By David Hicks
Every year TBM conducts a fair number of operational assessments of potential acquisitions, often for private equity firms. Part of the due diligence process, these assessments evaluate the target’s current performance, identify risks and estimate the growth potential and capability.
In this article, we share what we’ve learned from performing these assessments, especially in capital intensive, process operations. We then dig deeper into asset and equipment conditions as an indicator of a business’s overall condition, value and growth potential.
Among the manufacturing companies that we have assessed, there are three major areas of focus that stand out across different industries:
These are all interrelated of course. Asset condition reflects leadership priorities, and the depth of lean manufacturing practices is an indicator of management’s knowledge and capabilities. In addition to top-line growth potential, private equity buyers will factor the opportunities and risks in each of these areas into the deal thesis.
When we walk into a plant the first thing that we notice is the overall cleanliness. If it’s a dirty production process that will temper some of our expectations. Still, cleanliness is a strong indicator of management control and process discipline. If there are oil leaks and absorbent material on the floor under the machines, it points to some level of disrepair that isn’t being addressed.
Closer to the equipment and machines, we will look for grease guns, zerk fittings, and signs that they are being used. If grease guns are mounted on a shadow board next to the broom and dustpan, that shows good workplace organization and some degree of autonomous maintenance where operators help tend to the equipment.
We also listen. Anyone who has worked around gearboxes and conveyors for a while can hear when a gear is slipping or when bearings need to be replaced.
Beyond how the equipment looks and sounds, we will examine how maintenance work is being managed. This starts with seeing if the maintenance department is adequately staffed. One facility we recently assessed was running 24 hours per day, five days per week with only one maintenance person on one shift. It was a risky strategy that explained the condition of their equipment and their unplanned downtime.
Everyone says they are doing preventive maintenance. To find out what they’re actually doing, during the assessment we will ask a series of open-ended questions. For some plants, preventive maintenance means having a rep from the OEM come in once a year to look at the machine. That’s always a good idea, but it’s not nearly enough.
Floor managers will often say they do machine maintenance after every so many hours, so many days or pounds of throughput. We look for evidence and reports showing that preventive work is both scheduled and that it is actually done. If an operator has an issue and calls maintenance, is anyone recording that work ticket? Or do they rely on the maintenance guy to remember what’s been done to each machine?
We are big proponents of computerized maintenance management systems (CMMS), which are used to track such repairs. If a plant uses such a system, we will look at how they are using it, and if there’s some discipline around it. The value of such software typically comes after three to five years, when historical analysis can be used to check if components and consumables are meeting their engineered lifespans and by aligning spare parts inventory with what’s needed when.
A number of the companies that we have assessed for buyers are still run by the founder, or they are family-owned. In such cases, the business leaders often don’t see the value of a CMMS. They have always gotten along just fine without one and aren’t inclined to make the investment, which makes it a kind of maturity indicator and a sign of a potential cost-savings opportunity.
Such systems or spreadsheet-based records can also reveal the amount of maintenance work that has been deferred. This is often the case during acquisitions when deferred expenses will temporarily boost earnings and make the operation look better from a financial perspective. All manufacturers will defer maintenance at some point to fulfill customer orders or meet monthly production quotas. Well-managed companies will eventually catch up with their PMs.
Last year we executed an operational due diligence project for a private equity client that encompassed multiple sites and facilities. The buyer wanted us to look at the equipment and report on its age and how well it had been cared for. Specifically, they wanted to know about any major capital expenses that might pop up in the near future, as well as the expenses required to transition any part of the business to other plants in the event of consolidation.
Our analysis included capex category spending (maintenance, growth, safety/regulatory), capex as a percent of sales (for industry comparison), capex to depreciation ratio, and three-year trends. Across all of the facilities, we found that their capex spending was not keeping up with depreciation. At a basic level, this means that they were wearing out the equipment faster than they were replacing and caring for it.
Private equity buyers have an exit plan in mind (typically within three to five years) when they purchase a company. They need to know if they will get an adequate return from any investments that they have to put into operations. In this case, the capex analysis did not derail the project, but it did give the buyer an indication that there would be some catch-up spending, and to discount their offer accordingly.
While quantifying future capital expenses is important, the primary focus of value creation for private equity firms is on growing the top line either by consolidating operations and businesses, or by growing sales with existing assets. From our site-level assessments, they want to know how well the plant setup and management will be able to support such growth. If sales are doubled, will the production lines and equipment be able to handle it?
That’s a good question for any business owner to consider. How could you double sales? How would your managers and equipment cope if current volumes were doubled? In many cases, creativity is the answer.
Our assessments of manufacturing operations frequently uncover a lot of unused capacity. The equipment and work cells are set up and running, but the plant is only operating on one shift, and they aren’t running anywhere near the equipment’s rated capacity. Today, this is often because they can’t find enough people locally who are willing to work second or third shifts. In these cases, we will look at the capability and cost of additional automation that could enable additional shifts.
Increasing capacity by adding a shift is a fairly straightforward calculation. Estimating the growth potential from improving maintenance practices can be equally significant, but it requires a deeper understanding and experience.
For example, during the course of our career, one of us became general manager of a plant that had been doing almost zero preventive maintenance. The previous management team’s strategy was to run the main piece of production equipment full out, then repair it when it broke down. Needless to say, it broke down on a regular basis.
We implemented a disciplined preventive maintenance program, integrating it into the weekly production schedule. Every Wednesday the machine would be taken offline for a few hours. We did the same thing for the plant’s other essential equipment, establishing weekly, monthly, quarterly and yearly preventive maintenance procedures.
Over several months, uptime improved dramatically. So dramatically that we were able to more than double output and the sales orders fulfilled by the plant with no additional equipment investments. We were even able to bring business back inhouse that had previously been outsourced to a sister plant because of capacity constraints.
This is the type of opportunity – doubling sales with existing assets – that private equity buyers always hope to uncover. As a business leader or owner, identifying and capitalizing on such opportunities will boost current earnings and maximize the sale price when it is time to sell your business.
Key Takeaways
Private Equity Operational Due Diligence + Value Creation
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