by Luis Miguel Ochoa Comments (9)

Transaction Advisory Services: Industrial Products – Got Working Capital?

Transaction Services - Industrials

If investment banking and management consulting had a baby, it might just be transaction services.

You do plenty of analytical work, but you also get insight into companies’ operations that you’d never gain from working with high-level spreadsheets all day.

And hey, you can even apply “structured frameworks” to solve problems.

Our interviewee today works in the industrial products team at a Big 4 firm’s Transaction Services (AKA Transaction Advisory Services) department, and he can tell you all about:

  • What it takes to break in
  • Why you’d want to work there
  • And why the work itself may be more interesting than what you find in traditional IB roles

The Lay of the Industrial Landscape

Q: Why did you choose Transaction Services rather than management consulting or investment banking?

A: Like a lot of my classmates from my undergrad, I was interested in roles that give you the chance to work with senior-level leadership, “big picture” focus, and broad assignments – management consulting, investment banking, and corporate finance rotational programs all fall into that category.

But I liked Transaction Services more than IB because you go into more depth with the analysis, and you get to know a company’s operational side better; plus, you skip a lot of repetitive work, such as pitch books and revising presentations 78 times.

At the same time, the role is more numbers-oriented than strategy or management consulting, which appealed to me quite a bit.

Recruiting for IB and Transaction Services was quite similar, with a heavy focus on accounting and valuation in both, so it was reasonable to pursue both roles at the same time.

Q: And how is your department organized?

A: My group is called “Industrial Products” (example from PwC right here).

Unlike an industrials coverage group, we’re pretty much all product-focused: assurance, advisory, and tax.

As part of the transactions services team, we focus on advisory.

The companies we work with are in the aerospace & defense, business / professional services, chemicals, engineering & construction, paper & packaging, manufacturing, metals & mining, and transportation and logistics industries.

Q: And what do you need to get in?

A: Obviously, you need basic accounting, spreadsheet, and presentation skills, but charisma should also be on the list.

A lot of people assume that you don’t need “soft skills” in a more analytical role, but that’s wrong: you still need to be able to have a conversation with anyone, create rapport, and develop the relationship because you often work with other groups at the firm.

Plus, you get more client interaction than an IB analyst would, so you have to be comfortable with speaking to clients and answering their questions.

Q: A lot of people want to get into Transaction Services as a steppingstone to IB or M&A – what advice do you have for them?

A: It can be a good approach, but a lot of people don’t take recruiting seriously.

People who miss this step end up in audit or non-TS roles for a long, long time.

I have seen too many people knock on my peers’ doors asking for coffee chats, informational interviews, and time on the phone, all without exercising empathy.

People have regular day jobs they need to focus on, and recruiting is typically the last thing on anyone’s mind – so if you approach our group and can’t add value by sharing insights or articles that might be of interest, your chances aren’t great.

Lack of persistence and lack of follow-up are other reasons why few people transition into our group – I guarantee that someone will quit or will get laid off, so it’s only a matter of time before a spot opens up.

This is why you can’t just start networking with our group before internal recruiting begins.

You have to start long in advance, stay in touch episodically, and be willing to wait for the right opportunity.

Adding Value, Getting Hired, and Putting on Your Technical Hat

Q: How does your team add value to a company’s operations?

Why would a company hire a transaction services team in the first place?

A: Because we translate financial analysis into operational recommendations.

We might look at a company’s use of human capital or its inventory level, and then recommend a different approach based on that (e.g., purchase more or less inventory in advance or change the timing in some way).

Acquirers (the “Advisory Services” part) often hire us to do a deep dive on acquisition targets and make sure there’s no huge red flag that will cause their earnings to plummet by 50% after the deal closes.

There are some broader tasks like “Tell us about this sector,” but for the most part we’re more detail-oriented and financially/operationally-linked than other professionals.

Q: Where do clients come from?

A: Unlike in banking, you hardly do any pitching as a junior here.

The senior relationship managers bring in clients through their respective networks, and they develop those relationships in the same way that MDs at banks develop their relationships: via meetings and calls over years or decades.

Mind share is important here.

Q: So let’s say a client hires you – what types of tasks would you perform?

A: Often, a hedge fund, private equity firm, or other financial sponsor wants to explore a sector.

Rather than providing a list of acquisition opportunities or company profiles (read: one-page or two-page summaries), our coverage team provides something “higher level.”

For example, we might compare the performance of various industrial sectors to the country’s GDP or show which sectors experience the most volatility.

