The Toolkit

Tools for building the future

The Toolkit with John Stewart, Founding Partner at MiddleGround Capital

Top Takeaways

  • A labor shortage in manufacturing is just around the corner. If your business isn’t preparing for it, you will be in a huge mess. Addressing the manufacturing talent shortage isn’t just about filling open roles. It’s about finding the right workers for your business.
  • Hire an operation professional with years of experience and knowledge to help you make the right decisions in every aspect of your business. Hire the best and get real results.

Guest Profile

John is the Founding Partner of MiddleGround where he is responsible for the overall management of the firm. John started his career as an hourly line worker at Toyota Motor Corporation and held numerous management and executive positions over an 18-year career. John made the move to private equity in 2007, joining the prior firm as an Operating Partner.

MiddleGround Capital is a private equity firm that invests in B2B companies in the industrial and specialty distribution sectors in the lower middle market in North America & Europe. They are differentiated as true operators who have experience working in and managing businesses that range from the lower middle market to Fortune 500 companies.

MiddleGround Capital brings private equity, consulting, investment banking and capital markets experience to our portfolio companies. Their team has been trained and has significant experience working for both bulge bracket and middle market firms, such as JP Morgan, Bank of America and Harris Williams. Collectively, they have held more than 40 Board of Director positions for middle market businesses.

Over the next 10 years, John was progressively promoted throughout the organization and became a Partner in 2016. Throughout his career, John has worked on numerous transactions and served on the Board of Directors of over 25 businesses across both middle market and Fortune 100 companies.

John is frequently sought after by fellow investors, Limited Partners, and business leaders for his vision and leadership for Industrial Manufacturing businesses. John’s “blue collar” roots are the DNA of our firm and set the tone for our firm culture.

John was recognized in 2020 as a Top Thought Leader in the Lower Middle Market by Axial John has been the subject of numerous articles, including the cover story for April 30th, 2012 Businessweek John was named by Automotive News as one of the Top 10 Rising Stars in the Industry in 2007.

John is a published author. His book “Toyota Kaizen Continuum: A Practical Guide to Implementing Lean” serves as the core of our operating system and the curriculum for our lean manufacturing boot camp activities.

Episode Highlights

Reshaping Your Business: Operation Confidence

  • “We focus on reducing transaction risks by underwriting more of what we can do in the value creation plan to create equity value.”
  • “About a third of our team are operating professionals, people that have run operations, which is one of the fundamental things that we do differently than everybody else.”
  • “Many private equity firms have a VP or a Director on their investment team, mostly under the 30s without business experience, and they’re advising the CEO. We try to hire and have management teams that are experts in their given industry.”

Common Mistakes Industrial Businesses Make

  • On pricing: “Many times, we’ll buy a company and find out that their largest customer is not profitable. So, avoid getting tricked just because a customer gives you so much revenue. It’s causing all this disruption inside the organization.”
  • On pricing: “With fluctuations in material pricing, the difficulty of obtaining labor today, and the supply chain disruption, nobody quantifies the cost of those, and that’s no way to run a business.”
  • “The biggest mistake I see is that people don’t  understand where they make money in the business; how the cash flow generates.”
  • “Another problem in the industry right now is that people need to prepare for the coming labor shortage. There’s a big bubble that’s getting ready to come when the economy does start to take off again.”

Automotive Industry Reshaping Over the Next Decade

  • “At the beginning of this year, we started holding more inventory than we needed for the operations just to ensure that we didn’t have supply chain disruptions.”

Why John sees a massive increase in working capital coming for OEMs:

  • “For us to operate with the demand that we need, especially in automotive, we need the car inventory out there for people to select from.”
  • “There are so many things that drive the public markets that are just people’s confidence in the brand rather than anything directly tied to the business results.”
  • “75% or more of tier-one automotive suppliers’ revenue comes from the internal combustion engine. And nothing is being done about changing that right now. Because the volume of electric vehicles is still so small, it’s never it’s not going to replace what’s coming from internal combustion engines. The automotive industry is a wonderful business!”

Listen to the full podcast episode for an in-depth discussion!

John Stewart’s Contact Information

Contact number: (917) 698-3754

Email: jstewart@middlegroundcapital.com

LinkedIn: https://www.linkedin.com/in/johnstewartky/

Website: http://www.middlegroundcapital.com

About the Host:

Justin Fortier lives in Brooklyn, NY, and works for a consulting company serving industrial companies.

How to Connect with Justin Fortier

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Transcript

Justin Fortier: Hi, John, thanks for joining us on the podcast today really excited to talk with you about Middle Ground Capital because I looked at a lot of private equity firms, especially in the industrial space and Middle Ground stood out pretty unique as both its approach and that it’s worked with a number of automotive suppliers, which is rare in the PE industry. So thanks for coming on.

John Stewart: Yeah, absolutely. Thanks for having me.

Justin Fortier: Can you share a little bit about how you got into private equity, and then lead into the thesis for Middle Ground Capital?

