Year-End Recap: How Did We Do, and How Will We?
In our recent webinar, “Year-End Recap and Mega Trends in the Printing & Packaging M&A Market,” we were happy to report that the pace of dealmaking in the industry remains strong and that opportunities for buyers and sellers should continue to be abundant at least in the near term. How long these conditions will last is impossible to predict. For the moment, though, as M&A advisers, we like what we’re seeing.
The economy is stronger and so are many printing and packaging companies. Banks are lending at rates that remain historically low. The EBITDA multiples of publicly traded printing and packaging companies are healthy, and the interest of private equity investors is keen — they’ve clearly taken the industry off the “blacklist” they’d kept it on during the recession.
The M&A climate is especially favorable for the sellers that we call “haves”: firms that have taken steps to make themselves less dependent on pricing and “stickier” in terms of the loyalty they inspire in their customers. In a fragmented industry with no end of consolidation in sight, these forward-looking companies will have their pick of offers from growth-minded buyers eager to acquire them.
Printing and packaging companies have five ways to grow: three that are organic and two that are driven by acquisition. To grow organically, a firm can find more customers for what it currently does; attract new business by adding products and services; or wait for the competition to disappear. Growth by acquisition happens when one firm buys another or the two agree to merge.
For a long time now, it has been much easier to grow by acquisition than by organic expansion. Given the ongoing contraction of the industry and the fact that strategic buyers have a lot of excess capacity to fill, we don’t expect this truism to change. Thus, our perennial advice is that every owner should be thinking either of buying or of selling — but only with a sound strategic purpose in mind.
This is counsel for buyers in particular to take seriously. Just wanting to be bigger isn’t a sufficient reason to grow — there needs to be a plan for translating greater size into new benefits for customers. Successful acquisitions have clear business objectives that, when they are fulfilled, yield value for everyone with a stake in the transaction.
Buyers have three strategic imperatives in choosing their acquisition targets: to reposition into growing (i.e., less mature) markets; to drive efficiencies that mitigate lower pricing; and to replace sales from shrinking markets. Simply closing the deal doesn’t satisfy the imperatives; rigorous post-purchase implementation is what turns them into profitable realities.
M&A transactions may be earnings-based EBITDA acquisitions, tuck-ins or cashless mergers. Although tuck-ins used to be the most common type, especially during and immediately after the recession, the bulk of the action currently is in EBITDA deals. Tuck-ins still occur, however, and often on terms more favorable than sellers could get a few years ago. (More about cashless mergers in a moment.)
In earnings-based transactions, all eyes are on the EBITDA multiple: the number used to establish the value of the business being sold. Publicly traded companies typically command higher EBITDA multiples than privately held firms, but increases in public multiples tend to pull private multiples in the same upward direction.
In 2016, public company EBITDA multiples averaged 6.3 for commercial print firms and 9.7 for those specializing in packaging. The range for private firms was about 3.5 times EBITDA at the low end and 7 at the high end (a multiple enjoyed by only a handful of sellers).
We are often asked what drives multiples of EBITDA. We reply that both quantitative and qualitative factors are at play. Quantitatively, for example, a history of revenue and earnings growth, a healthy balance sheet and a non-concentrated account list all warrant a higher multiple. Having production specialties, loyal customers and a non-union workforce are plusses on the qualitative side.
A company can also get a boost in multiple by doing business in a high-margin premium segment. These days, almost anything related to packaging qualifies as “premium.” For commercial printers, large-format output, retail POP, customized direct marketing and Web-to-print e-commerce are among the most desirable segments to be in.
As mentioned, tuck-ins based on asset market valuations still represent a dependable way for buyers to achieve non-organic growth. In these transactions, buyers get and retain what they want the most: active sales accounts. Instead of closing their doors, sellers earn compensation over time and can pocket whatever cash they raise from liquidating equipment the buyer does not want to purchase.
Right now, tuck-in sellers are earning royalty commissions on retained sales for 2 to 5 years at 3% to 7% — a respectable payout for owners of smaller businesses who are looking for an exit strategy with an ROI.
The other route to an M&A is the cashless merger. This transaction resembles a tuck-in except for the fact that instead of a royalty, the seller receives stock in the combined entity. Cashless mergers create partnerships in which former competitors find that they are stronger as one than they were on their own. With no need for cash to change hands, the partners can focus on leveraging their shared strengths and eliminating duplication.
Many printers made good use of their strategic options in 2016, and New Direction Partners expects to see more M&A activity happening at the same brisk pace in the year ahead. But, as wide open as the opportunity window appears to be, conditions will not stay this favorable indefinitely.
This is because technically speaking, we are overdue for the next recession. Declines in GDP occur roughly every five years, and the last such period of decline ended in June 2009 — seven and a half years ago. The conventional wisdom also holds that the risk of recession rises in the second year after a presidential election. If the conventional wisdom is correct, 2018 could be a challenging year for M&As.
The worst may not happen, but the reality is that every print company owner should have at least a contingency plan for selling the business or growing it by means of a strategic acquisition. Steps taken in either direction will strengthen the business whether the transaction closes now or materializes further down the road. Stronger firms mean a stronger industry and better opportunities to grow within it — or exit gracefully from it when the time finally comes.
Peter Schaefer, partner at New Direction Partners, is an experienced dealmaker with more than 25 years of investment banking and valuation experience, 20 of which has been focused exclusively on the printing and packaging industries. He has closed more than one hundred transactions in virtually every segment of the printing and packaging industries. In addition, he has performed hundreds of valuations for ESOPs, estate and gift tax planning and strategic planning purposes. Contact him at (610) 230-0635, ext. 701.