Targeting sectors for investment
With a significant number of private equity groups (PEGs) working to succeed in this market, it has become increasingly difficult to identify targets poised for significant growth based on financial analysis alone. Plante Moran has noticed that the leaders in this area are increasingly turning to niche analysis to single out businesses that have the financial stability necessary to take full advantage of near-term trends in the market to outpace their competitors. Fund managers who search for businesses in a particular sector that have the knowledge, experience, and capital to take full advantage of the next shift seem to be outpacing managers who aren’t seeing the full picture.
To understand what sectors are poised for growth, and which businesses are poised to lead that growth, PEGs should analyze various specialized industry niches to determine where potentially game-changing innovations have been underutilized or where competitors are struggling to adjust to a new technology or market shift. Plante Moran has identified four sectors where such conditions exist and the characteristics of businesses that may be best suited to outperform competitors over the next few years. This section highlights some trends and indicators that we believe will drive growth in the following sectors: automotive suppliers, food and beverage manufacturers, franchise systems, and healthcare.
It’s hard to ignore the fragility of today’s supply chain as the automotive industry undergoes dramatic change and post-recovery restructuring. The industry has grown to volumes we haven’t seen in a decade, and suppliers are being pressured by their OEM customers to meet increasing demands for new products and expanded production capacity. As a result, supplier business models are being tested as they’re forced to devise new strategies to achieve profitable growth.
The capital requirements and investment risks at play in this dynamic market space can be daunting, but successful suppliers will understand the inevitable impact of industry change, and look to the following strategies to chart their course:
- Build efficient, highly effective OEM relationships and offer value-added services, particularly in areas such as engineering and technical support, pricing and costing transparency, warranty responsibility, transportation, and delivery.
- Add critical value through innovative products and technical knowledge.
Supplier investments in R&D and early involvement in OEM R&D and engineering processes can help differentiate them from competitors. Higher value-added, innovative products will almost always result in significant profit margins.
- Provide extensive technical support for vehicle launches.
As new vehicle models proliferate in number, the ability to meet program targets without sacrificing quality will have an increasingly critical impact on sales.
- Invest in targeted vehicle platforms.
As fewer and combined vehicle architectures drive up production volumes for suppliers but lead to consolidation of the supply base, suppliers must place their bets and figure out — quickly but cautiously — where and how to invest.
- Devise geographic growth strategies.
Smart international strategies will be crucial to supplier support of OEM customers as they boost production in Brazil, India, China, Mexico, and other emerging markets. Suppliers must align their physical footprint with their business model — regional, multiregional, or global.
We’ve seen too many suppliers chase volume only to hurt their businesses by accepting razor-thin margins. That’s not to say companies can’t be successful with volume-based business models, but the trade-off must be deliberate if their goal is to increase shareholder value, and mitigate risk, in the long run.
Food and Beverage Manufacturers
Food and beverage manufacturers are working to keep up with shifts in American preferences. Changes in consumption are occurring at both ends of the economic spectrum, with wealthy consumers willing to pay more for organics and premium labels while lower-income households have become more price sensitive than ever. The companies that have been maintaining a focus on consumption trends and economic changes like those described below should be positioned to gain market share over competitors that haven’t planned for these variables.
Increased U.S. obesity rates have driven many consumers toward more health-conscious options and back-to-basics natural foods, such as organic, raw, single serve, low fat, no GMOs, and no preservatives.
Distribution channels are fundamental to success in this sector. Companies must choose between direct-store delivery or central distribution, whether to fight for space at large retail outlets or focus on targeted smaller stores. Once a company decides on what stores and how to get the goods there, it also has to work hard to manage product locations within the stores.
Other factors to consider in this sector include food safety audits and innovative packaging concepts.
Franchise businesses are expected to grow and create more jobs at a faster pace than the rest of the economy in 2015 for the fifth consecutive year, according to The Franchise Business Economic Outlook: 2015. This makes businesses operating with a franchise operating model appealing targets. However, not all franchise concepts are created equally and funds that have chosen this model for investment all agree there are some key indicators that make one concept more appealing than another for investment.
- Differentiated concepts.
PEGs look to invest in organizations that have a unique value proposition and sustainable competitive advantage, preferably across multiple brands.
- Attractive unit-level economics.
PEGs will want to clearly understand how a franchise defines the strength and consistency of the business’ unit performance.
- Opportunity for growth.
PEGs are looking for vibrant concepts devoid of market saturation or other geographic boundaries that inhibit future growth.
- Other factors for consideration include a franchise’s international footprint, franchisee satisfaction, customer relationships and satisfaction, and an organization’s closure ratio.
The healthcare industry has been experiencing fundamental structural changes to meet regulatory requirements and financial goals while maintaining focus on patient care and health. High earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples are luring sellers into the market ahead of plan, and the competition among investors looking for strong operating companies and management teams has intensified.
- It's important to consider culture early.
Perform cultural due diligence prior to the LOI stage. If cultures and management philosophies don’t align, the deal may not be worth the investment and post-transaction efforts necessary to achieve your investment goals.
- Addressing healthcare's triple aim.
Providers, payers, and private equity investors are all focused on:
- Increasing access to care through new or improved venues
- Improving care through new technology and better provider-patient engagement
- Reducing costs by eliminating unnecessary treatments and inefficient cost centers
- Senior living providers focus on the facility of tomorrow.
With three million Baby Boomers retiring annually for the next 20 years and projected demand for nearly 76,000 senior-housing units by 2030, investment in new and renovated facilities has never been so critical.