Top 5 Deal Opportunities in the West

west regionRegulatory and technological changes will lead to a flurry of merger and acquisition (M&A) activity that will require the services of investment banks, particularly in the West region. IBISWorld has identified five industries that are concentrated in the West and will require capital raising and corporate M&A services during the next five years. The West region has long been an area of growth; from 2000 to 2010, the population of the region grew 11.8% total, with the urban population outnumbering its rural counterpart nearly six to one. The urban population is concentrated in California; the Golden State is home to seven of the 10 most densely populated urban areas in the United States, including Los Angeles- Long Beach-Anaheim, San Francisco- Oakland and San Jose. According to the US Census, the West region is home to about 17.0% of the US population, making it the second-most populated region in the country.

IBISWorld examined its database of more than 1,000 industries to isolate those that are concentrated in the West. The five industries highlighted below exhibit a high average profit margin, low structural risk, strong growth or high M&A activity, providing deal opportunities for investment banks. Structural risk measures the impact of competition, entry barriers, government assistance, volatility and other fundamental characteristics affecting all industries. Industries with low structural risk and high profit margins represent favorable acquisition targets, increasing demand for M&A services provided by investment banks. Growing firms seek out investment banks to raise capital and further expand their businesses. On the other hand, firms operating in consolidating industries will require business valuation, M&A advisory and restructuring services provided by investment banks.

Snack Food Production

The Snack Food Production industry manufactures items such as potato and corn chips, pretzels, popcorn and other similar snacks. Industry operators benefit from economies of scale because larger companies are able to achieve lower per-unit costs when producing large volumes of snack food. In addition, larger operators are often able to obtain more reliable contracts with suppliers of raw materials, such as corn, wheat and potatoes. Furthermore, the industry has benefited from technological developments that have increased automation during the production process. The industry uses machines that automate traditional mixing and baking processes, as well as hulling and separating operations that remove hulls from a variety of seeds and nuts. The West region is home to 23.8% of total industry establishments due to the high population concentration in the region, as well as a strong input supply network. Operators strategically position themselves near large urban areas to save on shipping costs to downstream customers and from upstream suppliers.

Investment banks are likely to have the opportunity to provide capital raising services to help fund the development and marketing of new products. During the five years to 2018, industry revenue is anticipated to grow at an annualized rate of 2.5% to $32.9 billion. Over this five-year period, operators will particularly focus on new product innovation to ensure that their brand image does not become stale in a relatively saturated marketplace. Innovation will be driven by a healthier eating trend that has resulted in higher consumer demand for products with more natural ingredients and lower fat and cholesterol content. The industry’s 20.7% profit margin is also forecast to grow as the prices of inputs fall and become less volatile. Furthermore, margins are anticipated to increase as a result of industry consolidation.

Producers will pursue acquisitions to expand their market reach and market share; some producers may look to use acquisitions in place of new product development to achieve these goals. Many of the industry’s newest operators produce healthier snack foods that use more natural ingredients. Consequently, established operators are expected to explore acquisition options to expand their product offerings. This trend is exemplified in General Mills’ recent acquisition of Food Should Taste Good and J&J Snack Foods’ acquisition of Kim and Scott’s Gourmet Pretzels. As a result, investment banks are expected to have plenty of opportunities to provide valuation and acquisition advisory services to the Snack Food Production industry.

Public Transportation

According to the American Public Transportation Association, ridership in 2012 was the second-highest ever since 1957. In the West region specifically, Los Angeles’ light rail system experienced an 18.5% increase in ridership and its heavy rail system experienced a 3.7% increase. The Public Transportation industry primarily consists of regional transportation systems that operate along regular routes on a fixed schedule; chartered services such as taxis and limousines are not included within the industry. The success of public transportation providers hinges on government funding and incentives, as well as maintaining a good reputation with the local population. The industry has recently benefited from rising gas prices and low disposable incomes. As the prices of gasoline and owning a vehicle have risen, consumers have turned to public transportation systems to fulfill their local traveling needs.

About 23.4% of total industry establishments are located in the West region. While most cities have public transportation programs, metropolitan areas such as Los Angeles and San Francisco have some of the nation’s largest operations. In addition, Los Angeles’ “car culture” provides great opportunity for the public transportation system to undergo further expansion, such as its current plan to expand the city’s subway further west. Currently, the industry is able to maintain its 5.6% profit margin largely through government subsidies. However, as budgets tighten at the state and federal levels, public transportation providers and local governments may turn to private-public partnerships.

