Industrial manufacturing deals insights: Midyear 2020

Industrial manufacturing M&A followed the global macroeconomic downward trend in March and April resulting from COVID-19, which led to the weakest first half in deal value since 2014.

Industrial manufacturing experienced a significant decline (46%) in deal value from the first half of 2019 to the first half of 2020, while deal volume declined 21% during the same period. The sector had five transactions greater than $1B, which accounted for 36% of the total deal value during the first half of the year. The largest transaction, Danfoss A/S’s acquisition of Eaton Corp PLC-Hydraulics Cylinder Business for $3.3B, contributed to an overall strong first quarter for the year. However, as the global pandemic began to ramp up in March 2020, industrial manufacturing started to see significant drop-offs in M&A activity as deal value and deal volume declined 63% and 36%, respectively, in Q2 2020 when compared to Q1 2020. 

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We expect deal volume and value in the second half of 2020 to begin to recover from the sector lows seen during the peak of the COVID-19 pandemic. We saw significant declines in transacted volumes in Apr-20 (108 announced deals) and May-20 (117 announced deals), which we expect will gradually increase and hit more normalized monthly levels of ~200 deals by early 2021. Historically, aggregate deal value has been driven by mega-deals where we anticipate seeing a decline over the next six to 12 months as companies focus on managing their way out of the pandemic and emerging stronger. Many companies will continue to focus on value preservation through cash flow and cost management measures as well as minimizing supply chain risk as their supply chains, most of which are less financially stable, also transition to a different way of doing business. We expect the following factors to drive a resurgence in M&A activity in the sector in the H2 2020: shifting industry paths, supply chain risk management and efficiency, the future of capital and need for technological innovation.

Our expectations by type of activity:

Shifting industry paths: As the pandemic has created a new way of living, overall declines in consumer spending and travel have led to a softening of industrial manufacturing end markets, such as automotive and aerospace & defense. The decrease in economic activity from the effects of the pandemic will very likely result in excess capacity in the sector for the foreseeable future resulting in the need for divestment of non-core assets, consolidation and, for the least fit to manage through the transition, bankruptcy. We believe this will drive an uptick in strategic deployment of capital by those corporate investors with strong balance sheets and opportunistic investment opportunities for financial buyers.

Supply chain: Given the uncertainty caused by trade and supply chain disruption we have seen during the pandemic, we expect to see a renewed focus on product sourcing and supply chain efficiency. As the trade war with China continues to play out and companies begin to re-evaluate where they produce and sell their products, supply chains will likely become more localized. This factor inherently will provide increased opportunities for M&A.

The future of capital: We expect to see continued low interest rates for the foreseeable future along with continued economic stimulus through the end of 2020 and potentially beyond. Furthermore, the decline and continued uncertainty in end market demand for industrial manufacturing products coupled with concerns over the economic impact of a resurgence of the virus in 2H 2020 will continue to impact valuations resulting in increased opportunities to use M&A as a strategic tool to create shareholder value.

Technological innovation: In the medium term, we expect to see companies invest in additive manufacturing, digital factory and digital supply chain solutions. Investment in these technological capabilities will result in increased machine-based manufacturing which will not only increase manufacturing efficiency but also reduce the risk of operational disruptions due to human causes (e.g., strikes, pandemics and the like) as well as decrease supply chain risk.

In summary: Albert Einstein said, “In the midst of every crisis lies great opportunity,” and the COVID-19 pandemic is no exception.  The economic impact of this pandemic will be felt in a meaningful way well into 2021. As in any crisis, there will be winners and losers. The winners will be those who have the financial capabilities and insights to take advantage of the opportunities that arise and have the experience and discipline to develop and execute on a fundamentally sound value creation plan.