Playing Defense Creates Value in the Long Run

Currently the stock market is doing well, optimism in the economy is good, and debt remains cheap. All of these factors have created a robust M&A market for companies across many sectors with good companies achieving valuations that strong companies would normally achieve. This is expected to continue. For company owners and sell-side advisors that is great news. At this stage, when activity levels are high the smart money should strive for acquisitions that will have sustainable revenue during the inevitable downturn. This is a more defensive strategy due to its counter-cyclical nature.

For the power sector, this strategy crosses a broad swath of companies due to the critical nature of the industry. The most intriguing segments will be the companies that manufacture parts or provide services that are necessary to maintain the power infrastructure, such as industrial service companies that do shutdown/turnaround work or manufacturers that produce parts used in maintenance/upgrade kits or are consumables.

This seems like an obvious play, but when you look at the energy industry, tangential to the power sector, buyers currently have concerns about further acquisition due to current price of oil. New drilling and expansion of production is only taking place at economical sources, but existing production continues to thrive at most locations. To maintain these operations as well as the downstream refining portions of the industry, substantial investment will need to take place to keep production at current levels. This should result in the companies that manufacture consumables and maintenance/upgrade kits as well as industrial services continuing to thrive. Even so, buyers have become more cautious about this sector in general. One notable exception would be the transportation and storage of oil.

Using the energy sector as an example of the contraction that will inevitably take place should provide an important lesson for all segments of the economy and power in particular. With similar capital expenditure trends, power will eventually need to cut back on expansion and large scale overhauls of current facilities once the economy contracts. When this takes place, the companies that will continue to do well will be focused on providing the parts and services that will maintain current operations as well as provide operational efficiencies in a cost effective manner.

For business owners, this creates and good time to sell. Buyers will be focused on current performance, which should be strong and growing based on the overall economic trend. In football, you hear the phrase “defense wins championships.”  As a New York Giants fan, I have seen this time and again. None of the Giant’s Super Bowls were won due to a great offense. The defense always led the way. This type of mentality for business owners should lead to higher multiples when selling. The company’s defense (maintenance focus) will help create more reliable earnings during a downturn, which should result in a higher valuation and the business owner’s victory when sold.