Apr 17 2013
As seen in the M&A Alert and discussed at the The M&A Advisor Distressed Investing Summit
The expression “Buy American” has secured a position within today’s society. Numerous websites are dedicated to promoting US manufacturing, providing lists of companies that manufacture products exclusively within the United States. Books like How Americans Can Buy American educate readers on why and how to shop American. Even well-known ABC broadcaster Diane Sawyer founded a “Made in America” pledge, asking viewers to pledge to buy US-manufactured products because it could stimulate the economy through job creation. This movement becomes even more important when considering the common theme linking US manufacturing industries: most are dying.
Market research firm IBISWorld queried its database of more than 1,000 US industries and identified the top five dying sectors in the country. Some of these sectors are declining in light of technological changes (e.g. Printing and Paper Products), while many more are failing in light of mounting import competition, particularly from emerging markets. Despite the myriad issues these sectors are experiencing, including declining revenue, news is not all bad – at least for investors seeking opportunities. Companies in these dying sectors could prove favorable investments, yielding high returns.
Apparel & Fashion Accessories Manufacturing
The Apparel and Fashion Accessories Manufacturing sector includes a number of textile manufacturing industries, including men’s and boy’s apparel, hosiery mills, leather goods and luggage, and shoes and footwear. These industries are all in the decline stage of their life cycles, primarily because of overwhelming competition from substitutes that can be produced at lower costs in various Asian countries. Import penetration has been a key factor driving falling demand for the respective industries’ products and services. For example, over the five years to 2013, revenue for the Men’s and Boys’ Apparel Manufacturing industry has declined at an estimated annualized rate of 13.3% to $1.8 billion, including an anticipated drop of 4.4% this year. Low-priced imports, which jumped from 70.4% of domestic demand in 2003 to 90.6% in 2008, will account for an estimated 96.9% of demand in 2013 and 98.3% by 2018. Additionally, US companies are increasingly sending their manufacturing activities offshore to countries like China that have access to low-cost labor.
According to the International Monetary Fund World Economic Outlook Database, 2010 average wages in China, Vietnam and Singapore were $2,250, $1,152 and $1,089, respectively. Comparatively, a US apparel manufacturer’s average employee earned about $33,579 in 2010. Lower wage costs translate into lower cost structures.
Moreover, many of these industries have low market share concentrations on which potential investors can capitalize. The four largest companies in the Men’s and Boys’ Apparel Manufacturing and Hosiery Mills industries generate about 25.0% and 30.0% of industry revenue, respectively, while the four largest players in the Shoe and Footwear Manufacturing industry generate about 5.0% of revenue. Potential investors could seek to create a dominant player in one of these industries, which could then achieve above-average profitability.
Printing & Paper Products
The Printing and Paper Products sector is made up of several printing-related industries on the manufacture, wholesale and retail level. Many of these industries, including atlas and map publishers, calendar publishers, printing services, paper wholesalers and art and office supply manufacturers, have arguably become outdated because of the ubiquitous reliance on computer technologies. For example, the Art and Office Supply Manufacturing industry faces significant external competition from electronics, which are increasingly used for design projects and communication. Consumers and businesses alike are turning to a myriad of technologies and software, including computers, tablets, e-mail and drawing and sketching software, for design and communication purposes. As a result, there is less dependency on the nonelectronic supplies that the industry provides, such as paper, pens and canvas boards. Revenue for the Art and Office Supply Manufacturing industry fell 3.1% per year on average from 2008 to 2013 and is forecast to continue downward at an annualized rate of 2.9% through 2018.
Despite this sector’s diminishing revenue and relevance, several of its industries actually have segments that are in the growth stage of their life cycles. For example, the Newspaper Publishing industry has been in a state of decline during the past decade as a result of growing consumer reliance on internet outlets for news consumption and a greater preoccupation with community-or regional-centric news. Although the industry is declining primarily due to the advent of the Digital Age, the industry is benefiting from focusing on smaller and community publications and moving its news content online. For example, the New York Times Company, publishes about 18 daily newspapers and more than 50 websites. Increasingly the company is using a firewall system to generate revenue beyond advertising; a firewall system requires users to pay for reading materials.
