M&A Activity -- Expect a Surge in Mergers
By Harris DeWese
Another wave of merger and acquisition activity is mounting in the printing industry. Soon it will sweep across the industry as never before. It began mid-year 2003 and is likely to continue for several years. This new era of consolidation will be of greater magnitude than previous periods. It will have a different impetus and many new characteristics.
This surge is enabled by an improving economy, continuing low interest rates, buyers' pent-up demand for external growth, the difficulty associated with organic growth in printing and the catalytic effect of a handful of recent mega-deals.
This new period of consolidation will be driven by the industry's inexorable drive to dramatically shrink capacity; the vital need to manage and control fixed and variable expenses; the related need to improve profit margins; the increasing demands of digital and variable data technology; and smaller printers' attempts to survive as they face more intense competition from their larger and more efficient competitors that have broader offerings.
Printing will be an exciting place to be for the next several years. It will create soaring wealth and enormous satisfaction for some, but debilitating despair for others.
The next few years will feature more deals among the top 50 largest printing companies. These mega-deals have already begun with the Moore Corp. purchase of Wallace; the subsequent announced deal for RR Donnelley to buy the new Moore-Wallace; and Von Hoffmann's purchase of The Lehigh Press. In these three deals more than $3.7 billion in print sales changed hands—more sales than changed hands, for example, than during the entire year in 1997.
More Local Mergers Out of "Necessity"
Small, privately held local and regional printing companies will begin to merge at an unprecedented pace. This phenomenon was spurred by the 2000-2002 weak economy coupled with the tragedy of 9/11, which devastated the balance sheets and income statements of thousands of smaller printers. These deals truly shrink capacity because they usually involve larger and better financed companies acquiring the sales and selected assets of smaller and weaker competitors, whose plants will be shut down and whose equipment will be mothballed or sold abroad.
Specialty Printers Aggressively Pursue External Growth
Specialty printers, including all types of label, direct mail, flexible packaging, wide-format, P.O.P., forms and variable imaging/digital printing companies, will aggressively seek growth and greater efficiency in their existing and closely related markets.
Private Equity Billions Will Chase After Promising Printing Segments
The massive overhang of high-yield investment dollars held by and available to private equity firms, venture capital firms and merchant banks has already begun to chase promising targets in the printing industry. These bankrolls had built up during the slow 2000-02 period and there is an urgency to get these funds invested.
The acquisition of the Sheridan Group by two private equity groups and the recently announced transaction to acquire and privatize publicly traded Workflow Management by Perseus and The Renaissance Group are examples of more to come.
Resumption of Consolidator M&A Activity Is More Defined
Consolidators in the 1990s, like Consolidated Graphics, Mail-Well, Schawk, Quebecor World and Taylor Corp., have expressed a more guarded and defined willingness to resume their external growth by acquiring desirable targets in specific geographies. These deals will be aimed at strengthening existing plants through "tuck-in" acquisitions, increasing penetration into desirable locales, building market share in desirable specialties and building national account capabilities. It could also result in "trades" among these large companies with multi-plant holdings. These trades will enable the consolidators to beef up market share in their present markets by trading away plants in markets where they have a smaller, unprofitable presence.
The consolidator activity will be much more selective than the earlier "growth for the sake of growth" transactions that occurred in the mid to late '90s.
It will also feature a much more disciplined approach to deal valuations. These buyers will use more exotic valuation models and there will be less aggressive competitive bidding for desirable targets.
Small Printers Will Unite in Buying Groups or Roll-ups
Printing companies in the $500,000 to $10 million annual revenue range will either become targets for "franchise" type branding roll-ups or join and form huge buying groups. This new phenomenon will evolve as a Darwinian reaction to competitive pressures. This new form of consolidation, like the others, will be driven by the overall printing market's need to find equilibrium by equalizing supply and demand.
The end game is to match press capacity with the needs of print buyers to adjust price levels to obtain more desirable profit margins. Most capital expenditures during this era will be for faster, high-capacity equipment to replace older, slow, unproductive equipment. Mail-Well announced, in its recent quarterly earnings report, its intention to spend $25 million during 2004 mostly for new presses that can replace two older presses. This capex strategy, of course, reduces variable expense by eliminating factory labor.
