Leveraging manufacturing to increase M&A deal value

Obj

ectiv

es Strategy Customer Compliance

Corporate strategy enabled through manufacturing capability

Uninterrupted product supply to customers and partners

Adherence to regulatory and legal requirements

Design and implement an integrated operating modelAccelerated migration to future state operating model with integrated processes, superior balance of global vs. local (fit for purpose) and rightsizing

Manufacturing transition road maps, transition service agreements (TSAs) and transition manufacturing agreements (TMAs) to support product and service continuity and enable process handoffs

Provide business continuity through sustained material and product availability to customers

Drive higher productivity from equipment base

Improve productivity, capacity and performance Streamline network design

Efficiently integrate, separate or shut down manufacturing sites

Value-focused approach to site separations and site shutdowns with emphasis on cross-functional strategic

considerations and speed to execution

Develop locations and size of manufacturing plants to meet current needs and support growth

5

Leading CFOs and executive leadership teams understand that a major event, such as an acquisition or divestiture, frequently provides the opportunity for implementing a new manufacturing structure. Altering the structure and capabilities of the manufacturing supply chain can provide a significant value opportunity, but it also entails high levels of capital expenditure that can be difficult to reverse. Manufacturing typically accounts for 30% to 40% of total cost synergies in an integration, making it imperative for this function to have a “seat at the table” early in the deal process.

Companies can improve the sale price in a divestiture through structural changes to manufacturing operations, and aligning the footprint to the deal perimeter and identifying cross-functional interdependencies. Yet, most companies lack the understanding of work stream dependencies and the critical path to disentangle them.

Our experience supporting some of the most complex M&A transactions and transformations has shown that the following five actions can make the difference between a lackluster and successful manufacturing acquisition or divestiture.

1. Improve productivity, capacity and performance

2. Streamline network design

3. Provide business continuity through sustained material and product availability to customers

4. Efficiently integrate, separate or shut down manufacturing sites

5. Design and implement an integrated operating model

Accelerated value creation

1 2

3 4

| Leveraging manufacturing to increase M&A deal value2

Key activities

1Improve productivity, capacity and performance

Improving manufacturing performance can be one of the quickest paths to increasing gross margin and releasing cash. Most transactions typically extract short-term value, but focusing on improving manufacturing performance can provide significant long-term value in most operating environments and market conditions. During an integration, companies should share operational leading practices to address overall equipment effectiveness (OEE) and improve capacity and utilization. This often improves margins by reducing waste and variability and leveraging existing capacity for growth and throughput.The challenge is making these improvements sustainable, which can require structural changes to the manufacturing operating model. Dashboards that pull data in real time from manufacturing execution systems (MES) and other tools have dramatically improved the ability of plant personnel to monitor and maintain sustainable productivity gains. For example, an EY team led operational turnaround efforts for a PE-owned manufacturer of advanced aerospace and defense products. Within three months, the team was able to stabilize earnings before interest, taxes, depreciation and amortization (EBITDA) and convert work-in-progress (WIP) valued at 50% of EBITDA into cash. It also established sales and operations planning (S&OP) processes that balanced WIP and cash demands of the business through a detailed review of the client’s inventory, training select team members in root-cause analysis methods and tying the first-to-space yield into the S&OP process.

2Streamline network design

Plant rationalization is often cited as a key value driver in transactions, along with the mandate to reduce headcount in the merged entity. On average, companies reduce fixed costs by greater than 25% as the result of network optimization.

Defining the optimal manufacturing network requires a comprehensive review of the alignment with strategy, manufacturing operating practices, critical expertise and end-to-end product flows. The focus should ideally be on the proximity to customers and suppliers to evaluate network options and identify the best option available.

In one case, an EY team helped a diversified industrial goods manufacturer evaluate and manage the implementation of its manufacturing; distribution; and maintenance, repair and overhaul (MRO) network optimization with an ambitious goal of reducing the company’s manufacturing footprint by more than 70%. We modeled the client’s future state network, looking at make vs. buy decisions for each product, and then streamlined the network based on plant or supplier capability, capacity and cost variables, which further identified opportunities to reduce fixed costs by an additional 25%.

3Provide business continuity through sustained material and product availability to customers

During a transaction, the manufacturing facilities of the new entity have to comply with all regulatory and legal requirements. The manufacturing organization’s top priority during an integration or divestiture is to stay focused on running the day-to-day business and maintaining supply continuity for customers.

Maintaining consistent customer delivery by having plant certification or regulatory requirements and industry-specific factors — including capital equipment, manufacturing processes and data in place — is critical throughout an integration.

Devising the appropriate supply strategy involves careful, up-front planning and accounting for the numerous interdependencies with other internal functions and the external supply chain network, including suppliers, customers, partners and regulators. This can make divestitures a challenge when assets, infrastructure, people and processes are integrated and shared across businesses.