Lawn & Garden Products
Much of the Lawn and Garden Products sector, which includes plumbing fixture manufacturing, florists and lawn and outdoor equipment stores, is declining. The situation is becoming increasingly dire for the sector’s manufactures (such as those of plumbing fixtures and outdoor furniture) as low-cost imports continue to gain a greater share of domestic demand. Within the Outdoor Furniture Manufacturing industry in particular, imports are expected to increase at an average annual rate of 4.9% during the next five years to account for an estimated 93.3% of demand in 2018. China is the primary importer for this industry and many others in the sector.
These industries also have a moderate market share concentration, which means investment and expansion opportunities are prevalent for the industry’s largest companies to increase market share concentration by acquiring smaller, more niche or regional companies. In fact, consolidation has already begun within these industries: During the five years to 2013, the number of outdoor furniture manufacturers has fallen at an annualized rate of 7.0%.
While the Florists and Plant and Flower Growing industries are also declining, they have been victim to escalating external competition from online retailers. E-tailers are able to offer discounted prices for comparable goods because of lower overhead costs, while brick-and-mortar retailers have more difficulty competing on price because of higher cost structures. Additionally, the ease of shopping online is a competitive advantage.
There are some bright spots for these industries, though: Florists and growers that can develop relationships with online retailers, such as Teleflora and FTD, will likely experience greater revenue and profitability.
Family Recreation Centers
Consumers’ leisure time is diminishing, particularly in light of rising employment levels. At the same time, there are copious recreational and entertainment activities available to consumers, ranging in cost from free (e.g. watching television) to moderately expensive (e.g. golf) to very expensive (e.g. international travel). Consequently, the Family Recreation Centers sector, which includes karaoke bars, miniature golf courses and bowling alleys, has a lot of competition. Competition is expanding too as newer technologies like home video games and interactive websites allow consumers to replicate the experiences of, say, singing karaoke, playing golf or bowling, from the comfort of their homes.
Smartphone apps, websites and games like Karaoke Revolution made for Xbox, PlayStation and Wii devices are just a few examples. These substitutes have been reducing demand for these industries’ services and will continue to do so in the coming years. Over the five years to 2018, revenue for the Karaoke Bars, Miniature Golf Courses and Bowling Centers industries is forecast to fall 2.4%, 2.5% and 0.5% per year on average, respectively.
In response, respective industry operators are investing in restructuring. For example, the Bowling Centers industry is slowly adapting to a changed marketplace, with an increasing number of bowling centers focusing on implementing new and more modern amenities and technology, such as full bars and wireless internet access. These shifts could provide a competitive advantage over digital and in-home entertainment options, and many of these new product and service lines also are more profitable (e.g. food and alcohol service).
Consumer & Trade Product Manufacturing
The Consumer and Trade Product Manufacturing sector includes audio-video equipment, computer, household furniture, lighting, bulb and ink manufacturing industries. All of these industries are in the decline stage of their life cycles. A combination of factors, including import penetration and technological developments, has transformed these industries from mature to declining.
The Ink Manufacturing industry, which produces ink for end users like newspaper and magazine printers, commercial printers and office supplies wholesalers, is declining due to a shift toward digital media. Over the next five years, the digital takeover will continue to reduce industry demand and force companies out; industry revenue is projected to fall at an annualized rate of 1.4%, while the number of companies drops an average 4.5% per year.
On the other hand, the Audio and Video Equipment Manufacturing industry, which manufactures electronic audio and video equipment for home entertainment systems, vehicles and public areas, is benefiting from the digital transition internationally, but not domestically. According to IBISWorld estimates, imports will take over the industry by 2018, satisfying about 97.7% of domestic demand. Offshoring manufacturing activities to countries with cheaper labor is a dominant trend in the industry, with more multinational corporations, such as Samsung, LG and Hitachi, moving operations to low-wage countries.
Threatened, but with investment opportunity
Several themes emerge from analysis of the top five dying US sectors. First, import penetration, supported by cheaper foreign labor, is a key factor driving many US manufacturing industries into a state of decline. From apparel to audio and video equipment, few manufacturers are immune to the difficulty of competing against low-cost import substitutes. Second, external competition is another barrier precluding these industries from returning to a mature or growth stage. More specifically, much of this external competition is coming in a digital form. Brick-and-mortar retailers are failing to compete against more price-competitive online retailers that benefit from reduced cost structures because of their digital presence. Other industries, like bowling centers and karaoke bars, are unable to overcome the growing number of entertainment alternatives generated through technologies like smartphone apps, interactive video and the internet. That said, high-risk, high-return opportunities abound for investors able to identify and capitalize on the growing segments of these declining industries or able to acquire a large player within any of these industries and expand its market share.