Bankruptcies and Liquidations Will Be at Record Levels
In addition to the five previous M&A related initiatives, many reactionary and indecisive printing company owners will file for bankruptcy protection or liquidate—either voluntarily or involuntarily—at unprecedented rates. This type of consolidation permanently eliminates capacity and leaves lenders with devalued and unneeded collateral.
Expect to See Some Dramatic Consolidation Activity
I estimate that the 2004-2009 consolidation era will see more than $30 billion in aggregate print sales change hands. Buyers will pay more than $20 billion to acquire these revenues. Overall, I expect 3,000 to 5,000 printing companies to disappear and thus shrink approximately 30,000 press cylinders and about 15 percent of the jobs out of the market. This will occur despite overall print demand increasing at rates of 4 percent to 7 percent annually.
This kind of dynamic future raises many questions for printing company shareholders and managers.
The Important Questions to Ask
"How will the mega-deals and hence mega-companies affect my company and the market(s) I serve?"
"Will I be a buyer, seller or a liquidator?"
"If I'm a buyer, what, how and when do I buy?"
"If I'm a seller, will any buyers be interested? How do I prepare my company for sale and how do I obtain the maximum value?"
"If I'm headed for an inevitable liquidation, when is the right time and how do I help to preserve my personal wealth?"
The remainder of this article is a primer for small- and medium-size printing company owners and managers. It is intended to acquaint you with the language, practices and mathematics of consolidation in the printing industry.
The M&A Transaction Process
The majority of companies acquired in the coming new wave of M&A deals will be taken to market. The owners of these companies will consciously decide to sell the company. In these cases, the owners will either decide to "do it themselves" or retain a lawyer, accountant, business broker, M&A firm or investment banker to market their company.
There will be a handful of occasions where a strategic buyer targets a competitor or a strategically desirable company and comes courting. "Strategic Buyers" are essentially other printing companies. They are contrasted to "Financial Buyers," which are companies or individuals who buy for the purpose of building and operating a company for the short term, but principally for the purpose of obtaining an extraordinary return on investment when the company is resold.
These buyer-initiated overtures will mostly be limited to the mega-deal and strategic buyer categories. There will be some occasions where a local or regional company CEO—recognizing weakness or desirability in a competitor—will pick up the phone and ask to "have lunch." Targets that respond positively to these overtures will need immediate valuation advice and prepare an information package for the buyer.
Do it Myself or Hire Outside Help?
Owners who decide to sell must decide whether or not to manage the sale process themselves or hire an outside firm to do the work. This decision often is made based on the size of the company, management's financial expertise, management's M&A expertise, the need for internal confidentiality, what the company can afford and the amount of management disruption arising from the complex activities associated with selling a company.
These proactive sellers must then develop or cause their representative to develop an information package, either in the form of an Offering Memorandum (aka Descriptive Memorandum) or a less desirable package of financial and operational documents, which describe their companies.
This information, whether formally or informally prepared, must contain outside accountants' compiled, reviewed or audited statements for, at a minimum, the past three years; an internally prepared, year-to-date balance sheet and income statement; a schedule of fixed assets and accumulated depreciation; and other documents that describe the customer base, sales effort, operations and management.
Who Are My Most Likely Buyers?
The next step requires the preparation of a buyer list appropriate for the transaction. A local, $2 million, general commercial sheetfed printer, for example, would not list RR Donnelley as a potential buyer. Donnelley is a multibillion dollar, international printing company and, although someone at its Chicago headquarters might be gracious, its M&A department wouldn't be interested.
The small local printer's buyer list should include larger local competitors and, if known, any print salespeople or local competitor's managers interested in owning their own company.
Do not overlook the managers in your company as potential buyers in a Management Buyout (MB0) or the possibility that your employees can buy out your shares in an Employee Stock Ownership Plan (ESOP).
Whatever your category, the preparation of a buyer list must be selective and specific to your company. A massive shotgun solicitation wastes time and can create problems associated with confidentiality and rumors.
What Is My Company Really Worth?
Sellers must develop a reasonable and obtainable expectation for the value they will receive for their company. Prices determined solely in the minds of the selling shareholders are frequently subjective, biased and unrealistically high.
Often sellers falsely "hope" that buyers will pay for their sweat equity, some mysterious value associated with a misunderstanding of goodwill or their company's future performance. This mindset can be, "Well, we've lost money for the past five years, but now we're poised for enormous growth and profits." Buyers are not willing to pay for future performance.
