Mergers and Acquisitions — When Sweet Turns to Sour

JUST WHEN it appeared that merger and acquisition activity was beginning to garner steam in the printing industry, along came a downturn in the economy. Is it a recession? Ask again about six months from now. Most economist pundits feel we’re heading in that direction or at least may start suffering stagflation—slow growth, high unemployment and fast-rising prices.

At any rate, the writing is on the wall, enough so that President Bush rushed through a $170 billion economic stimulus package in February, and Federal Reserve Chairman Ben Bernanke continues to cut interest rates to help stave off a recession.

For the sake of discussion, let’s assume we’re heading into what will be widely hailed as a recession. As printers, concerns revolve around the obvious—materials prices, the cost to produce goods, the cost to deliver said goods and the ability to pass resulting increases through to customers. Also, from the it-goes-without-saying department, printer fortunes are pinned to their customers’ ability to remain relatively recession-proof.

On the M&A front, however, the impact of a recession—even with the benefit of using past models—is uncertain and won’t be seen for several quarters. A lion’s share of deals that are hammered out in the front end of 2008 trace their genesis to the period before the recessionary kettle began to whistle.

“Our M&A blueprint has not changed, but current choppy market conditions will have an impact on when we ‘break ground’ on our next acquisition,” notes Jim Andersen, president and CEO of Chanhassen, MN-based IWCO Direct, whose primary business—direct mail printing—is as recession-proof as any in the industry.

“(In a weak economy) the bar for moving ahead with a merger or acquisition is set higher,” Andersen says. “Existing customer relationships must be closely examined to identify needs and long- and short-term viability. Any acquisition will likely be focused on adding value and talent to our current integrated manufacturing and marketing services platform rather than simply expanding existing capacity.”

As the economic picture turns bleaker, Andersen feels it becomes even more imperative for all parties to perform thorough due diligence. He anticipates a resurgence of strategic buyers, “like public companies that need to defend market share and gain competitive advantage in a soft economy.”

Keeping It in Perspective

When assessing economic conditions, it is important to maintain perspective. Harris DeWese, chairman and CEO of Compass Capital Partners in Exton, PA, who has advised more than 140 printing company transactions, notes that even in recessionary periods, reductions experienced are comparatively modest. Private equity money has not dried up by any stretch; DeWese fields calls from equity firms on a daily basis.

Valuations will be down as lending tightens up, according to DeWese, but with lending rates also down, it’s an opportunistic time to borrow money for worthwhile projects. Even in a downturn, he notes, companies need to change hands or find successors.

“The better companies, the good companies, are going to find buyers,” he says. “There are some fairly big deals on the horizon that will happen even if we go into a deeper recession.”

Again, certain market segments are, by their nature, more able to weather the recessionary storm than others. DeWese stresses that a job-chasing general commercial printer that lacks account loyalty is far more vulnerable than a specialized printer serving, for example, the pharmaceutical vertical producing labels and miniature folded inserts and outserts. DeWese, ever the green thumb, also likes specializations such as horticulture.

“Those kind of printers go through a recession really well unless their customers are materially affected by a recession and are selling fewer units,” he says. “A horticultural printer is greatly dependent on the number of plant units that are sold in nurseries around the United States. It’s a much more predictable, recession-proof business.”

What could we expect to see in a recession? DeWese feels there will be a spike in bankruptcies, and the M&A circuit may see a drop off of as much as 20 percent to 25 percent. A company worth six times EBITDA may slip to 5.5, with much hinging on bank lending multiples. However, with favorable lending rates and pent up demand from both financial and strategic buyers, it’s still an atmosphere conducive to getting deals hammered out.

“I don’t think the economy is going to play a large role,” DeWese remarks. “We’re not going to see nearly the effect we saw in the 2001 to 2003-04 period. Things will clearly be softer and we’ll see fewer deals done. When that happens, bankruptcies increase and it’s usually the bottom of the food chain that goes belly up.”

Bob Cronin, managing partner of boutique consulting firm The Open Approach, concurs that private equity funding is still ample, with particular interest given to direct mail, wide-format commercial, packaging and labels. Certain segments of web and sheetfed printing may experience some softness.

“I don’t think it’s going to be dramatic at this time,” Cronin says. “Going into next year, if the economy continues the way it is and we go into stagflation, no one knows exactly what that will mean.”

Much attention is being drawn to Quebecor World. The Montreal-based printing giant, at one time the crown jewel of North American printers but now struggling to stay alive in creditor protection, could unwittingly shape perception as to the viability of certain segments of the industry. However, some have argued that the sum of Quebecor World’s pieces is greater than the value of the whole, and the revolving door of management has stripped the company of focus and customer loyalty.

From an M&A viewpoint, a dismantling of the Quebecor World machine could well impact the market for other companies within a given print segment and set benchmarks for future deals. It will undoubtedly cause the private equity community to do its homework on the state of affairs behind Quebecor World’s projected demise.

“Currently, they have tremendous segments of the printing business, and there will be heavy interest in wanting to have those be acquired by some private equity firms or other members of the printing community,” Cronin notes.

“Still, people are asking themselves, ‘What were the issues that caused their problems, and can I work through that to make the investment a success?’ I believe someone will be able to finance a transaction with Quebecor World, or parts of it, as a cornerstone and do it successfully in the marketplace.”

As for the near term, Cronin is bullish on the state of M&A in general. Activity was robust in the first quarter of 2008, and he saw evidence to suggest that would continue at least until the third quarter. Beyond that, depending on the efforts being made to right the economy’s ship, it is difficult to project.

“Our transactions are excellent right now,” he adds. “We have a number of buy side and sell side assignments, and three properties that are LOI (letter of intent) to be closed within the next three weeks. We’re also getting calls from people to assist them in getting due diligence from another private equity company doing a transaction with another entity and another investment banking firm.

“Will this go into the third and fourth quarter this year is the real question,” Cronin concludes. “A lot of these transactions started before some of the serious questions came up about the credit crunch. With theses issues and the M&A situations, people are looking for a better buy, like when they’re looking for foreclosures in houses. People are always buying and selling, and somehow there will be a level reached where everybody will find it to be an acceptable risk.”PI

By the Numbers

The pace of transactions in the printing industry increased in 2007. Although the numbers of deals, on average, has increased since the low of 2001, the valuation “craziness” exhibited during that timeframe has not re-surfaced, nor do we expect it to in the near term. Too many of the national buyers were “burned” by overpaying for companies and were forced to liquidate, sell or file for bankruptcy protection.

The accompanying chart below shows the range of EBITDA multiples paid for printing companies since 1996. The upper line shows the high end of the range; the lower line shows the bottom range. For clarification, in 2007 buyers of printing companies typically paid somewhere between 4.5 and 6.5 times EBITDA. This is up dramatically from the nadir in 2001 and 2002, when the range was only 2.5 to 4.0 times.

There are a range of multiples of EBITDA paid for printing companies. As has been the case during the past few years, 2007 was a year when buyers targeted sellers with well-considered reasons and plans that made sense. Buyers were more deliberate during due diligence and securing financing, and they were more rigorous investigating a target’s “fit.”

Of the 55 transactions, most were among specialty printers acquiring more market share or diversifying in a proximate customer segment. Specialty deals represented 68 percent of the completed transactions, but an even higher percentage of the total revenues acquired. This is more evidence that specialty printing companies generally have greater value when compared to general commercial printing companies.

—Peter Schaefer President, Compass Capital Partners