John Stewart: Sure. My background is, I started my career working for Toyota Motor Corporation, actually started as an hourly line worker on the night shift at their plant in Georgetown, Kentucky. A lot of people don’t know that. But that’s the way this largest facility in the world. I started up in bumpers on the Toyota Camrys. And over an 18-year career, I worked my way through management, was promoted successively throughout the organization, completed my undergraduate degree and ended up stationed in the United Kingdom running their operations over there. So that was in 2005-2007, I was in the UK. I was contacted by a recruiter that was recruiting for a new private equity firm that had spun out of another firm that was focused on industrials, they had owned some companies that in the industrial space at their prior firm, and some of those firms had used lean manufacturing or the Toyota production system processes in their facilities. And they recognize those as superior methods. And those facilities have performed better for them. So they set out to look for somebody with that background. I’ve done a lot of public speaking at Toyota, and was highly trained in the Toyota Production System. I actually authored a book on lean manufacturing, they contacted me through a headhunter and I joined them in 2007. I was interested in making a move out of big corporate culture. I had been there for 18 years, I started when I was young, I was 20 years old when I started. I was 38 when I left and I was looking at the next chapter of my career. I was interested in going to maybe a smaller company doing something a little bit more entrepreneurial. I was familiar with private equity, because a lot of our suppliers had been acquired by private equity firms. And so it was an interesting concept. I’d never visited New York City before I went to my interview in December of 2006. So I ended up joining that firm in March of 2007. So I moved my family back to the US. New York based private equity firm was there, started as an operating professional on the operating team, working with their portfolio companies. And then over a 10 year career with them. Very similarly, I kind of learned the business from scratch, became the head of their operations team then became a managing director on the investment team and started leading transactions became a partner in their firm. And then, as a lot of private equity firms do as they start being more successful, their strategy started to shift and I started out they were doing distressed turned around, and then post the Great Recession, there weren’t a lot of turnarounds. So we kind of morphed into a good degrade industrial strategy. And then as they raised more capital with their third fund, they wanted to become more of a generalist value buying shop. And so I left with Scott Duncan, who was with me at Toyota Motor Corporation, Scott came up on the engineering side, and I came up on the manufacturing side. So he had worked with me for nine years at the prior firm. And then our other partner, Lauren Mulholland was on the transaction team side. And so we left and started Middle Ground in 2017, really, with the idea that we wanted to stay focused on industrial, that’s mine and Scott’s background, that’s where we had a lot of success in the deals that we lead, you know, in the time that we’ve been leading deals, we’ve never lost money on an industrial asset. So we’ve got a really good track record of, you know, buying companies really, you know, good companies, and then just making them better using some of the, you know, principles that that we’ve acquired through the years. And so, you know, so we started Middle Ground in May of 2018, really, with the idea of being focused North American headquartered, industrial, b2b and specialty distribution acquires really with an operations first principle, so with, you know, two of the three founding partners having deep operational backgrounds, it’s just a different way of kind of looking at the world. And, you know, a lot of investors want to, they do want to directly invest with operators. And so he gave us some differentiation, you know, in the market. So we look at industrial b2b specialty distribution, try to stay focused on the lower middle market, we look for good companies that historically have grown in line with their core markets, but that have really good products. So we try to stay away from commoditized products, we try to stay with, you know, highly engineered components, but we’re really looking you know, for a good business and how to make it better. And typically, what lines up well with us is a company that historically has grown and has good gross margins, but their net margins are really not what they need to be and there’s some opportunity some underperformance in the business. And we look at every line item of the p&l balance sheet when we go through and are working through our filtering of companies to develop something that we can value creation plan. And that’s really the big filter for us on how we select the types of businesses that we’re going to acquire.

Justin Fortier: Yeah, that’s really rare that somebody has that might be one of one starting on the production floor as a private equity firm founder. So I could definitely see how that that’s a pretty differentiated product for your limited partners at your firm in that value creation process, you’re bringing the operational background, what are some of the ways you typically are looking to improve your companies, once you buy them, I noticed that you seem to have adjusted some of the product portfolios across the companies you bought. Notably, it looked like there was some change in between plasmon and dura and Shiloh and Mendler How do you think about both operational improvement as well as using multiple acquisitions to build new companies?

