Reilly/Schaefer on M&A Directions: A Question of Business Values

As we discussed in the first installment of this series, the pace of mergers and acquisitions among printing and packaging firms finally is on the rise after years of languishing in the doldrums. That means there's heightened interest in finding out what companies are worth and in determining what kinds of deals can be structured around these valuations.

Whether a company is sold as a going concern or as a tuck-in, valuation usually will be based either on a multiple of EBITDA (earnings before interest, tax, depreciation and amortization) or on net value of assets. These methods are the norm, not just in printing, but in most other "mature" industries, as well.

Generally speaking, multiple of EBITDA will be the method for profitable businesses and net value of assets the alternative for businesses that are not as profitable or are rich in assets. Whichever is used, buyers like the results from both methods to be comparable. Why? Because if one is greater than the other, the difference could raise questions about the viability of the deal.

Seeing net value of assets exceed the value established by multiple of EBITDA, the buyer may wonder whether the business will generate enough future profit to justify the purchase price. If multiple of EBITDA is ahead of net value of assets, accounting rules about goodwill (the difference between the purchase price and the fair market value of the net assets) may force a future write-down known as "impairment."

All Else (Not) Being Equal

Most of the time, a buyer wants valuation to be driven by profitability, not by value of assets. But because the objective of any transaction ultimately is to increase shareholder value, the profitability of both parties enters into the calculation. ("Shareholder value" is different from "enterprise value," a definition that excludes cash and debt. Shareholder value reflects both.)

No shareholder value is created when a company buys another company at a higher multiple of EBITDA than the buyer could command if it were the one being purchased. This is why New Direction Partners recommends that its buyer clients set a walk-away price by keeping at least a one-point spread in their favor between their EBITDA multiples and those of the companies they have targeted for acquisition.

We are frequently asked, "What drives EBITDA multiples?" Two factors drive EBITDA multiples. Anticipated future earnings is the major driver of multiples. The higher growth segments enjoy higher multiples. Commercial printers that are not growing may have a multiple of 4; packaging firms in growing segments may have a multiple of 6 or even more. Most buyers look at historical growth rates as the best predictor of future growth rates.

The other driver of EBITDA multiples is size. The larger the deal, the greater the interest in the transaction and the larger the multiple. Transactions based on $3 million or more in EBITDA see an increase of 0.5X to 1.0X multiple. Transactions based on $10 million or more in EBITDA see an increase of over 1.0X multiple.

A valuation based on sale of assets begins with an appraisal of everything that represents value: primarily, accounts receivable, inventory, and plant and equipment. Next comes determination of goodwill—the portion of the selling price over and above the value of the assets. Although New Direction Partners typically doesn't ask sellers for asset appraisal in multiple-of-EBITDA transactions for its buyer clients, a buyer's lender may insist on the procedure anyway even though the deal is not to be asset-based.

Frequently, the effective or implied EBITDA multiple of a net asset valuation is above 10. These sort of situations usually are the source of the rumors you hear about wildly attractive EBITDA multiples. But, they're misleading because, in reality, an unprofitable company being valued strictly on the basis of its assets has little or no EBITDA to multiply. The value of the assets, being so much greater than actual EBITDA, creates the false impression that the multiple is astronomical.

Net value of assets is the valuation method most commonly used for tuck-ins. In the years immediately following the downturn of 2008, however, it applied to most types of deals—a reflection of the depressed state of the M&A market at the time. Today, the vast majority of transactions we handle for packaging companies are EBITDA-based. Our commercial printing deals are about evenly split between the two. Overall, with economic conditions improved and buyers more optimistic, the industry has returned to multiple-of-EBITDA as its preferred structure for M&As.

Theory of Universal Attraction

If you're thinking about a transaction of your own, the need for accurate valuation will be obvious. But, no matter what your present plans, the broader point of valuation is that it gives you a handle on the attractiveness of your business in the M&A marketplace. We say "attractiveness" because New Direction Partners believes that no printing business, regardless of its financial condition, should ever think of closing its doors in bankruptcy or liquidation if it has customer relationships that can be quantified.

To arrive at the correct selling price for your business, you must first be clear about what you are selling. Although the name and the reputation of your business are meaningful to buyers, what primarily interests them is the future potential of your customer base. Our advice to clients is that if you've properly reckoned the value of these relationships, someone, somewhere will want to acquire them from you in a deal that will serve you better than just walking away from everything that you have created.

Even if you are not in this frame of mind now, you may find it useful to begin thinking about the valuation method you would use in preparation for a sale. Remember that in today's industry, every printing company is a potential candidate for the buyer's or the seller's role in an M&A transaction. Consultation with a qualified M&A advisor can bring your options into focus.PI

About the Authors

Paul Reilly and Peter Schaefer are partners in New Direction Partners (NDP), the leading provider of advisory services for printing and packaging firms seeking growth and opportunity through mergers and acquisitions. NDP assists its clients by giving them expert guidance and peace of mind at every stage of the process of buying or selling a printing or packaging company. Services include representing selling shareholders; acquisition searches; valuation; capital formation and financing; and strategic planning. NDP's partners have participated in more than 300 mergers and acquisitions since 1979. Collectively they possess over 200 years of industry experience with transactions in aggregate exceeding $2 billion. For information, e-mail info@newdirectionpartners.com

1Before Federal and State income tax on proceeds and before transaction expenses.

2Value is normally paid over time (2-4 years) and a function of sales actually transferred to buyer.

3Before Federal and State income tax on proceeds and before transaction expenses.

CONSIDERATIONS FOR BUYERS

• Do not overpay—purchase price as a function of acquired EBITDA, including synergies, should be 1x less than the buyer's EBITDA multiple.
• Purchase price paid in excess of underlying net purchased assets is recorded to goodwill and under today's accounting rules is subject to an impairment write-off.
• In some markets, acquisition is the most efficient way to grow sales.

CONSIDERATIONS FOR SELLERS

• Future cash that can be generated from your customer base drives value.
• Prefer to be sold under the EBITDA valuation method.
• Never close doors—your firm always has more value in a sale than in being liquidated.