Composites business outlook: Consolidation on the horizon

As we kicked off the New Year, we reflected on a composites industry that is once again at a crossroad. We observed that the growing demand for materials innovation and technology advancement of the past several years has poised the industry for momentous growth in an expanding array of applications and end-markets. Ironically, the same driver behind the industry’s growth and distinction in those years has resulted in one of the greatest challenges the industry will face as it moves forward — an unprecedented level of fragmentation.

As it stands, there are currently more than 400 processors and manufacturers in the carbon fiber-reinforced plastic segment alone that each generate less than $20 million (USD) in annual sales. Granted, to many in the industry, this might seem like a relatively sizable revenue base. But if this figure is compared to annual sales numbers in most other industrial segments and end-markets, it is clear that a $20 million company is very small. A similar degree of fragmentation also can be found throughout the rest of the composites industry (suppliers of fibers and resins, equipment and ancillary products). Now, if we contrast the diverse array of specialty companies that comprise the lower end of the market to those at the top end of the market, where there are 8 to 10 large industry players with annual revenues well in excess of $100 million, we see an industry that is primed for consolidation.

Before going any further, it should be noted that consolidation need not be perceived as inevitably negative. In fact, consolidation that is entered into appropriately and executed properly can introduce quite an additive element to a company’s expansion strategy and provide ample personal and professional growth opportunities for its employees. There are two ways to look at consolidation. On one hand, it is seen as a means of cutting costs to preserve profit margins. In a mature and established industry that does not have high growth characteristics, consolidation is an effective strategy for vertical integration and/or reduction of overhead expenses. On the other hand, in a rapidly growing, technology-rich industry where profit margins tend to be healthy, consolidation efforts are more typically geared toward building scale, adding capabilities, diversifying end-markets and/or leveraging organizational infrastructure to help professionalize a growing business. Obviously, the composites industry fits into the latter category.

Setting the demographics of the industry aside for a moment, the composites market is gravitating in the direction of greater strategic definition. More than ever, customers are looking to their suppliers for a complete solution as opposed to simply a product or service. In response, suppliers are aspiring to the role of integrated solution provider, which can be defined as a company that is capable of offering everything from design, materials science and applications engineering all the way through manufacturing and technical support. Subsequently, there is a significant growth opportunity for integrated solution providers because they can differentiate themselves from their competitors if they have the capabilities to deliver a larger portion of the supply and value chain.

I see a small but growing number of manufacturers and suppliers taking heed of this trend and proactively seeking ways to deliver an increasing portion of the value chain. This intimate community of small- to medium-size composites players has identified the evolution of the market, and each is executing a strategy around it. Strategies include raising external capital to fund growth and expansion as well as developing strategic acquisition efforts to add specialized capabilities to existing core service offerings.

The result of these actions will be a number of streamlined industry players jockeying to fill the void in the market between the masses of small niche suppliers and the handful of large corporations. These middle companies will be very well positioned for explosive growth and profitability as they move forward. We expect this trend to be particularly relevant outside the aerospace sector in emerging markets. An integrated provider’s ability to deliver a comprehensive solution will be critical to easing and accelerating a new customer’s journey along what will be a very steep new-technology learning curve. This is particularly true in markets where composites technology may not have the same legacy of evolutionary development we’ve seen in aerospace.

This shifting landscape creates an attractive opportunity for a strategic acquirer to string together several technology-rich and synergistic assets, creating a fully integrated and scalable operation that can really make some noise in the industry. Over the past year, we’ve seen glimpses of this trend coming from large nontraditional strategic acquirers that have acknowledged the need to have a meaningful foothold in the composites industry.

Similarly, the financial community continues to take notice of some growth opportunities in the advanced materials sectors, and we expect to see technology-focused private equity or venture capital groups make a run at this same strategy. Such investors specifically target sectors with above-average growth profiles that enable them to deliver above-average returns for their investors. And in an economy struggling to regain momentum, the composites industry’s growth rate — projected to reach double digits over the next five years — presents a very compelling investment thesis.

Supporting the list of strategic rationales for deal making in the industry is the fact that credit markets are aggressively seeking opportunities to put capital to work. Last year was a record year for many banks and lenders. Consequently many of these institutions have lofty expectations as they begin to build on that momentum, moving into 2012.

When we put all of this together, we see the building blocks for healthy transaction activity going into an election year and ahead of likely increases in capital gains taxes in 2013. In fact, with corporate valuation levels peaking, abundant available capital and easing credit conditions, 2012 has all the potential to be a boom year for mergers and acquisitions and financing transactions across the board.