When it comes to due diligence for acquisitions in the manufacturing and distribution sectors, private equity firms often underemphasize the value of a thorough operational review. Manufacturing and distribution companies face a variety of operational challenges and issues that create high risk for an acquirer. Conversely, it is possible to turn these same challenges and issues into tremendous opportunities. Consider these examples.
For a deal involving a manufacturer and distributor of home décor products, a fundamental assumption of the investment thesis was that adequate capacity existed to support the growth trajectory. A detailed review of the target’s capacity indicated that such was not the case and that a significant capital investment would be required within two years. The private equity firm used this information to adjust its offer prior to committing to the investment.
A firm considering acquisition of an electronic components distributor believed that warehouse operations could not support future growth. A review of operations and facility layout and design, however, demonstrated that such growth could be supported with minimal investment. This finding allowed the private equity firm to negotiate with knowledge that operational expense projections were overstated and that the target’s operations included embedded hidden value.
A rigorous operational due diligence approach should focus on the most meaningful levers that link directly to revenue enhancement, cost reduction, and physical asset management. Such an approach is critical to identifying hidden value and hidden landmines, and to developing action-ready plans to address the above.