Carving Out Deals in the Industrial Market

Jul 09, 2023

One Equity Partners-backed Clayens Group's deal to acquire Parkway Products and complete a carve-out of a Crystal Lake, IL injection molding manufacturing facility may be representative of the kind of deals PE is going to see in the industrials sector.

Deal volume has been down since the middle of 2021 but some industries have faired better than others. Some dealmakers tell Mergers & Acquisitions that the industrials sector is poised for a pickup in activity as manufacturing, industrials and demand come back onshore. Here's why.

The carve-out by Clayens Group, a value-add outsourced contract manufacturer of high-performance polymers, composites and precision metals, should help the firm achieve scale in North America while also diversifying its customer base and technical capabilities.

"I think we are going to see a tremendous amount of M&A activity throughout the latter part of this year and into 2024 in particular," says Josh Adams, a partner with OpenGate Capital. "And I think that's just down to a more systematic point of view where you’re seeing a tremendous amount of opportunity just not being able to be capitalized, mainly driven by the debt market. So I think overall the industrial sector is going to continue to be very active."

Adams describes the current market for industrials as an ‘interesting’ one. Much of the current state of the market results from a lot of onshoring and nearshoring taking place in recent years which was highlighted by the supply chain dynamics and challenges faced during Covid. The supply chain issues exposed during the pandemic have resulted in an additional increase in onshoring and bringing manufacturing facilities back home which he adds is positive for the domestic GDP.

Since the pandemic, private equity investment in industrials has begun to regain traction. From a high in 2018 of $120B in deal value across 939 deals, the industry saw a decline in the pandemic years of 2019 and 2020 with a combined deal value of $129B across just 942 deals over these two years, according to data provided by Pitchbook. The following year nearly returned to pre-pandemic levels before the macroeconomic market turned in 2022. So far in 2023, there have been $24B in deal value across 103 deals.

"There's been a slowdown certainly borne out by the statistics for the first quarter of 2023. So on the whole, there's been slow deal activity," says Roger Morscheiser, a partner in Shearman & Sterling‘s M&A Practice. "That said, the drivers of M&A remain the same. It's a great way to increase scale, obtain new capabilities, new talent and execute on strategic objectives. And for those buyers out there who are not reliant on debt financing, who have sufficient capital to deploy, the opportunities are still there for them and they’re pursuing them."

As a result of market conditions and in speaking with strategics in the industry, Adams believes that carve-outs are a natural mechanism for industrial transactions.

"The corporate community that we spend significant time with understand their broader strategy and it's clear that they’ve identified assets and businesses that they would like to sell and that there are businesses that they will likely come to market with," Adams says. "Today, it's just not the right environment. But we expect to see a significant increase in corporate carve-outs."

The firm differentiates industrials into basic materials: building products, chemicals, packaging; and diversified industrials: metals, minerals and aerospace and defense. The reason those subsectors represent attractive industries is that they have gone through some dislocation and they have a need for consolidation while continuing to show growth; organically and inorganically. For example, overcapacity in those markets creates a need for things to happen and that typically comes in the form of M&A.

Divestitures to private equity is "an area where I’ve seen more activity," says Morscheiser. "Also those deals tend to be more middle market where reliance and access to debt financing isn't as necessary, and those deals can be funded with more equity capital, rather than accessing debt."

From the seller's point of view, a carve-out is a valuable way for the firm to raise capital and focus on core competencies. Morscheiser notes the driver companies are always looking at is how to grow and excel in a tough environment and sometimes that means shedding assets that aren't adding to that goal.

OpenGate has acquired businesses in upstream chemical manufacturing like feedstock and raw materials and subsequently acquired a firm that does chemical distribution distributing those products. Through the combination of these acquisitions, the firm is now able to cover the feedstock raw material all the way through to a composite piece of chemical, or value-added product that goes right to the customer.

Professionals note that as a result of complexity, the market can be very inefficient which has an impact on value and the transactions themselves. However, it allows informed firms the freedom to take a business unit and operationally engineer that business into a standalone firm and grow that firm through M&A and organic means. This allows the carved-out business to really change.

"The reason why we’re doing that is that you’ve seen a need for those things to be consolidated," says Adams. "Going back to the theme of the challenges that we see in supply chain management, the ability to have a distributor who can continue to be price sensitive and deliver products in a speedy, timely manner has a really interesting scalable business model. So it's more of a business model than it is an industry. But the distribution channel allows you to be very aggressive on M&A, and have the ability to build up regional players and then more national players. And that's something that we continue to spend time on. We’re doing it in the chemical space, we’re looking at it in the building products market, and we’ve also looked at in the packaging market."

OpenGate isn't the only firm looking to make the most of the opportunity in the industrials sector. Apollo, J.F. Lehman & Co. and Hill City Capital‘s recent deal for Atlas Air Worldwide Holdings, a provider of outsourced aircraft and aviation operating services shows other groups in the space.

Additionally, firms including KPS Capital Partners, Blackstone, GIC, New Mountain Capital, Ares Management, Baypine and Owl Rock have all completed industrial corporate carve-outs in recent years.