Profitable Company Valuations
Sellers are best served by seeking a professionally prepared market valuation for their company. These valuations, among other things, will be based on current market conditions and prices paid in comparable transactions.
A professionally prepared valuation will also examine the valuations placed on selected publicly traded printing companies. It will use capitalized earnings analysis to estimate the value of the seller's company by capitalizing current earnings (usually the trailing 12 months). The valuation will also seek to "normalize" earnings by adding back to or adjusting earnings for cost that disappear if the company is sold. These addbacks can include excessive owner's compensation, non-performing family member compensation, excess rent paid for plant real estate held "off the books" by the shareholders, the effect of equipment operating leases and other non-recurring expenses that presently depress earnings.
The valuation should also consider the effect and potential risk of excessive account concentration and any other risks the business faces in the near term. Chief among these other risks is the loss of present management and/or sales post-transaction. Companies that have deferred needed equipment and are faced with significant, near-term capital expenditures will find their valuation penalized.
The valuation will result in an estimate of the company's market value in terms of its total capitalization of debt and equity, and will be stated as "Total Enterprise Value." Total enterprise value is the sum of all funded or interest bearing debt plus the equity the sellers will receive at closing. This is also referred to as the Total Consideration that will be paid to the shareholders and lenders at closing.
A company, for example, may have a total enterprise value of $10 million. If this company has $3 million in funded debt, the shareholder will receive $7 million for his equity at closing.
Buyers and valuators derive enterprise value by applying a multiple to normalized EBITDA. The present range of multiples in the printing industry is from 3.0 times to as much as 5.5 times for the most desirable targets. Multiples can vary widely from one printing segment to another, so do not expect, simply because you love your "enormously desirable," $7 million, unionized, commercial sheetfed printing company, that your valuation will be assigned a multiple at the high end of the range.
Furthermore, do not assume since your company, in your mind, is so "special" that it deserves an even higher multiple than those stated above. In addition, although you may recollect or have heard that much higher multiples were being paid in the late 1990s, do not expect the multiples of yesteryear. It will not happen. Finally, if you bother to calculate the multiples being paid in the mega-deals, you must remember that those values are being assigned to the enormous revenues and the capabilities of companies whose stock is widely held and liquid in the public markets.
Sellers who enter the market with "stars in their eyes" because their brother-in-law accountant told them their company was worth some pie-in-the-sky value will not sell their companies and will live forever in a state of angry disillusionment.
Unprofitable/ ("Underwater") Company Valuations
Sellers whose companies have minimal EBITDA and/or excessive debt may find that their valuation must be based on Adjusted Book Value. This requires a professional valuation to determine the fair market value of the current and fixed assets; then subtracting the current and fixed liabilities to arrive at Adjusted Book Value.
The buyer will also perform this analysis and it is rare that a buyer's conclusion equals that of the seller; hence a negotiation will be necessary. Frequently, the buyer will agree to pay the seller for the Adjusted Book Value at closing and then a royalty on actual collected sales over a period of time. These royalty rates range from 3-10 percent, for terms of three to five years.
The royalty rate and the term depend on the buyer's analysis of the profitability of the seller's revenues when produced either under the new management or in the buyer's plant, if the seller's plant is to be closed.
Once selling shareholders have agreed to a reasonable price, they should consider other possible transaction terms. These should deal with structure: Do you want the consideration paid in cash or the stock of a publicly traded company? Are you willing to accept some or all of the consideration in the form of secured seller financing (you receive payments secured by a promissory note that is secured by your company assets)?
Are you willing to accept some or all of the purchase price in the form of a performance-based earnout paid over time? Earnouts are usually based on earnings over three to five years and are paid annually by the buyer. Most frequently they are 10 percent to 30 percent of the purchase price and are based on agreed upon operating profit or EBITDA performance.
Why Accept Anything Other Than Cash?
Buyers are motivated to use earnouts because they may fear that shareholders, who now have bulging bank accounts and who are staying on to manage the company, will lose their motivation for profit performance or will suddenly decide to take their money and leave the company to play golf. Buyers may also propose a seller-financing component because the purchase price is not totally financible through conventional sources.
