownership for them, as well as a return to their investors who need to deploy funds and grow somehow.

It’s not all about cash earnings, hockey-stick growth and light balance sheets. Plus, acquiring 100% is not the only obvious choice for Search Funds.

Contrast this approach with the archetypal sluggish and leaden “investor-only” funds.

Furthermore, on financing specifically, innovative deal structures are not just becoming more common for buyers: we have seen sellers becoming increasingly comfortable with flexible arrangements using tools such as earn-outs, warranty insurance and other exotic arrangements to bridge buyer-seller expectations and manage exits. I don’t know entirely what to put this down to. Experiences over the last decade and a demographic shift in business owners, perhaps? Valuations have certainly weakened and made the current market conditions a buying opportunity for investors. Perhaps sellers are coming to terms with that?

Secondly, add to the mix the new labour government, which will define the macroeconomic tone for UK plc for the next 5 years. The proof of the pudding is in the eating, but the noises they made during the election campaign ought to favour the sector: talk of industrial policy, talk of new infrastructure and house building, talk of energy efficiency and green jobs. We also must assume that the Prime Minister is well disposed to the sector: he certainly did not tire of reminding us that his father was a Tool Maker during the debates.

The Bigger Picture

I am not persuaded by the consensus view on inflation outlook. I understand (but am not persuaded by) the reasons given for the spike we saw: war, supply chain issues, skills shortages, strong demand, spiralling energy prices… However, in my view it is government spending that did the damage, and that shows no meaningful sign of abating longer term. Au contraire. We may well anticipate rates coming down per the Bank of England, but those of you sad enough (like me) to actually read actuarial reports will see a different longer-term picture being painted.

Continued Government stimulus, as well as geopolitical tensions and shocks (including, potentially, a protectionist second Trump term), may further accelerate re-shoring to the UK and add to inflationary pressure. So, what are the smart people doing? Well, the data tells us that the big companies, the trade acquirers, know that if they have a proven track record of successfully generating value through deal activity then they will find future deals easier to finance in unstable conditions and happy shareholders. Those that don’t, will not. So, the (smart) big companies are also keen on deals and I sense this is contagious.

The UK Manufacturing deal scene is a complex story, but the investors’ interest in the sector’s strategic growth remains strong and the macroeconomic weather for the sector could now be brightening up. As ever, proper planning is key and getting professional advice on board as soon as possible is the way to maximise your deal’s value. To reach out to Luke or a member of the Scrutton Bland team, email hello@scruttonbland.co.uk or call 0330 058 6559.