M&A REPORT -- New Era of Consolidation

BY ERIK CAGLE

Who can forget 1998 and 1999? Those were easily the salad days of merger and acquisition in the commercial printing industry.

The dotcom craze was sweeping across all U.S. industries, with venture capitalists seeking new avenues into the printing segment. Wall Street coveted this largely fragmented industry, and a wave of new kids on the block, consolidators, embarked on the IPO-and-roll-up philosophy. Roughly a half-dozen of these consolidators vied for the growing number of printing companies looking to become cogs in much larger machines, seeking either payola or the benefits from the economies of scale. The national economy was a well-oiled machine, and everyone wanted a slice of the fiscal pie.

When Quebecor merged with World Color, eyes bulged as if witnessing the finale of a fireworks display. An omen, perhaps...

A large sigh of relief was let loose when January 1, 2000, passed without computer chips causing worldwide havoc. But the economy's circuitry began to smoke and fizzle in the fall of that year. The industry followed suit as 2001 turned ledger books red. Dotcoms disappeared, leaving behind only customer lists to be scavenged. A national recession keyed massive layoffs and plant closings. A number of consolidator models crumbled into bankruptcy, while others readjusted their focus.

M&A was DOA. But a new dawn is breaking.

Economic indicators are pointing toward tangible national recovery by year's end, with prosperity for the printing industry ticketed for the first half of 2003. Already there are signs that some of the biggest players in consolidation—those who remain, that is, the venerable names in printing—are mobilizing in their war rooms. Thus far, some of 2002's biggest deals include:

* Consolidated Graphics, Houston, buoyed by the return of negotiating master Chris Colville, has annexed American Lithographers of Sacramento, CA; Carqueville Graphics of Streamwood, IL, a deal that originated last September; and Regent Printing & Imaging of Tulsa, OK, which was merged with Tulsa Litho to create Consolidated Printing Solutions.

* Moore Corp., Toronto, made a large splash when it acquired The Neilsen Co., a $90 million Cincinnati printer. This move came on the heels of a $100 million cost-savings initiative by CEO Robert Burton in 2001, in a campaign that has helped the company's stock rise from the $4 range to $13+.

The vast majority of deals, however, have involved smaller, competing firms that joined forces to enhance product and service capabilities. While these will certainly continue, there are indications that a number of much bigger deals are also on the horizon.

"We believe M&A activity will absolutely accelerate during the course of the year, but mostly in a strategic context," states Gregg Feinstein, partner with Berenson Minella, which offers investment banking services to the commercial printing industry. "The days of buying sheetfed printing companies as part of a 'roll-up' strategy preceding an IPO will not come back any time soon.

"What you will see are many of the traditional buyers coming back into the marketplace along with some new players, all buying assets that add something operationally to their businesses. They will be pursuing deals that accomplish a strategic objective for them and add scale to their operations. This could, for example, involve a product extension to assist in 'cross-selling' or a geographic fit, which fills a need in the markets they serve."

Feinstein believes larger transactions will transpire from the likes of Moore and Quebecor World. Berenson Minella acted as financial advisor in the Neilsen deal, which Feinstein feels added a commercial printing platform to Moore's other products.

"I would expect Moore to replicate the series of successful acquisitions that Bob (Burton) and members of his team pursued at World Color in the mid-1990s," