Mergers and Acquisitions: M&A’s Class Struggle

TAKE A look at the news pages of Printing Impressions, particularly during the first quarter of 2010, and you will be confronted with a skewed reality of the merger and acquisition (M&A) market. The deals are breath-
taking in scope:

• Sussex, WI-based Quad/Graphics annexes Worldcolor (nee Quebecor World) of Montreal at a price that should shake out to roughly $1.4 billion.

• Chicago giant RR Donnelley spends nearly $500 million to acquire storied financial printer Bowne & Co. of New York.

• IWCO Direct, Chanhassen, MN, orchestrates a move to obtain the U.S. operations of Transcontinental Direct. The latter boasts sales volume in excess of $120 million annually.

• Houston-based Nationwide Graphics purchases the assets of its former ward, Premier Graphics.

There have been other deals of lesser magnitude, yet nonetheless substantial. Consolidated Graphics (CGX) and its subsidiary, AGS Custom Graphics, acquired Modern International Graphics and Modern Logistics. Most recently, IntegraColor, of Mesquite, TX, picked up Dallas-based The Color Place.

Amazingly, most of these deals were announced within the first two months of 2010. Any one of these transactions could be the highlight of an entire year, and bring to mind the rash of deals that shaped the last significant M&A era of 1998-2000.

Are More Deals Ahead?

But two questions persist as we view the present state of merger and acquisition activity. Are these deals representative of the current transactional climate? And can we expect to see more of the same as 2010 marches on? Judging by the reaction of some veteran observers, the answers, respectively, are "no" and "maybe."

"The two mega-deals (Quad/Worldcolor, RR Donnelley/Bowne) do not herald a renewed spate of M&A activity in the printing industry," notes Harris DeWese, chairman of Compass Capital Partners and a leading transactional consultant. "They were deals that enabled the buyer to gain much greater market share in the segments they serve—financial in the case of Donnelley buying Bowne, and long-run publications and catalogs for Quad in the Worldcolor deal.

"Both of these deals were accomplished at bargain values, so the investments were modest for mega firepower...It also would not surprise me to see either Quad or Donnelley make a run at Brown Printing if they can get it past Hart-Scott-Rodino."

James Cohen, executive vice president of mergers and acquisitions for CGX, says that while the big deals didn't illustrate any industry trends per se, he does feel these moves indicate some bullish attitudes toward the future.

"It's not likely that we will see more mega-deals today solely because a few have occurred already. That might be the case for a company that felt particularly threatened by one of the mega-deals."

Indeed, the larger print community at times seems to harbor subtle resentment toward the attention that is sometimes thrust upon the industry transactions with the head-turning price tags. These sales, they argue, cast an unrealistic light on what the majority of companies are enduring. John Hyde, senior vice president of NAPL and a consultant with 20 years of experience, feels the top-end moves aren't indicative of what's at play for 90 percent of the printing industry.

Citing NAPL research, Hyde notes that 90 percent of the industry's members are "treading water or worse." While the top 10 percent are traded as going entities based upon EBITDA, the balance are primarily sold based on their underlying assets.

"For most companies, the asset that has the greatest value is the general intangibles—the customer relationships," Hyde adds. "Historically, it would have been the equipment, but that hasn't been true for quite some time. The customer relationships are extremely valuable, simply because companies need sales. There's an imbalance between those who need sales and those who have sales."

More Closures

How will the balance of 2010 shake out? According to CGX's Cohen, as the economy goes, so follows the fate of M&A activity. Absent meaningful recovery, he sees more distressed companies either liquidating or merging with stronger counterparts. Unfortunately, Cohen doesn't believe the industry has reached rock bottom.

"Unfortunately, we are only at the tip of the iceberg in terms of business failures," he contends. "Banks will eventually dig themselves out of their tremendous backlog of workouts and restructuring, and begin to focus on their printing company credits. When they do this, you'll see even more business combination transactions and liquidations in our industry."

Valuation expectations will play a large role in M&A fruitfulness going forward, according to De-
Wese. Sellers, uplifted by the high-visibility deals, are buying into the recovery message, while buyers are aggressively holding prospects' feet to the low-ball fire in the name of low demand.

Reasonable expectations, and a middle ground, must be sought out. "Both sides must make some mental adjustments with respect to prices, whether their transaction can be price with a multiple of EBITDA or on an adjusted book value basis," DeWese notes. "If you didn't sell during the 1995-2000 
period, you missed the golden era for printing industry M&A."

Carl Norton, founder and CEO of Nationwide Graphics, sees financial institutions wielding much influence over the tone of industry deals as the year wears on. "When bank lending eases up, we will see smaller companies making strategic mergers and acquisitions," he says. "I believe that financing will play a major role in facilitating the smaller deals since smaller, privately held companies usually don't keep an abundance of liquidity on their balance sheets."

As for Hyde, he is advising that clients with designs on selling their healthy business to sit tight in favor of sunnier skies. Only "must sells"—companies in financial distress or those with issues at the executive level—should consider entertaining offers under the current economic conditions.

"The financial results from 2007, 2008 and 2009 are not trending upwards for most companies," he cautions. "Without upward trending financials, there can't be enough of a growth rate to justify a high price."

Hyde also cites the psychological element as playing a role in M&A transactions, with buyers taking a much more aggressive posture in challenging assumptions. The short fuse exhibited by lending institutions also spells more opportunities for distressed sales as wounded printers are forced into liquidation scenarios by impatient banks.

Of course, obtaining financing in 2010 is not the same animal that it was in 2000, though some may argue that a strong balance sheet is a strong balance sheet, regardless of the year.

"The asset deals will continue," Hyde adds. "This is long-term in nature because of the structural changes in our industry. At least 20 percent of the printing companies will be going out of business in the foreseeable future, many through asset sales." PI