John Stewart: Yeah, so you know, in so it’s a couple of ways one is, we touch every line item in the p&l and balance sheet through our value creation plan. So looking at working capital management, which, you know, the kind of just in time principle of Toyota manufacturing and, and in keeping low inventories and reducing waste out of the process are, you know, are able to use that to generate a lot of free cash flow at the businesses. And then on the p&l side, we’ve just, you know, over 15 years of investing in private equity, we’ve become really good at like, knowing how these individuals small facilities operate. And so, you know, typical facility be 50 million in revenue, you know, 100,000 150,000 square foot facility that if you’re driving up and down the highway, you see it numerous industrial parks, you know, across the Midwest, and in other areas. So there’s, there’s literally, you know, 1000s of opportunities out there for us. But you know, we’ve kind of refined the skill set, and so that we can identify these things prior to buy in the business. And we look for the things that we’re going to execute the things that our team has the capability to execute, to drive 25% or more of the return. And so what that does, is it reduces our reliance on debt. And so you know, a typical plain vanila private equity LBO sponsor is, you know, they’re gonna want to put 35 40% equity in the deal, and then finance the rest of it, you know, I’ve been doing this for 15 years, and the only way that you can really lose money by in, you know, heavy asset businesses, like industrial companies, is to put too much leverage on them, the chances I’m gonna buy a company that in five years that are products are gonna go out of favor with their customers is zero, it’s not gonna happen, and the chances that we’re bad operators, and we’re gonna run a company into the ground zero, it’s just not gonna happen, we’re, you know, we’re really good at what we do. So we try to like focus on reducing risk in these transactions by underwriting more of what we can do in the value creation plan as a way to create equity value, which takes pressure off us having to use leverage to create as much of the return, and so will typically put 5060. And we’ve done a couple of deals, the dura shot, the dura deal we did with 100%, equity at close in Shiloh, we did with 80% equity at close. And so you know, we’re, we’re because of our operational capability, we put a lot more equity to work in the business still underwrite to private equity, like returns, and create a lot of value, but also take a lot of risk out of the transaction. Because now, you know, with a very little debt on the business, there’s not a lot of things that can go wrong, that can that we can lose control of the business. And that’s, that’s really, you know, we have zero tolerance for zeros and Middle Ground. So, you know, we don’t want any of our portfolio companies, you know, had to hand the keys over to the banks. And so, you know, we self select away from that. So that’s part of our, like, core strategy is to look at all those items, about a third of our team are operating professionals like myself, people that have run facilities that are run operations. And so that’s one of the fundamental things that we do different than everybody else, a lot of private equity firms, you’ll have, you know, a VP or a director on the investment team that’s, you know, 27 28 29 30 years old, that’s leading the transaction and post closed, they’re on the board, they’re trying to, you know, give advice to the CEO and everything in the company, but they have no business experience, they have no practical experience for us, we don’t manage that. That way we manage differently, the people that are working, and given advice to the CEOs or people that have actually operated these companies in these facilities. And so it’s just a really different dynamic. Our CEOs look at our team as like a resource to help them to execute, and not you know, people that are just kind of like managing the numbers and you know, looking for explanation. And so from a core from an operational standpoint, we helped to build like excellence in everything that they do, so they can deliver on the commitments. And so if you can do that, then when you start to look at the commercial side of these business, where it’s whether it’s in the automotive, which we have done, you know, some investments in automotive or any other kind of industrial in market, what we do is we try to partner with management teams that are experts in the industry. And we’d like to say We’d like bringing a lot of expertise to the table, but we’re not the experts. So we try to hire and have management teams that are the experts in their given industry. And with all the reps that we have on looking at these companies and owning these companies, that are maybe our manufacturing, delivering the different end markets, we can actually help to optimize their ability to kind of like, you know, deliver on the commercial strategy for the business. And then we bring a tool that we use at Toyota called Hoshin Kanri, which is strategic planning to the table, and we teach the these teams how to think about the business and what it’s going to look like five or 10 years from now and how to position it. And as you mentioned, in the Dura transaction, you know, we really transformed that business, you know, when we bought the business, they were probably historically 60 to 75% of the business was mechanical cables. So you know, when you pull a hood release lever, there’s a cable that actuates the the latch out in the front, you pull the trunk, there’s a lever that does that, when you roll the windows up and down, you know, there’s so you have all these switches, you know, all in levers. So there’s all these cables, parking cables, and all kinds of different cables in the vehicle. And as the industry has moved to more electric actuated motors, a lot of those cables have become like less, the cars are less reliant on these cables, even like electric shifting, and electric, you know, actuated, brake pedals and, and fuel pedals, accelerators, and so forth. And so the business was seeing their cable business decline in when we bought the business, they just won a large contract with a large OEM to produce battery trays, for electric cars, but they had no experience producing these trays, they had three facilities that needed to be built in the depth of COVID, two in Europe and one in North America. And so we we bought the business, we closed the transaction with 100% equity, because we needed to invest $250 million over the next two years to build these one of a kind facilities. And then we got to work doing that. But we were able to have the vision to see what the business could be after those battery tray facilities were up and running, and how the mix change was going to be in the business. And so we started looking at how we could divest some of the non core assets, to generate cash flow to pay for the investments that needed to be made for the future of the business, and really positioned that business, you know, for the future. And so again, that’s a formula that we kind of are willing to go through. And there’s a lot of sweat equity that comes in that because there’s a lot of work that has to be done. And so you know, to look at a business that may be doing a billion dollars of revenue, and find this, you know, 300 or $400 million revenue pocket inside of it that’s really interesting and has like a real value to it. But then working with the rest of the business to kind of you know, clean it up, if you will, so that you can position the business so that, you know they’re using the cash flows from sometimes declining businesses in order to fund future operations.

Justin Fortier: Yeah, it sounds like you’re somewhat in a space that not many others can play in because they don’t have the same operational confidence that you do that when you go out and you make a five year plan that doesn’t just involve cost cutting, it involves reshaping a business through operations, you’re in a league of your own. I saw that Shiloh had a similar thing where you sold off your was it it’s Castlight business to Palatine. So yeah, selling off one part of the business to fund investment in future higher growth area. So that way, you don’t need to take on as much debt. And you can focus on using debt in the transaction. Or you can focus on maybe using debt or selling off a business to fund future expansion. Am I getting it right?