Sellers who are motivated to stay on and continue working, and who may want additional value, should consider earnouts and seller financing components in their deals because they frequently enable the buyer to pay a greater value. They also defer taxes that are paid by the seller.
Contacting the Potential Buyers
Once the valuation, buyer list and Offering Memorandum have been completed, an anonymous "teaser" sheet and a deal process letter must be prepared for the potential buyers. This communication can be preceded by a phone call to the target buyer's CEO or corporate development department to determine, on a no-name basis, their preliminary interest.
If the buyer expresses interest and wishes to receive the Offering Memorandum, he must execute a Confidentiality Agreement prepared by your attorney. This document is defined later in this article.
Now it begins to get fuzzy! Once the buyer has your Offering Memorandum and wishes to move on to more in-depth discussions the process begins to take on a life of its own. No two deals happen the same way no matter how carefully the seller or his representative try to plan the steps.
It will suffice to tell you that if a buyer provides the seller with a "preliminary indication of interest" (a statement that the buyer's perception of value is within striking distance of the seller's expectation), then the seller will likely wish to invite the buyer for a plant visit, meetings and an opportunity to learn more about the business through question and answer sessions. Often it is desirable if management prepares a formal, two- to three-hour presentation to orally and graphically tell their company's story as facilitation for the buyer's questions.
If serious interest continues after plant visits and management meetings, and if the buyer is indicating a willingness to pay a satisfactory price, he may indicate a desire to prepare a non-binding Letter of Intent to Purchase (LOI) or the seller may request this document. Although LOIs are largely non-binding, the standstill and confidentiality provisions are binding. This document frequently affords the best opportunity to negotiate price and deal terms and conditions. It is defined later in this article.
The LOI will propose a negotiable standstill period, which is ordinarily somewhere between 30 and 120 days, with 90 days being the normal period. During this period the seller agrees to permit due diligence investigation under certain conditions and to negotiate only with the buyer. Sellers who violate the standstill agreement can be sued.
Most buyers will require on-site due diligence visits by its management, lawyers and accountants. This task can consume from one to three weeks and is usually exhaustive. The buyer will examine all of the current and fixed assets, internal books and records, contracts, leases, any existing litigation and any unrecorded liabilities. A list of required due diligence materials can number in excess of 100 items. Buyers who find a significant, unreported liability will understandably seek to adjust their offering price.
The buyer will present a draft Purchase Agreement shortly after the mutual signing of the LOI. The seller should realize that the buyer's attorney will prepare and negotiate the agreement, and he or she is usually a highly experienced M&A attorney. The seller should, likewise, engage a seasoned deal attorney since the first draft of the Purchase Agreement is usually decidedly in the buyer's favor.
Closing and Funding
When due diligence is complete and when the attorneys have negotiated a mutually acceptable Purchase Agreement, the transaction is ready to close and fund. A delay can occur if the buyer has a financing contingency and has not yet obtained his lender's firm commitment. Large publicly traded strategic buyers rarely have a financing contingency, since ready cash or an existing credit line are adequate to finance the deal. Financing contingencies usually arise in deals with Financial Buyers. Closing and funding the deal usually occur on the same day.
Learn the Language Of M&A Deals
Merger and acquisition terminology can be confusing and subject to varying interpretations. Usually just the buyer signs a "Confidentiality Agreement." Occasionally buyers will require the seller to also sign. The document is legally binding and it promises that the buyer will not disclose its interest in acquiring the seller.
It promises to maintain all seller documented information in strictest confidence and to return such documents immediately if purchase discussions are abandoned. It further prohibits the buyer from soliciting the employment of any of the seller's employees, generally for a period of two years. Although it's much harder to obtain, it can prohibit the buyer from soliciting business from any of the seller's customers for some period of time.
A "Term Sheet" is a 1-3 page document that sets forth the economic terms and conditions of a buyer's offer to a seller. It is non-binding and can contain some non-economic terms and conditions. It is intended to reach a price understanding with a seller early on so as to avoid the legal expense of more costly, later stage documents and wasted time if the two parties cannot agree to economic value for the company.
A "Letter of Intent to Purchase" (LOI) is mostly non-binding except for language describing the term of the "stand still" that stops a seller from negotiating with another buyer and for confidentiality provisions. It is generally a 3-10 page document that is signed by both parties. It usually sets forth the major economic and legal terms and conditions of the proposed transaction. It defines the buyer's timing for, and practices for, conducting due diligence. In some cases it may contain a Break Up Fee provision providing that a penalty be paid by the party who abandons the transaction.
