What is the Value of a Commercial Heat Treat?

An Interview with Ryan Murphy of KAL Capital Markets

We are excited to be speaking today with Mr. Ryan Murphy Co Founder of KAL Capital Markets of Long Beach, CA, USA a firm which advises entrepreneurs and private equity groups on liquidity events, recapitalizations and capital raises.

Ryan this is the first time we have interviewed an individual with such extensive knowledge when it comes to the valuation and sale of commercial heat treaters, I am excited to ask you a few questions. Lets start off with some details about your own background as well as some details about the firm you co founded, KAL Capital Markets.

Sure thing. I am one of the two founders of KAL Capital which, along with my partner Trevor Bohn, we founded six years ago. The mission is fairly straight forward; we provide M&A advisory services to businesses within the aerospace / defense supply-chain. We think being dedicated to the sector allows us to better understand and position our clients’ business as well as to develop meaningful relationships with the best buyers. Ultimately, we think this leads to better outcomes (higher prices!) for M&A processes that we run.

While you have obviously been involved in mergers and acquisitions for a number of different industries our real focus is on metal finishing, surface treatments and heat treating. How many of the projects that you have been involved with over the years would fit into these categories?

We have a lot of overlap with you because the world of surface treatments has been a very important part of our practice for over a decade. We have been heavily involved in metal finishing transactions having advised on nearly a dozen of those types of businesses including many of the companies that ultimately became Valence Surface Technologies. On the thermal spray side, we represented market leaders including Southwest United (sold to PCC) and Hitemco (sold to Lincotek). Heat treating has been an adjacency that has become more active for our practice recently with the sale of the Hot Isostatic Pressing provider, Kittyhawk.

Are you able to share with us any company names?

Nope. We are only able to discuss transactions that are closed. Confidentiality is critical to us.

How do you determine the value of a company?

Valuation is always more of an art than a science. There are a variety of subjective factors that influence what a market price would be. Ultimately, what we do is create a competitive market for a business that will remove all subjectivity and allow a business owner to understand exactly what his business is worth and who would buy it.

I am sure that besides a multiple of EBITDA there are a number of other factors that determine the value of a firm. What would be the top 3 or 4 factors that need to be considered when putting a value on a company?

EBITDA is always going to matter, but I agree there are a few other high-level topics that drive the multiple. The most important to me is how differentiated a service the company is providing. Is it highly complex, with high-barriers to entry? Or do the customers have a wide-range of choices? The answer to that question generally gets you to important follow-up conversations around margin profile and future growth potential. Additionally, specifically in the world of surface treatments available capacity is important. If a business requires substantial investment to grow, buyers will discount the opportunity materially.

Over the years “The Monty Heat Treat News” has had some involvement with putting buyers and sellers of commercial heat treats together and several times the seller has brought up a point which I find hard to answer, perhaps Ryan you have a suggestion. A seller will say yes I agree with your valuation of the company today but how do we account for future growth? As an example the seller feels next year will be a banner year and believes he should be compensated for that even though historically the numbers don’t reflect this-suggestions?

It’s a tough question. This really gets to the topic of timing. We often find ourselves making recommendations on when is the right time to start a dialogue with buyers and effectively make sure that a seller gets compensated for future growth. Sellers get compensated for future growth via multiple of current EBITDA. A business that has highly probable growth streams with limited capital requirements should garner a higher multiple. A business that will be flat or low-growth gets a lower multiple.

I would say that the majority of sales in the commercial heat treat industry involve heat treats selling to other heat treaters, having said that though it is certainly not uncommon for a private equity firm to buy a commercial heat treat. Who is willing to pay more?

This dynamic has evolved significantly over the past decade. Historically private equity was viewed as focused on distressed or underperforming businesses and looked to cut-costs as way to generate returns. Today, private equity is much more diverse with a significant portion of the industry looking to buy healthy, growing businesses. Additionally, there has been a tremendous flood of capital into the private equity world, forcing these groups to be more aggressive from a valuation perspective.

While the commercial heat treat industry is a large one in terms of dollars it does not have an especially high profile in the overall manufacturing sector. Do many of the buyers that you work with specifically ask for an acquisition in this industry?

Aside from a handful of well-known strategic buyers, the majority of interested buyers are likely to be private equity groups. These folks generally are open a range of opportunities so wouldn’t ask us for a particular piece of the A&D supply-chain. That said, there has been an increased awareness that the Tier III or surface treatment providers are often one of the more attractive places to invest. There are a few factors that drive that including the service or tolling nature, low working capital requirements and robust barriers to entry driven by the upfront capital requirements or approvals (both Nadcap and OEM).

Are you seeing more or less interest from potential buyers in the metal finishing/heat treating industry?

Definitely more. The success of the Valence Surface Technologies platform raised the entire industry’s profile.

Now this is a very loaded question Ryan. Based upon rising interest rates and the threat of a recession in 2023 is this a good time for the owner of a heat treat to consider selling? It’s a loaded question because the flip side of this question would be is this a good time to buy a heat treat?

We haven’t seen any weakness in M&A activity or valuation for our clients. That said, I think many of the businesses that we work with have been insulated from a lot of the recession-risk because there has been a really nice recovery in commercial aerospace and continued growth in many defense-focused platforms.

Ryan I appreciate your time and look forward to keeping in touch with you over the years. Thank you, Gord

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