John Stewart: Yeah, exactly. That’s exactly in our code. I mean, sorry, Shiloh is a good example of that, you know, that was in the depths of the recession, I’m sorry, of COVID that we bought that business. What had happened is Shiloh was a public company that was doing about $95 million of EBITDA pre COVID, they had racked up over $500 million of debt, because they were a public company, and they were chasing revenues. So they had acquired a lot of casting assets that had a legacy in the industry of really being kind of problem, individual facilities. They had good revenue to them, and they even had good earnings. But it required a lot of CapEx to maintain those casting operations. And we had owned casting platform at our prior firms. So we’re very familiar with the assets. And when we acquired the business, you know, we were able to drive a lot of value just through the process of the bankruptcy. And you know, it’d be in the middle of COVID. And not a lot of people, you know, being able to pull off a transaction like that. But when we closed the transaction, we only close the deal with $41 million of debt and put 170 plus million dollars of equity to work in the transaction. And so here’s a business that was doing 95 million of EBITDA, that had declined about 40 million of EBIT da in the depths of COVID found itself 10 times levered, went through a bankruptcy process. And instead of using, we could have raised three or four times leverage on the asset if we wanted to, and it was still doing at the time, we closed the transaction, about 50 million of EBITDA, we didn’t go out and take all the debt that we could, because we were in the middle of COVID. And we didn’t know what was going to happen in the automotive field at that time. And we, you know, we didn’t want to put that pressure on the company. So we overreact monetize the deal. And we’re able to do that, because of the operational skill set that we brought to the table, and the things that we knew that we could do to drive value in the business. And that’s a great story for us, because we bought that business in November of 2020. And by April of 2021, we returned to to x on that 100 and $70 million dollar equity that we put in the deal. And so we sold off two non core divisions of the business, we sold off the Castlight division, and we sold off the blank light division to two strategics. And you know, through that, we returned, you know, almost twice as much as we had put into the business. And, and then once we got it kind of down to what we really liked, which was the stamping component of the business, which had really good free cash flow generation had been over and under invested in through the years. And then we sold off some non core assets of dura, we actually combined those two businesses into our new Shilo platform today, which is, you know, one of the leading providers of structural solutions, including battery trays for new electric vehicles, which there’s very few of those facilities in the world. And, and we’ve invested over $250 million building those new facilities over the last couple of years. So we’re really excited about that platform and its future for success.

Justin Fortier: Yeah, one of those is in Alabama, right?

John Stewart: Yeah. Yep. In Muscle Shoals, Alabama, we just opened a facility there. We have one in North Macedonia in Europe, and then in the Czech Republic.

Justin Fortier: Yeah, that’s interesting. What are some of the ways that you think that whether it’s public companies or other private equity backed companies, or I guess, in the rare case, a family owned business, that’s going to put it into your hands? What are some of the mistakes that you think operators are making running industrial businesses right now? It sounded like you said that for Shiloh, they were chasing revenue growth, because they were public company and using lots of debt for that, is that the primary way that that a business gets itself in a difficult position, despite it having a solid core that that would maybe make it that the right place for Middle Ground to maybe have an opportunity at in the future?

John Stewart: Yeah, so let me be clear, so we you know, those were two examples of companies that were in like stressful situations, we typically don’t do distress turned around. We’ll do like a bad balance sheet, but a good company. So positive EBIT, dot positive cashflow. So we’re not really like looking at like the real heavy turnarounds. But I can tell you, after 15 years of doing this, I’ve never bought a business where anybody were the owners, the CEOs, the CFOs, where they actually know where they make money. So you know, they, they may have the gross margins, and everybody manages to that, and they have their standard costs. But the company’s not operate to the standards, they haven’t rolled standards, in years, there’s millions of dollars of variances running through the p&l. And as long as the outcome at the bottom is acceptable, nobody’s really digging into the weeds in the detail. And so many times we’ll buy a company and we’ll find out that their largest customer is not profitable. So when you look at like the amount of overhead that’s focused on that customer, the number of meetings that they have, and all they do is talk about that customer’s needs and what they need. And it’s really causing all this disruption inside the organization. They’re, they’re doing it for a really narrow margins, because typically, their largest customer is really sophisticated, and they’re squeezing them. And so they have really narrow margins. And, you know, with fluctuations in material pricing with with the difficulty of obtaining labor today, with the, you know, the disruption in the supply chain, there’s all of these things that are going on, and nobody quantifies the cost of those and so your winners, which are probably some of the lower volume, the mid volume programs are, you know, covering all of the losses of the of the big customer, so they’re basically supplementing your largest, you know, customer and so that’s no way to run a business, but we you know, we dive in and you know, do product profitability analysis, and we, you know, we actually, like take those variances and we allocate them, you know, to each of the line items in the p&l and we help educate the management team. Once we take them through the process and we’re able to work with that with them, then yeah, they can make the right decisions like they know the right decisions to make but it’s having the sophistication And, you know, having the systems available to, to get to that level of degree of detail in the analytics to know, you know, where you’re actually making or losing money. Of course, once they kind of see the picture, then you know, they want to take action, and they’re able, for the most part to take action in those scenarios, but just teaching and making sure that the management team at the business really knows where their money is being made, and don’t get tricked, just because this customer gives you, you know, so much revenue, and, you know, all these different things into thinking that, you know, they’re, they’re a great customer, they’re a great customer, if you can, you know, make a profit and, and you can support your organization, that’s a great customer.

