M&A Activity: The Invisible 'Tuck-in' DealsApril 2013 By Erik Cagle, senior editor
Cronin expects more robust activity for the label, packaging and direct marketing services providers, as the market believes in the long-term potential of those segments. Generic print producers, meanwhile, will suffer as pricing pressures, extreme overcapacity, and union and pension obligations will make it harder to consummate a deal, he says.
Cronin notes that many of these owners do not grasp the rise and fall of their asset value, market conditions and industry perceptions. "Owners must move away from the 'build it and they will come' mentality and begin using resources to fund R&D efforts for new products and services," Cronin remarks. "Financing, a poor balance sheet, recent weak performances, older equipment and a lack of differentiators impacts a company's value and potential for a successful exit."
The M&A market can be one of feast or famine. Take Jim Cohen, executive vice president of mergers and acquisitions for Houston-based Consolidated Graphics (CGX), who characterizes the current state of industry transactions as "slow and ugly, with a smattering of attractive opportunities." Declining or recovering earnings, meager growth prospects, eroding gross margins and delayed capex moves are all continuing to cloud the M&A forecast.
"We will continue to see more of the same—distressed deals and smaller mergers of two drunks trying to prop each other up and a few healthy deals—for the next year," he says. "There will also be some healthy companies that will put their toes back in the water to test the M&A market. With each day that passes, owners will have more runway behind them that shows improved profitability from the recession dip, and this longer period of improving earnings will give buyers more confidence and make them more willing to make acquisitions."
There are other variables that could spark more transactions in the coming years. Cohen adds that some owners don't have confidence in the industry moving forward, while others cannot afford, or refuse to risk, investing in newer technologies like digital printing. It's a double-edged sword; he notes that the most attractive M&A candidates, the ones with the best cases to sell, are solutions providers that have already embraced newer technologies, made the necessary capex and kept their pricing up. Those still languishing in the same challenging verticals from 10 years ago will find it difficult to locate an enthusiastic buyer.
Cohen cautions that one mistake an owner sometimes commits is running the company as if he/she is going to sell it. Delaying capex, new technology and not reinvesting profits back in the business are tell-tale signs. Another mistake Cohen sees is growing top-line sales at the expense of profit margin, either through lowering prices or overpaying for tuck-in acquisitions.
"Another common mistake is entering the market to sell your business with unrealistic expectations relating to pricing," he notes. "Not only will this lead to disappointment, but it is very disruptive to any business to be on the market for a long period of time—especially if it doesn't have a happy ending."
One development in recent years has been the emphasis on infrastructure assets, according to John Hyde, senior vice president of the National Association for Printing Leadership (NAPL), who heads the association's mergers and acquisitions advisory team. He cites the example of acquiring a company that is geographically "just far enough" and "just close enough" to warrant a partial consolidation. "The concept is that the target would be viable financially on its own and it would also feed the mother ship," he remarks.
Hyde has witnessed an uptick in "healthy" M&A where there is sufficient cash at closing to make it worthwhile for shareholders, not just for the seller's creditors. It's a trend that goes back to 2011, though he stops short of saying there is a robust market for entities sold as a going concern.
Hyde notes there are many family-owned businesses still dominating the landscape, companies that face unique challenges as they seek to transition ownership. It's not unusual for firms to suffer from poor communication between family members and business partners, which can lead to missed opportunities.
New Direction Partners, an M&A advisory firm, has witnessed a "fairly robust" M&A market in the past 12 months, notes Peter Schaefer, partner. He's seen an increase in buyers willing to pay cash for healthy businesses, a welcome diversion from the recent period when buyers were highly risk adverse and fearful of overpaying in an economy that could bottom out further. Those concerns have been allayed.
"There also remains a strong market for tuck-in opportunities," he says. "These are smart, low-risk opportunities for a buyer to fill up his/her existing capacity by purchasing a book of business. From the seller's perspective, this structure is not as attractive as all-cash at closing, but it at least enables the seller to get more than liquidation value for a struggling business. Depending upon a company's specialty, size and profitability (or lack thereof), this may still be the only option for a seller."
Buyers like being able to pick and choose from the available equipment, he notes, and paying for revenues successfully transitioned, while sellers find the royalty rate alone makes it more attractive than an outright liquidation. It can protect the jobs of many employees, while enabling the seller to get a higher price if revenues return to normal levels, he points out.
Schaefer admonishes prospective sellers to not halt investments in their companies, and points out that buyers will rightfully reduce their offer if there is a need for material capital expenditures. "It's critical for a seller to continue running the business as if a transaction isn't going to happen until the day of closing," he adds. "This is a distracting process and an owner cannot afford to be marginalized if a transaction doesn't occur." PI