Establishing a manufacturing transition road map that incorporates transition service agreements or transition manufacturing agreements, coupled with inventory build strategies, can enable supply continuity and process handoffs. Although TSAs can be disruptive to the seller, they can accelerate the transaction process even before complete operational separation.

As an example, a major medical device company engaged an EY team to support it with carving out a business unit. Included in the deal were products commingled in one of the seller’s plants. Due to regulatory issues, the buyer was unable to transfer the operations to its chosen location, delaying the close. We resolved this timing issue by creating a transition manufacturing supply agreement (TMSA) that allowed the seller to bridge this period and continue supplying product to the buyer. This TMSA limited the disruption from day one and maintained the forecasted revenue of the acquired business.

| Leveraging manufacturing to increase M&A deal value3

4Efficiently integrate, separate or shut down manufacturing sites

Separating a manufacturing site or closing a facility is often necessary when transitioning to a more efficient manufacturing network during an integration or divestiture. However, if these transitions are not executed carefully, they can significantly disrupt a company’s operations.

During a merger, significant efficiency gains can be made by moving products and equipment around and closing redundant manufacturing facilities. It is important that executives clearly understand production processes and capabilities, current and projected volumes, product mix, manufacturing costs, utilization, labor, infrastructure and supporting capabilities.

A divestiture may require plants to move their manufactured products to other locations, causing complex product planning and human resource strategies. And changes in product demands may lead to unnecessary or inefficient plants that may need to be closed. Regardless of the cause, these moves are always complex and often place revenue streams at risk.

Key steps to consider include identifying constraints, understanding geographical and local complexities, developing detailed work plans and analyzing risk. There are numerous constraints to consider when planning for a plant closure, including customer supply continuity, capacity planning, working capital considerations and the timing of restructuring charges. These constraints may need to be fully understood and accounted for when determining the overall closure strategy and timing.

The level of detailed planning required cannot be overstated, as the smallest detail can derail the program. Before committing to a strategy, a risk analysis can be performed. Establishing guiding principles can assist decision-makers as they make difficult trade-offs and determine the level of risk they can tolerate.

Local expertise is invaluable in developing and executing the appropriate strategy for a plant closure or separation. Each separation or closure is unique and requires a tailored execution plan.

An EY team helped a technology company decommission its large manufacturing plant in Asia and transfer production to another country in the region. The team developed a plan with local and regional government support and tailored separation plans to mitigate human resources, inventory, logistics and IT asset risks. The client realized more than $200m in its EBITDA run rate benefit and over $1b in enterprise value.

5Develop and implement an integrated operating model

Transactions affect an organization’s global supply chain, and executives need to “restyle” their manufacturing operating models in a more integrated and collaborative end-to-end manner. To design and implement a future state manufacturing operating model that enables the corporate strategy, an organization can engage a thoughtful approach to avoid disrupting existing integrated business processes.

Operating model considerations at the corporate and plant level — including the degree of centralization and control, the level of integration, the degree of standardization, and the definition of roles and responsibilities — involve trade-offs that can impact product quality, cost and service levels. Designing a model with the appropriate size and capabilities is key, but developing a transition plan to the future state operating model is just as essential.

Transforming the supply chain in a strategic collaboration

An EY team helped a Fortune 50 life sciences company implement a supply chain transformation in which the company entered into a strategic collaboration model with a leading contract manufacturer (CM). The scope of the transformation included about $10b in revenue, with five franchises across five countries, about 20 plants, 7,500 employees and 50,000 stock-keeping units (SKUs).

To mitigate operational risks, we constructed detailed separation plans driving the separation and stand-up of the new organization. Agile collaboration was enabled via a shared, cloud-based enterprise resource planning system, which was implemented for seamless data sharing and visibility.

The collaboration model was implemented with no supply disruption to customers and is expected to save the company almost $3b.

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This material has been prepared for general informational purposes only and is not intended

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Contacts

Ashim TalukderManaging Director EY-ParthenonErnst & Young LLP ashim.talukder@parthenon.ey.com

We want to thank J.D. Kearney, Mike Davis and Kevin King for their contributions.

Jeff SchlosserPrincipal EY-Parthenon Ernst & Young LLP jeffrey.schlosser@parthenon.ey.com

Conclusion

Manufacturing is a key component in determining if the expected value from an acquisition or divestiture is realized. In fact, improving manufacturing efficiency often supports the underlying deal rationale for an acquisition. Executing on a value creation program during a transaction can require bandwidth from manufacturing employees who support the program while also performing their day-to-day roles. Supplemental resources with experience in manufacturing, value creation and M&A can prove invaluable.

In a divestiture, clearly defining the deal perimeter and identifying interdependencies and manufacturing product and process flows can help buyers understand the products and services that may need to be set up at close or post-close to facilitate business continuity and preserve the deal value.

These key capabilities can accelerate value creation during a transformative event and may enable the corporate strategy, customer supply and alignment with compliance requirements.