John Stewart: It’s not about gouging, the customer is not about anything about that, but it’s about being fair and doing business, you know, in a fair way. And so I think the biggest mistake I see people make is not understanding, like, where they actually make money in the business, where they’re where, where the cash flow is being generated, maybe that customer, you know, maybe they generate 50 or 75% of your EBIT, da, but they consume 100% of your CapEx, right? And so now, you know, you got to look at it based on what what good does it do to have somebody that generates $75 million of EBITDA, but, you know, has $50 million of CapEx, like it that, that free cash flow formula doesn’t work for anyone. So, you know, really understanding that and how to manage that situation, you know, that’s one of the areas, you know, we’ll we’ll tell the management teams, we have a lot of expertise, we’ve managed to do these things in the past, we work with very sophisticated customers and vendors. And you know, again, when you sit down with all the data and the facts, and you can sit down with your customer, and you can show them the facts in the data, and they’re not going to argue with you about that they’re probably one of the questions are probably wondering themselves is why weren’t you coming to us sooner, you know, with this as a problem. So I think that’s one of the, you know, biggest problems that we see, I think another problem that I see in the industry right now is people aren’t preparing for the labor shortage that is coming, you know, there’s a labor shortage in manufacturing right now. And, you know, our government’s you know, and I’m a big believer that we don’t wait on the government to solve our problems. You know, they’re just not capable, like they can’t even agree on, you know, like, anything for them up in Washington, like, let alone anything that matters for us here. And, you know, the working class. And so, you know, people that have, you know, positions of authority, leadership and business can make more of an impact than anyone can. And so, when you look at the labor situation, right now, it’s a pay prop, like, you know, in manufacturing, having people making the same amount of money, manufacturing a product are working at Taco Bell, it just doesn’t make sense and nothing against people that work at Taco Bell. But you know, asking you, if you want churros with your order, and operating the CNC machine requires a whole different, you know, skill set. And so we have a big initiative, we’re pushing internally to get the lowest wage in our portfolio to $25 an hour by 2025. And the way that we’re doing that is not just paying people more, but we’re actually using automation. And so looking at, you know, ways to automate these processes, you know, there’s probably, you know, in our portfolio alone, there’s probably 235 1000 applications were ever someone every day, all they do is load and unload a CNC machine. And that’s all they do is all day long. They’re unloading loading it the technology around 50 years to automate that. And so people look at like a payback analysis and say, Well, can we get a payback analysis? Well, there really is no payback analysis, if you can’t hire people to do the process. So you have to do it. And so this automation, this kind of wave of automation that needs to be happening right now in manufacturing, it’s going to be the differentiator between people that are addressing that issue. And looking at it head on today. And people that aren’t, because they’re not going to be able to get access to the labor, you’re not going to be able to infinitely kind of push, you know, the rising cost through to your customers without innovation and without doing these things. And so I think there’s like a big bubble that’s getting ready to come when the economy does start to take off again, and you start to see volume start to build and you start to see the supply chain be less disrupted, and the inventories returned to normal. You’re gonna see this massive labor shortage that nobody’s preparing for, and people are talking about the labor shortage today. But think about what that’s going to be five years from now. And if the business If your business isn’t preparing for that today, then you’re going to you’re going to be finding yourself in a real big mess.

Justin Fortier: Something we’ve seen a lot on our projects is, you’ve walked into the HR and they do describe that they’re they’re losing to the culvers or the zex fees down the road, which it is up to the business owner to be able to create a better opportunity for workers.

John Stewart: Yeah, I mean, think about it. So you got, you got you got three people that are running CNC machines, right? You’re paying them $15-$20 now, right? And you’re competing with zax fees and everybody else and you know, exactly as they don’t have to work from 11 o’clock at night till eight in the morning, right, they don’t work the third shift. And so of course, I’m gonna go work in zax fees If that’s the case, because again, that’s just an unsustainable system. But you got these three people making $20 an hour operating these CNC machines, well, there’s no reason that you need a person operate the CNC machine, the machine does all the work by itself, you just need someone to load and unload, maybe inspect the part. Well, there’s, there’s automation solutions for that today. And if you automate that process, probably that company is facing rising demand, but they just can’t hire the people. But you can probably still buy the CNC machines. So you now if you automate, and you get or one person can run three machines is not about laying the other two people off. It’s about using those other two people to buy six more CNC machines, and that use three people to generate nine times the revenue. And now you can afford, you know, you were paying $60 an hour for those three machines. Now you can raise the labor of $25 or $30 an hour, you can train that worker how to operate that automation and that equipment in that process. So you can increase your efficiency. And you can raise the wages of your employees, and you can train the employees, you know how to do a more skilled job. And so those are the things that we’re trying to teach our management teams. And if you’re going to be ready for that in 2025-2026 when this bubble I think is going to hit, you got to start planning for it. Now you start got to start addressing your standards. And right now there’s a huge backlog with companies that do automation. And so you know, we had a business called Alko. They make hydraulic hose fittings for hydraulic hoses, so we don’t make the hose we make the fitting. And for these products, we’re using different kinds of screw machines or CNC machines are high dramatic machine centers. And we had this one process that required seven operators and we were trying to automate it. It was going to year lead time to automate it, it’s going to cost $250,000. The cost wasn’t really the problem. But it was the timeframe to do it. Because everybody’s trying to use more automation. So we took the solution differently. Being operators, we started our own automation team. So right outside my headquarters here in Lexington, Kentucky, we have a 12,000 square foot fab shop. We hired Toyotas automation team. So we’ve got a group of nine engineers and fabricators that design our equipment in these solutions. And they went in and in three weeks and for $35,000, did a solution that eliminated seven workers. Now we weren’t we didn’t have to eliminate the workers. We just redeployed them because we needed them because our volumes are increasing. But again, it’s just another differentiator for us. I mean, I may be one of one of as far as private equity partners that started their career as an hourly employee. I definitely know we’re one of one when it comes to private equity firms that own their own machine shop and are making automation equipment that’s going into their facilities. So again, we’re breaking the mold kind of in every way. And because we’re so focused on just industrial businesses, we can get really knowledgeable about these businesses and we can develop our own solutions. And so our automation team is helping our companies. And our CEOs, they love our automation team and they wish that we had 90 people instead of nine, because of the type of work that they’re able to do in these facilities.

Justin Fortier: You answered the next question I was going to ask, which was about the system integrators, because that seems like it would be a bottleneck going forward. Some of the companies you’ve owned, maybe it was the Shiloh example that you already returned to AIX on that by selling off some of the divisions and growing. As I’m listening to you, it sounds like you’re really well positioned to support a number of businesses. How do you think about hold structure now that you’ve maybe are able to get some returns by sending off parts of the business, I imagined that the operators, the CEOs, the leadership, teams of your companies would be really disappointed to lose access to the Middle Ground Support Network during a sale process like most private equity firms? Do? I haven’t actually looked at your plans for exiting businesses, but I think this would be an interesting time to look at that.