It’s sort of like the “various indices against the S&P 500” analysis you see in banking, but focused on economic output rather than stock prices.

Meanwhile, “normal” companies might hire us to do a standalone analysis of their operations or financial performance.

Acquirers might hire us to do that deep dive on an acquisition target, like what I just described.

Q: So what sorts of technical assignments should you expect as an analyst or as an associate?

A: Sure… the most common analysis we do is called Quality of Earnings.

The idea is to see how much Net Income changed as a result of revenue growth and cost reduction, rather than other factors such as a movement in inventory prices or the valuation of line items within Current Assets.

So, for example, if a company’s Net Income is up by 50% but that’s mostly due to a fluctuation in inventory prices and cost-cutting measures that just took effect in the most recent quarter, that type of increase is not sustainable in the long-term.

Borrowing the definition from The CFA Institute, “High-Quality” Earnings means that they:

  • Reflect current operating performance – Predictability and persistence (“one-time charges” are suspicious) are key.
  • Act as a good indicator of future operating performance – For example, some people believe that a company’s Net Income can predict its future cash flows better than its previous free cash flows, under the argument that Net Income is “less volatile.”
  • Represent the firm’s intrinsic value on an annual basis – If a company provides an annual figure that reflects both operations and future performance, you should ideally be able to divide this by its cost of capital to estimate its value. If these figures are very far apart, something may be wrong.

The “Quality of Earnings” is influenced by:

  • Sector: Does the company depend on winning long-term customer contracts that may be highly contested (aerospace and defense)? Does it depend on constantly coming up with new, innovative drugs (healthcare)? Or does it have a monopoly where customers are locked in for a very long time?
  • Vintage: Similar to how valuations produced by comparable companies rise during market expansions, a company’s Net Income may also rise due to increased demand in the overall economy. Of course, this is more due to timing and less due to the company’s own ability to generate revenue.
  • Life Cycle (ex: start-up, early stage, expansion, mature company, declining company): It’s much harder to assess start-up and early stage companies, and even those firms in “expansion” mode, since operations and business models are subject to change.

Q: Great. So how do you actually measure the quality of earnings using specific metrics?

A: You can start with metrics like the Return on Equity (ROE) and the Return on Assets (ROA).

To learn more about these metrics, please see our tutorial on ROIC vs ROE and ROE vs ROA.

Another tool we use is the Accruals Ratio, often defined as: Change in Invested Capital / Average Invested Capital.

Where Invested Capital = Total Shareholders’ Equity + Total Debt – Cash & Cash-Equivalents.

A high ratio reflects a company’s greater use of accruals, and also represents how much discretion management exercises over the presentation of Net Income.

So we investigate this relationship and see how much, for example, a company’s earnings depend on Accrued Expenses or Accounts Payable and making supplier purchases on credit.

We also look at a lot of Working Capital items and see why Working Capital or Operating Working Capital (Current Assets Excluding Cash & Cash-Equivalents – Current Liabilities Excluding Debt) is rising or falling.

So you look at metrics like Inventory Turnover, Receivable Days, Payable Days, as a part of this and dig into the reasons why it’s changing.

Then you might go a step further and look at the underlying contracts and see if the company is representing its purchasing/collection decisions appropriately.

Based on this, you might come up with recommendations such as:

  • Increase marketing and distribution spending to reduce the time required to sell inventory.
  • Renegotiate with suppliers to delay payments.

You’ll also have to pin-point the probability of a company making or breaking its working capital target.

This affects how management is compensated and incentivized, and it also makes an impact on the company’s valuation since working capital directly impacts free cash flow.

Finally, you’ll often dig into debt-like items such as leases, assess their impact on the financial statements, and determine whether or not operating leases need to be converted into finance leases (now only relevant under U.S. GAAP since they’re treated the same way under IFRS).

For more on all this, please see our full tutorial to lease accounting.

Q: Great, thanks for sharing all that.

Any other technical elements that might be useful for our readers?

A: There is a widely used accounting formula known as the DuPont Analysis, which captures the relationship between effectiveness, efficiency, leverage, and the Return on Equity (ROE).

Here’s the basic idea:

+ Effectiveness = Net Profit Margin = Net Income / Revenue

× Efficiency = Total Asset Turnover = Revenue / Average Total Assets

× Financial Leverage = Average Total Assets / Average Shareholders’ Equity

= Return on Equity = Net Income / Average Shareholders’ Equity

So you assess how much the firm’s ROE is being driven by its “operational effectiveness” (net profit margin) vs. its “efficiency in using assets” vs. how much leverage it is using.

