Smart Stimuli

April 21, 2009
Every action has an equal and opposite reaction -- in physics, and in manufacturing finance

The fundamental laws of physics are vividly applicable to the world of high finance -- especially in today's challenging economy. A multi-year bull market fed by easy and extreme leverage has fallen into an equally deep multi-year bear market exacerbated by a shut down in the flow of credit.

At the time of this writing, the Dow has fallen nearly 48% from its October 2007 high to levels not seen since the mid-nineties, and private businesses continue to pare more than half a million jobs every month. The U.S. economy has been in recession for the 16th consecutive month, and the GDP shrunk at a 6.2% annualized rate in the fourth quarter of 2008. The Euro zone has been in recession as long as the U.S. and growth in emerging market economies like China and India has fallen off nearly 40%.

As manufacturing managers tread through this grim economic scenario, it will be vital to prepare for the eventual economic upswing by taking strategic decisions to realign or re-invest in areas that are most likely to be at the forefront of the recovery. In the United States, this means looking strategically at government funding, and taking action to benefit from it.

The New Stimulus "Action"

The American Recovery and Reinvestment Act of 2009, popularly known as the "Stimulus Bill," lays the Obama administration's groundwork for a multi-year strategic investment and spending package with an estimated cost of $787 billion. The bill combines short-term tax incentives with focused investments in the country's infrastructure and other government programs. Implemented in tandem with other fiscal and monetary stimuli, President Obama's administration is attempting to thaw the credit markets and help get the economy back on its feet quickly.

Outside of traditional government spending programs, the Stimulus Bill's programs are designed to take various financial structures and sector emphases, including:

  1. Direct spending in transportation, energy, healthcare and other civil infrastructure
  2. Tax credits and other incentives for clean, and renewable energy investments
  3. Additional types of tax-favored bonds to finance investment initiatives at the local level
  4. Federal loan guarantees to help unlock the credit markets

The appropriations in the Stimulus Bill add up to nearly $150 billion of direct funding of civil infrastructure projects. The ageing transportation network of the country is the most significant beneficiary of the Stimulus Bill, with about $48 billion allocated to upgrading roads, bridges, rail transportation networks, and other public transportation. Other expressed priorities of President Obama in construction and rehabilitation of public schools, investments in healthcare information technology, and building a broadband internet infrastructure, were appropriated nearly $30 billion. The National Institute of Health, the Department of Health and Human Services, and the National Science Foundation together received $18 billion in grants for construction projects, research equipment investments, and research employment. Furthermore, a $2 billion Neighborhood Stabilization Program has been created to assist cities and states with the purchase and rehabilitation of foreclosed and abandoned homes.

Another major initiative, built into various measures across the infrastructure investments, is in the area of clean and renewable energy and improvements in energy efficiency. Between installing energy efficient HVAC systems in public schools, improving energy usage in public housing, and providing tax breaks to consumers for renewable and clean energy installations, the Stimulus Bill aims to make strides in America's energy independence. The Bill has $30 billion allocated for direct spending on a new, smart power grid, advanced battery technology, and other energy efficiency measures. It also provides $20 billion in tax incentives for renewable energy and energy efficiency improvements in homes and offices over the next 10 years. Finally, there is $250 million available for grants or loans for energy retrofitting and green investments in assisted housing.

Being Financially Prepared for the Next Equal and Opposite "Reaction"

On Tuesday, March 3, 2009, President Obama and Transportation Secretary Ray LaHood announced the release of $27 billion in highway infrastructure funds. The first project got underway in Montgomery County, Maryland, with the award of the repaving contract for State Highway 650. Going forward, the effectiveness of the Stimulus Bill will be judged based on how quickly it results in new job creation and the stabilization of our economy.

Well positioned manufacturing businesses will certainly benefit from the largest government spending initiative since the interstate highway system was commissioned in the 1950's. Large and middle-market players in the construction, engineering, and infrastructure industries are already well positioned to successfully bid for engineering design and construction projects. While new entrants are likely to face stiff competition, many companies are working to carve out a niche in emerging areas like clean energy and wind farm development. With private equity firms still mostly sidelined by difficult credit markets and business challenges in portfolio companies, strategic investors are most likely to come to the forefront.

When considering buying into the infrastructure marketplace it will be imperative to factor in the impact of the newly available tax credits, especially in the areas of energy efficiency or renewable energy. In addition, creative approaches in financing large-scale infrastructure investments in solar, wind, and other renewable and clean energy will likely lead to new partnerships between private businesses and local governments.

Some established players in the construction, engineering, and infrastructure industries have already demonstrated the foresight of executing upon strategic opportunities in spite of a difficult financing market. Companies like Insituform Technologies, Matrix Service Co., Tetra Tech Inc., Stantec Inc., MasTec, Inc., and Perini Corp. have closed or announced acquisitions of providers of design, engineering, and construction services to the energy, transportation, environment, and water infrastructure arena. The following table outlines some recent M&A activity.

Anecdotal evidence suggests that the level of strategic discussion activity has picked up in other sectors like wind energy, clean coal, and health technology. Financial services firms and private equity sponsors are likely to play a significant role in aiding the M&A process, as capital is available, albeit expensive, for the right deals. Furthermore, valuations will likely expand in the near future, especially for highly synergistic deals, as we approach the beginning of a recovery and gain clarity about how the funds in the Stimulus Bill are going to be appropriated.

In conclusion, the worst economic downturn since the Great Depression has resulted in a historic response from our government. While people may not agree with the extent of government's role in the private sector or the burgeoning federal budget deficit, the stimulus provides significant opportunities for well-positioned manufacturing businesses and savvy investors.

Randy Paine is Managing Director and Segment Head, Industrial and Energy Groups and Arindam Basu is an Associate, Industrial Group KeyBanc Capital Markets.

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