John Stewart: Yeah. I mean, we still have to sell our businesses to generate returns for our LPs, but we do some education programs. So on a quarterly basis, we actually teach kind of lean manufacturing workshops at our portfolio companies and we’ve trained you know, hundreds of people across the facilities. We’ve got a team of resources that can do that training and so we’re trying to teach these businesses as well and then get the right leadership in place so that they can continue to do these things on their own. And so, we usually are very intense for the first kind of nine to eighteen months we own the business. And then during that time, we’re also trying to make sure they have the right leadership teams to keep these things going on an ongoing basis. And then, once we’re able to anniversary those results, and we’re able to continue to make improvements, what we really tried to do is, we try to let those businesses sustain themselves and then we start to look at, what are the strategic options. And so, it’s not always about exiting, sometimes, we can return capital, we can direct the transaction even more, take more money off the table, but we’re not afraid to double down. If it’s a good investment, and we can make more money by holding it, look, I got a fiduciary responsibility to maximize returns for my shareholders. So I got to look at what’s best for them, ultimately, and then the market right now where leverage is tight, and the leverage market is really tightening up. And so it makes things a little bit more challenging for some firms, we’ve been able to stay active. And we’re in the process of exiting two of our businesses right now. I would say, on average, we’re going to hold a business for about five years. Typically, we’re gonna look in the first, you know, 12 to 18 months, if there’s add on acquisitions that we need to do to diversify, if there’s non core assets, we need to sell in the business, if there’s new management teams, we need to bring in, if there’s things that we need to do, we’re going to try to do that heavy lifting in those first couple of years, then really positioned the business or the future, give the management team some runway to run, as far as winning new business and creating a nice backlog for kind of the newly established platform and kind of prove out the thesis for the business. And then once we’ve done that, then it’s time to take it to market and look for an opportunity to to realize in return.

Justin Fortier: For the businesses that haven’t been investing in automation, and are going to be surprised by that bubble you talked about where they’re really just not going to have a workforce or going to be forced to essentially raise wages until no profit. And then I’m not exactly sure what the implication is for that. What do you think will happen to those those businesses that either operationally efficient or or automating in the right way, a couple years from now, especially in something like automotive where there are established contracts with customers for multiple years already set up? How do you think those businesses will function? Will they just be unprofitable within larger companies? Or will there be a lot of opportunity for private equity firms that are able to do turnarounds?

John Stewart: Yeah, I mean, look, I think I think you’re gonna see, I think you’re gonna see, because of the current economy, I think you’re gonna see that happen, that it’s going to get forced the issue for some of them because of the tight liquidity markets, and the reliance that people have had on a lot of leverage in their transactions and the supply chain disruption. Now the recessionary environment that we’re in, all of these things are putting more pressure on these companies that the foreign exchange fluctuation, everybody thinks that a strong US dollar is a great thing, except when you’re a multinational corporation, and you got 60% of your sales in Europe or something like that. It causes a lot of issues and problems in these businesses. And sometimes, that’s just enough. When you look at the majority of kind of tier one and tier two automotive suppliers, especially the publicly traded ones, they’re operating that kind of sub 10% EBIDTA margins, that’s really slim. You know, I don’t want to own a business that like operates with 10% EBIT margins, that’s just not I’m not interested in that. And people are like, oh, that’s norm for the automotive industry. But no, it’s not I owned all kinds of assets that make 15%-20% EBITDA margins in the automotive space. I think the whole perspective has to change it at 10% EBITDA margins. You can’t afford to invest in CapEx, you can’t afford to have, leverage on the business, you can’t afford to do all of those things. So I think it’s really going to the access to liquidity is really going to rattle things. I think that’s even before the labor market issues start to hit the big challenge in the automotive industry that nobody’s talking about, there’s no articles on this. No one’s discussing it. I did an event for the Auto Show and one of the things I talked about, but all of these automakers and all these tier one suppliers, as the supply chain disruption has happened, and we’ve liquidated the inventory of finished vehicles in the market, and generated massive amounts of free cash flow. And what did those companies do with their free cash flow? They paid out massive dividends? Some of them did buybacks on stocks, they did all of these different things. Where’s all the capital going to come to replace all that inventory? Where’s it coming from? Nobody’s talking about it. I mean, think about the, the trillions of dollars, I estimate that it’s probably north of $1.5 trillion, to replace the finished goods inventory, back to the level, it was pre COVID, the normalized inventory levels where we’re used to, like, go into a car dealership, and are actually being cars that you can look at, like, right now you go to a car dealership, except for some of the people in the industry that aren’t doing so well, you go to a car dealership, there’s no cars, right? You can’t you can’t buy a car, but that’s not going to stay that way forever. The OEMs haven’t changed their model, I mean, the OEMs need the inventory, to so that they can manage the fluctuation in their manufacturing, right, because the peak demand doesn’t happen consistently throughout the year, more people buy, automobiles when the new models come out, and then through the spring in the summer season than they do in the fall in the winter, and so you’ve got to have that inventory to manage the fluctuations. Well, no one in the industry is even talking about how much capital is needed to replace that inventory. And that puts a lot of pressure on the OEMs. And on top of that, now they have this record requirement to invest in technology for electrification. So like, the the industry is like they’ve switched and like everybody’s going down the electrification pathway, almost whether people want the vehicles or not like everybody is going that direction, you watch the GM commercials, Ford, it’s all about their electric vehicles. Now, Chevrolet has the Eevee. And Chevrolet kind of highlighted, there’s been talks of spinning off the electric vehicle platform from the, from the internal combustion engine. And so but there’s massive amounts of money being invested in the technology around electrification, you also got the connected car, that’s next in the pipe where people are investing. And then after that, you got autonomous vehicles, which is kind of that trend is slightly reversed, it was kind of growing at double digits, now it’s down in the single digits. But that trend is going to continue. So you got the OEMs that have all these massive capital needs, they need inventory, they need these massive investments in new technology. And what are they going to do? Well, they have to partner with tier one suppliers that have good balance sheets that can afford to, to invest in and keep up with the technology shift. And so you’re not seeing that a lot. If you’d look at probably, I would say, if you look at 90% of the public, tier one, automotive suppliers, I would say that 75% or more of their revenue is coming from the internal combustion engine. And nothing is being done about changing that right now. Because the volumes on electric vehicles is still so small, it’s never it’s not going to replace, what’s coming in from internal combustion engines. And, and now people are having to use that cash because they relied on liquidity, they’re going to use a lot of that for interest expense for amortization payments, they’re still capex requirements to stay up with internal combustion engines. And so there’s this massive liquidity bubble. That’s going to happen even before we get to the labor problem that the original question was about, that the industry nobody’s talking about this. No one’s talking about, like, what where does this inventory come from? Like, whose balance sheet does that come from? Who can generate that much free cash flow to afford to put all of that inventory on their balance sheet? And like, no matter how healthy you are, it’s impossible to do that Tesla, with its like record valuation, they can’t produce them to put them in inventory anyway. So they have a whole different problem than the rest of the industry. But the rest of the industry can produce these vehicles. Once the supply chain clears up, but who’s going to fund the working capital build where that capital? Where’s it going to come from? That’s like a mystery question. I think that needs to get answered.