Over the next five years, industry revenue is forecast to increase at an annualized rate of 2.5% to $43.6 billion as lower unemployment boosts the number of commuters and the price of crude oil continues to rise. To meet rising demand, the industry will need high levels of capital to update aging fleets and purchase new vehicles that are more environmentally friendly. The potential for private-public partnerships and the growing need for capital give investment banks the opportunity to provide capital raising services to public transportation industry operators, particularly in the West.

Internet Service Providers

Internet services providers use a wired infrastructure to provide clients with internet access and other related services, such as web hosting, web page designing and hardware or software consulting related to internet connectivity. Depending on how extensive the company’s infrastructure is, operators may also lease out capacity on their network to support other companies. The industry has benefited from an increasing volume of online business transactions, which contributes to corporate demand for internet connections and value-added services such as security and data management. Operators also offer cloud and infrastructure services for easier access to online information across platforms. About 26.2% of industry revenue is generated in the West region. Similar to many other technology providers, California is the dominant state within the region because of the state’s high concentration of venture capitalists.

Operators in this industry have recently faced additional competition from companies like Google that have begun to develop fiber optic connectivity. In response, investment banks can provide capital raising services to internet service providers that are looking to advance their technologies and product offerings. During the next five years, industry revenue is projected to rise at an average rate of 3.2% per year to $61.1 billion as the Federal Communications Commission pushes to advance the number of broadband connections and internet reliability. As the residential market becomes more saturated in urban areas, providers will turn to more advanced technologies such as fiber-optics to increase speed offerings.

In addition, the industry’s smallest operators will represent acquisition targets for the most established companies. Small companies cannot offer bundled content and often cannot compete on price; they also tend to operate in more rural areas. Furthermore, some small businesses prefer niche providers because of the intimate customer service provided. Large companies are likely to acquire these providers as subsidiaries to expand their clientele and geographic reach. As a result, industry operators will need investment bank M&A services, including valuation and other acquisition consultation.

Land Leasing

Operators in the Land Leasing industry lease real estate that does not include permanent buildings; rather, industry real estate includes manufactured homes and mobile home sites, vacant lots and grazing land. About 25.0% of industry establishments are located in the West region. Once again, the region’s dominance is largely driven by California, which has the greatest number of retired residents, according to the Population Reference Bureau.

Since the financial crisis, the aging population has helped fuel renewed demand. The industry earns a 21.2% estimated profit margin as a result; retirees make up the industry’s largest downstream market. In addition, the industry has benefited recently because structures such as manufactured homes provide a low-priced home ownership option. Furthermore, the perception of lower social status traditionally associated with manufactured and mobile homes has been drastically reduced because the quality of these homes has significantly improved in recent years. As a result, demand for manufactured and mobile homes has risen slightly among nontraditional demographics, leading to increased demand for land leasing services.

The industry represents a potential opportunity for investment banks as it expands during the next five years; industry revenue is forecast to rise at an average annual rate of just 1.2% to total $6.7 billion. While mergers are not common within the industry, one company will often purchase the land of another as the previous owner exits the industry. As a result, investment banks can provide acquisition services, consultation services and help fund the purchase of new properties for successful land leasing operators.

Wine and Spirits Wholesaling

About 25.8% of establishments in the Wine and Spirits Wholesaling industry are located in the West region. Industry operators have positioned themselves near California wineries that produce about 89.0% of all US wine; California accounts for 19.1% of total industry establishments on its own. Despite a decline in total alcohol consumption following the financial crisis, the introduction of new value wines and spirits from producers helped wholesalers maintain growth. Even as revenue has grown, the industry has come under increasing pressure from direct winery-to-consumer sales, especially through vintners’ increasingly frequented websites. In 2005, the Supreme Court permitted in-state wineries to ship wine directly to consumers, but prohibited out-of-state wineries from doing the same. As a result, growth in California wine wholesaling operations has been limited by direct sales.

IBISWorld forecasts that industry revenue will rise at an average annual rate of 2.7% to $87.4 billion during the five years through 2018. While revenue is expected to increase, the number of enterprises is anticipated to decline as the industry goes through a period of acquisition and consolidation. Many distributors are family owned and operated; however, a growing number of operators are likely to accept acquisition bids and retire from the business. The trend will be fueled by the preference of major producers and retailers to deal with a smaller number of larger, more efficient distributors. In response, industry operators will require investment bank services for valuation and acquisition consultation.

Conclusion

Technological change, regulation and consumer demand will spur M&A activity in the West region during the next five years. In addition, many operators that have suffered losses since the recession are looking for nothing more than a way out. As a result, West-region industries will increasingly demand capital-raising, business valuation, corporate finance and acquisition services, providing business opportunities for investment banks. Perhaps most encouraging, the trend of consolidation that characterizes the five aforementioned industries is not isolated to one sector of business, but is likely to be far reaching throughout the US economy.

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