Ideally, you want the first two to drive most of the ROE since firms can only be levered so much.

Q: That covers quite a few aspects that are important to transaction services as a whole.

But what about items specific to the industrial products group?

A: Industrial Products covers quite a few areas, but the main financial metrics to watch for include:

  • Capital Intensity: Revenue / Fixed Assets: The more capital-intense a company’s operations are, the lower this ratio is.
  • Book-to-Bill: How quickly is a company replacing its current orders with future orders.
  • Capital Expenditures / Depreciation: This shows whether a company is expanding its fixed assets (the ratio would be greater than 1), maintaining them (the ratio is close to 1), or depleting them (a ratio lower than 1).

There’s a really good article here that lists other important manufacturing-related metrics; a few that we look at include:

  • Equipment capacity utilization
  • Manufacturing cycle time
  • Customer fill rate or on-time delivery rate
  • Total cost per unit (excluding materials)
  • Manufacturing costs as a percentage of revenue
  • Energy cost per unit produced

Epicor also published a great report on the major manufacturing metrics, which you can sign up for here.

Escaping the Service

Q: Where do transaction services professional turn to after completing their time in this group?

A: Most people in my group turn to business school, double up and get a CFA, pursue a role in corporate development, or go for a role that focuses on internal due diligence.

You do see people go into IB/PE as well, but that’s probably less common than those other alternatives, at least in the US.

Q: Where should you go to learn more about the industrial products group at the various Big 4 firms?

A: Take the same approach you would in an investment banking coverage team interview – know the sector, know the key metrics, and have in mind a few deals to discuss.

And start by reviewing your firm’s publications on the sector (a few examples below):

Q: Great, thanks for your time!

A: My pleasure.

M&I - Luis

About the Author

Luis Miguel Ochoa has facilitated a variety of strategic initiatives from corporate acquisitions to new market development. He earned his B.A. in economics from Stanford University where he was a member of the varsity fencing team.

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  1. I must point out that this is very different from what I do in TS services in Europe. Our job is as follows: 1) making IFRS adjustments, 2) proposing normalizations, 3) identifying risks for a transaction, 4) analyzing financial and operational data. Consulting-like assignments are less common.

  2. Hey Brian, just to expand on ways to break into TS at big 4, other than working at the big 4 in a rotational program what other work experiences would beneficial?

    1. Consulting, independent valuation firm, corporate banking, credit analysis, accounting, corporate finance…

  3. Hi,
    I would like to know more about the exit ops of the ts people, for example what exactly is about corporate development and internal dd? And is the experience of working in ts adding value to the application to b-schools? Where do ts people go after b-schools? Is it still IB and PE?

    1. Yes, corporate development and internal due diligence are common paths. A previous interviewee actually did that and went from TS to corp dev at a financial institution:

      The experience translates well to corp dev since you use a lot of the same skills and understand how to be very critical of a potential acquisition.

      It would be tougher to move into an IB/PE/HF role from this group, but it is possible if you have the right experience and match exactly what the firm is looking for. One issue is that a lot of bankers don’t value Big 4 experience or take it seriously (mostly because they’re ignorant of what it requires).

      Yes, TS helps for business school applications as long as you’re at one of the Big 4… it wouldn’t add as much elsewhere. After business school, a lot of people will just go back to their firms but at a higher level, or possibly move into corporate development/finance roles. IB and PE are tough unless you have gone from TS to the internal bank at the Big 4 firm, because they almost always want to see transaction experience working on entire deals, not just the due diligence aspect.

  4. Hi..
    What you described appears as a ‘due diligence’. Would it be possible for the interviewee to share a draft on how such reports look like? Thanks!

    1. Yes, it’s basically due diligence. The interviewee can’t share internal documents because they’re confidential, but I’ll see if there’s some other draft or example out there of what these reports look like. You might be able to find examples on Scribd or Docstoc if you search for specific deals or companies there.

  5. Hi,

    I was wondering: how early can you get into transaction services?
    I often hear that it’s not possible to enter those groups right out of college as they require prior experience. Is it true?
    As far as I know, some BIG 4 offer rotational programs as an Audit Staff member in which you work on Transaction Services projects, but not full-time entry roles in Transaction Services.

    Thank you.

    1. It is possible to get in at the entry-level (a previous interviewee was an intern and then won a full-time offer), but yes, more often they require some type of prior experience. So unless you do an internship at a Big 4 firm first and then move to TS directly from that, or continue within TS, you probably need some type of other full-time experience first.

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