Justin Fortier: Yeah. So you were suggesting that there needs to be more investments from the tear wants to help support? Did I get that right?

John Stewart: Yeah. But the problem is, is there 10% EBIT margin businesses, I mean, the where’s the cash is gonna come from. For years, that you look at, I’m not gonna name names on here, but you can just go down through the tier ones, even the really well known multibillion dollar tier ones, they operate at razor thin margins, so 10% EBITDA margins, on a $100 million or $500 million or $2 billion in revenue, it’s not a lot to fund everything that needs to happen. I mean, you look at like dura is a good example, we bought the business doing about 900 million in revenue. And they were doing pre COVID about 90% 10% EBITDA margins. So that’s what they were doing. Well, they had to invest $250 million to build three facilities, just three facilities to service one OEM and one of the smaller OEMs, one of the European luxury OEMs, to service their battery tray production. Imagine the investment that’s needed to do it for the best selling vehicles on the road, you’re talking like massive amounts of capital that have to be invested in this like technology. And we’re still at the emerging landscape of electric vehicles, like, are we still going to use aluminum for battery trays? Are we going to be using extruded aluminum stamped aluminum? Are we going to be using cast aluminum? Are we going to be using steel, because some people are still looking at using steel is there gonna be some kind of composite materials, there’ll be some kind of plastic material like that, that all hasn’t worked its way out like the industry right now, everybody uses plastic fuel tanks. Right, so everybody used to use fuel fuel tanks, then it moved to plastic fuel tanks. Well, now we got this battery tray technology $250 million, just to build three facilities, dura would have never had the ability to do that without middle grounds intervention, and their customer would tell you the same thing, we were on a call with them. And they would tell you that there’s no way that they would have been successful in launching their Eevee program if we hadn’t stepped in, and had the ability to fund that $250 million to build those facilities. But in order to do that, we had to, we had to require certain things of that customer that the OEMs aren’t used to. So for example, we had to tell them, like, you have to commit to your volumes, like whatever the volumes are in the year, we have to recoup that CapEx, because we’re funding it for them in advance, we have to recoup that on an annual basis, no matter what your volumes are, at the beginning of the year, in January, you remember the big debacle with Volantis, where there had a purchasing they, they came out with their own terms and conditions. And they said, We’re not gonna guarantee volumes, we’re not gonna, we’re not gonna worry, you can’t hold us to our forecasts and all that kind of stuff in the industry, gave him the middle finger and said, Well, we won’t give you any parts, they’re not a significant enough player. And we were one of the people that did the same thing to him and said, Okay, well, if those are your terms and conditions, then we’re going to be exiting all your business. And then what did they do, they made a huge leadership change in the inside the organization, and now they’re trying to reverse the damage that was done, by that arrogance. And so the time of like, the, the automobile industry, the OEMs, having all the leverage in the industry from like, the 70s, and 80s, that’s gone. The the tier one suppliers that actually have the access to cash to invest in technology, they have all the leverage in the industry right now. Because the OEMs can’t fund this stuff on their own. It’s impossible.

Justin Fortier: Sounds like they’re the suppliers are also going to need outside financial partners.

