Private Equity Challenges Amid the Supply Chain Crunch
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The effects of the global supply chain bottlenecks have been felt from the Port of Vancouver to the Port of Halifax and everywhere in between. Just about every business has been impacted in some form, but particularly the ones that depend on international trade. It’s also created a challenge for private equity firms looking to grow their portfolios.
Increased shipping costs and transport delays has led to tighter margins. There’s also the uncertainty regarding how long the situation will last. The end result is it’s difficult for private equity firms to calculate an accurate valuation for a potential acquisition. Nonetheless, there are steps sponsors can take to be comfortable with making transactions in this environment.
Noise in the numbers
The supply chain woes, which started in the early stages of the COVID-19 pandemic, have greatly accelerated over the past six months. With shipping costs skyrocketing, products delayed getting to market and no resolution in sight, the situation has created a lot of “noise in the numbers.” That is, the current environment has made it difficult to gauge a company’s true financial position, whether it’s liquidity, cash flow or EBITDA. What’s really giving private equity sponsors pause is the difficulty in projecting future returns as past and current performance may not be indicators of future profitability.
We’ve heard from one client that a shipping container that cost $3,500 to carry goods from Asia to North America a year ago now costs $35,000. Given that they ship about $50,000 worth of goods in that container, it’s easy to see how much that impacts the company’s bottom line. We are seeing companies attempt to pass increased transport costs to the consumer, but no company can expect to fully offset a 10x increase in its shipping costs. Businesses may even need to reevaluate their own product lines and distribution channels, weighing the cost with the opportunity. Changing their operations could mean a dramatic difference in future profitability and may even require time to invest in new facilities or acquire new customers, which could result in a near-term dip in their numbers.
Focus on resiliency
So how should private equity sponsors respond? It’s a matter of going back to the fundamentals and investing in business models, competitive positioning and leadership teams. One way to assess a company’s underlying strength is to see how they reacted to the early days of the pandemic or during the start of the tariff skirmishes in 2018. The companies that demonstrated flexibility and developed innovative solutions in response to those challenges are likely to respond similarly to the current supply chain crisis.
During the pandemic, the management teams of our borrowers, backed by the private equity investors they're working with, showed how quickly they were able to adapt to COVID-19. These teams were quick to react, including cutting costs, restructuring and taking advantage of various government relief programs. These management teams took every possible action to preserve liquidity and make sure their companies would have the flexibility to ride through the uncertainty to come.
Because of the noise in the numbers, the response and the creativity of management teams in times of uncertainty weighs even heavier in a private equity firm’s due diligence process. That’s why patience is the key to completing a deal.
If a potential acquisition target is going through a challenging situation, private equity firms—to use a basketball analogy—can opt to hang around the rim if the company has a strong business model and management team. In other words, they’ll keep the due diligence process going, giving the sponsor more time to see how the company responds to the challenge.
Being patient and disciplined also involves getting as much information as possible. That means leveraging your partners and expanding your sources of information to get a better understanding of what's happening on a macro level. You may want to talk to banks, accounting firms, industry trade associations or even other private equity firms. The goal—as with each due-diligence process—is to help you grow more comfortable with a potential acquisition, especially as the supply chain situation evolves.
Andrew Gouw, Managing Director & Regional Market Leader, BMO Sponsor Finance, contributed to this article
This article originally appeared on CVCA Central.
Evan Bennitt
Head, Sponsor Finance, Canada
647-217-7392
Evan Bennitt is Head, Sponsor Finance, Canada within BMO Commercial Bank, Canada. Evan leads a team of professionals focused on supporting Canadian Private Equity f…(..)
View Full Profile >The effects of the global supply chain bottlenecks have been felt from the Port of Vancouver to the Port of Halifax and everywhere in between. Just about every business has been impacted in some form, but particularly the ones that depend on international trade. It’s also created a challenge for private equity firms looking to grow their portfolios.
Increased shipping costs and transport delays has led to tighter margins. There’s also the uncertainty regarding how long the situation will last. The end result is it’s difficult for private equity firms to calculate an accurate valuation for a potential acquisition. Nonetheless, there are steps sponsors can take to be comfortable with making transactions in this environment.
Noise in the numbers
The supply chain woes, which started in the early stages of the COVID-19 pandemic, have greatly accelerated over the past six months. With shipping costs skyrocketing, products delayed getting to market and no resolution in sight, the situation has created a lot of “noise in the numbers.” That is, the current environment has made it difficult to gauge a company’s true financial position, whether it’s liquidity, cash flow or EBITDA. What’s really giving private equity sponsors pause is the difficulty in projecting future returns as past and current performance may not be indicators of future profitability.
We’ve heard from one client that a shipping container that cost $3,500 to carry goods from Asia to North America a year ago now costs $35,000. Given that they ship about $50,000 worth of goods in that container, it’s easy to see how much that impacts the company’s bottom line. We are seeing companies attempt to pass increased transport costs to the consumer, but no company can expect to fully offset a 10x increase in its shipping costs. Businesses may even need to reevaluate their own product lines and distribution channels, weighing the cost with the opportunity. Changing their operations could mean a dramatic difference in future profitability and may even require time to invest in new facilities or acquire new customers, which could result in a near-term dip in their numbers.
Focus on resiliency
So how should private equity sponsors respond? It’s a matter of going back to the fundamentals and investing in business models, competitive positioning and leadership teams. One way to assess a company’s underlying strength is to see how they reacted to the early days of the pandemic or during the start of the tariff skirmishes in 2018. The companies that demonstrated flexibility and developed innovative solutions in response to those challenges are likely to respond similarly to the current supply chain crisis.
During the pandemic, the management teams of our borrowers, backed by the private equity investors they're working with, showed how quickly they were able to adapt to COVID-19. These teams were quick to react, including cutting costs, restructuring and taking advantage of various government relief programs. These management teams took every possible action to preserve liquidity and make sure their companies would have the flexibility to ride through the uncertainty to come.
Because of the noise in the numbers, the response and the creativity of management teams in times of uncertainty weighs even heavier in a private equity firm’s due diligence process. That’s why patience is the key to completing a deal.
If a potential acquisition target is going through a challenging situation, private equity firms—to use a basketball analogy—can opt to hang around the rim if the company has a strong business model and management team. In other words, they’ll keep the due diligence process going, giving the sponsor more time to see how the company responds to the challenge.
Being patient and disciplined also involves getting as much information as possible. That means leveraging your partners and expanding your sources of information to get a better understanding of what's happening on a macro level. You may want to talk to banks, accounting firms, industry trade associations or even other private equity firms. The goal—as with each due-diligence process—is to help you grow more comfortable with a potential acquisition, especially as the supply chain situation evolves.
Andrew Gouw, Managing Director & Regional Market Leader, BMO Sponsor Finance, contributed to this article
This article originally appeared on CVCA Central.
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