Break Up Fees can also be known as Topping Fees and are intended to compensate the injured party for legal and other expense in the event that either abandons the deal prior to closing.
The "Purchase Agreement" can be developed by either the buyer or seller, but most often is written by the buyer's attorneys. The sellers provide the Purchase Agreement in cases where the selling shareholders have strict go-no go requirements for a deal and where the sellers intend to conduct a formal auction for the company. In these cases, the seller will provide the Purchase Agreement to the buyer in the early stages of the auction to make its acceptance a part of the buyer's offer.
Purchase Agreements can range from 30 to 60 pages or more and thoroughly describe every aspect of a transaction.
These agreements are signed by both parties at closing and contain: (1.) full details and the buyer's commitments for the purchase price and its structural components; (2.) the assets or stock being acquired; (3.) the seller and buyer representations and warranties; (4.) the method of calculation and timing of the payment or deduction of a working capital adjustment; (5.) the non-compete/employment agreements for selling shareholders who may be staying on or are leaving the company; (6.) the timing and nature of any post-closing adjustments to the purchase price; (7.) the amount, conditions and timing for the release of any escrow being held by the buyer to cover any unforeseen seller liabilities; (8.) the basket and cap language covering any unknown or unscheduled liabilities; (9.) a delineation of any excluded assets or liabilities; (10.) and the term and financial limit for the seller's overall liability.
Your Motivations For Selling?
Potential sellers must carefully examine their motivations for selling and decide that they are valid before initiating an effort to sell the company. These motivations can include printing industry burnout; an unwillingness to step up to any more debt, whether personally guaranteed or not; a desire to retire; poor health; a lack of potential successors from among your children or relatives employed at the company; or a desire to gain liquidity by extracting your wealth from your printing company investment and reinvesting it in more lucrative or safe investments.
For most, selling their company is a once-in-a-lifetime event. You only get one chance to successfully complete a very complex task. The how-to portion of this article, at best, is an outline and in no way is intended to communicate every twist, turn or outcome in an M&A transaction.
About the Author
Harris DeWese is the author of Now Get Out There and Sell Something available through NAPL or PIA. He is chairman and CEO at Compass Capital Partners and is an author of the annual "Compass Report," the definitive source of information regarding printing industry M&A activity. DeWese has completed more than 100 printing company transactions and is viewed as the preeminent deal maker in the printing industry specializing in investment banking, mergers and acquisitions, sales, marketing, planning and management services to printing companies. He can be reached via e-mail at DeWeseH@ComCapLtd.com.
Printing Industry Mergers and Acquisitions
Smart buyers want smart sellers. Rate your company on this scorecard.
Value Building Desirables, or
High end of the Value Range, or
Non-union work force
3-5 years of revenue growth
3-5 years of sustained EBITDA of 10%+
Audited financial statements
25-35% excess equipment capacity
35-50% additional plant facility capacity
Plant is not landlocked
Early stages of market-based, long-term lease
Good, youthful management willing to stay
No account concentration beyond 20%
Well-documented environmental compliance
No significant pending litigation
Clean, well-maintained facilities
No major facility maintenance problems
Revenues in excess of $10 million
Number one or two position in market
Identifiable, defensible specialty(ies)
No salesperson concentration above 20%
Strong ethics. No payoffs to print buyers
Strong supplier relations
All taxes are paid
Evidence of a tenured, happy work force
Value Beating Undesirables, or
You'll be lucky to even get an offer, or
Unionized work force
Need to spend millions for new equipment
Recent revenue declining
Declining or "peak and valley" EBITDA
Reviewed or compiled financials
Too little or too much excess capacity
Tight plant. No room for growth
Plant cannot be expanded
Late stage or undesirable real estate lease
Owner, CEO will retire
Severe account concentration 20%+
History of environmental problems
Company is being sued for big dollars
Sloppy, dirty facilities
Bad roof, ventilation, etc.
Revenues less than $10 million
Way down the list in market share
No differentiation. Low price spread
One key salesperson selling 25%+
Loose and fast with print buyers
Suppliers wish company would go away
Potential federal or state tax liability
© 2004 Compass Capital Partners