John Stewart: Because as you mentioned, at the start of the interview, that a lot of the a lot of private equity firms that take the book, if it says Auto, and they just chuck it in the garbage, right, no, it’s a cyclical business, the automotive industry is a wonderful business, we’ve made wonderful returns, and all of our investments that we’ve made at my firm here, in our prior firm, in the automotive industry, you have to understand what you’re doing. And again, automotive isn’t all we do, it’s only about, probably 20% of our portfolio. But the automotive industry is a great business, what other industry do you get forecasts, a year in advance from your customers that tell you how much volume they’re gonna need and in have that, up every month. So you have this reliable forecast, I have businesses where we enter the month, and we don’t have any idea what our revenues gonna be for the month, because we literally are going to sell whatever it is at that time in the market. So I know at that business, I would love to have a year of visibility from our customers. And so, the automotive industry is a great industry to operate in, you have to know where to operate. And so one of the things that we did, that’s different than what we did at our prior firm, is we started to really investigate some of these areas where there are macro economic items going on in the global economy, the regional economy, the local economy, and seeing where These were, these are interesting areas where there’s opportunity, and there’s growth, and then finding out how to get access to that. So we don’t invest in just any automotive business today. So we did we hired a third party, we did this elaborate research over a 12 to 18 month period. And this was prior to everybody kind of getting on board with this. This was back in 2017-2018 that we did all this work, but we really landed around, we want to invest around electrification lightweighting, connected and autonomous vehicles. And so that’s where every investment we do has some of that element to it. And that’s why we’re kind of directing them in that future. So we’re trying to take the core legacy business, either sell it off to generate cash to fund these new initiatives, or use it as a kind of a renewable annuity of cash flow that is can be used to fund the the technology advances that the company needs, but they need to have products and technology that are already accepted by the customer in one of these four areas for us to invest in them. So we’re like really disciplined investors, we’re not just buying any asset, we were able to, to jump on the dura opportunity that went through a bankruptcy process and the Shiloh opportunity that went through a bankruptcy process, but we were able to dissect those businesses. And we were able to see like the bat, and without the battery tray business, we wouldn’t have bought dura, having that electrification shift in their business was one of the main drivers, the lightweighting angle at Shiloh was the main reason for plasmin, the lightweighting. A lot of the products now on electric cars, that used to have to be metal, because of the resistance to heat in the engine compartment or the exhaust can now be plastic products. And it takes a lot of weight of the vehicle, which makes an electric vehicle or a hybrid more fuel efficient. And so, in plasmons aligned with that, and they are growing their business in that way. So all of these businesses that we’ve acquired have some one or one of these four trends that kind of dominates, maybe not where the majority of revenue comes from today, but where the majority of revenue will come in the future at that business.

Justin Fortier: Yeah, it sounds like the industry will also need a businesses that get really good at operating those internal combustion engine businesses to be able to buy them off of the businesses like the ones you’ve owned, that are shutting them to invest in the future. So there are people doing that as well. One kind of final theme that I wanted to touch on is I know you came out of Toyota with a focus on just in time, I think this has been a last two years, it’s 2022 now and just in time has been difficult, it’s been very difficult with some global supply chains that have been built out. And then the synchronization has been very difficult. How do you see that reshaping, if at all over the next decade as you’re doing your 510 year strategic planning?

John Stewart: Well, short term, like this year, at the beginning of this year, we started holding more inventory than we need for the operations just to make sure that we weren’t having the supply chain disruptions. And I think a lot of people have been doing that. So I think there’s a short term pickup and I would call raw material and component inventory. And so I think, that’s going to still be the case, I think what you’ll see is, is that, the longer that we have to operate in this constrained environment, I think when we when it gets time to go back to kind of normal inventory levels, I think you’ll see the levels come down slightly. But I still think that, in order for us to operate with the demand that we need, especially in automotive, we need the car inventory out there for people to select from, I mean, it’s pretty bad out there, I just purchased a vehicle from Audi, and the stick window sticker had all these options on it. And then it had all these negatives that were they just like didn’t have the components for like, the, the kind of rear sensors for like the cruise control and everything. So the distance monitoring and the advanced cruise control, and they just deleted it off of the window sticker and ship the car without the products, the customers are gonna put up with that for a little bit, but they’re not going to put up with that forever. And so, you’re gonna need to see, these inventory levels kind of come back to normal levels over the next, three to five years. And it’s gonna take that long, I think before inventory levels, really get to that level without there being like a, something happening. And it could happen in the next 12 or 18 months where demand really gets tamped down. Because of the recessionary environment and the rising interest rates and fuel costs could really hamper demand, which could build up inventories that way. But it’s still going to require a lot of consumption of free cash flow, and that’s still going to cause a lot of stress out there. And so we’re being very opportunistic in these markets. We keep a list of public companies that we think that should be private in the automotive space, but also in the non automotive space. I think it’s a great opportunity to look for public to private transactions, take people away from the dependence on the public markets. If a company’s less than a billion dollars or even $2 billion of revenue, it really shouldn’t be a public company. It shouldn’t be a private business. And then with the influx of capital into the private markets that continues to grow. And as the private markets continue to do well, it continues to grow the portfolio for sponsors, and ultimately for the investors, the LPs, and then there’s more capital to redeploy. So I think you’re gonna see more capital available in the private markets. And I think you’re gonna see more public to private transactions. And really, the private markets are, even though they’re, I agree that there’s, there’s some issues with some of the valuations, in the private market space because of the amount of liquidity that’s available to private equity firms. But I think it’s more real, as far as value than what you see in the public markets, the things that go on the public markets, like, if you look at the Dow Jones Industrial, there’s not a lot of those businesses where the conventional model for, what a company is actually worth, where it actually works anymore. And so there’s so many things that drive the public markets that are that are really just people’s confidence in the brand than it is anything that directly tied to the results of the business.

Justin Fortier: Well, thank you very much for coming on the podcast. This is definitely a lot for our audience and leaders and future leaders to chew on. This has been really entertaining and educational for me. So thanks for sharing about your business and your experience. Appreciate right.

John Stewart: Thanks for having me on. Appreciate it.

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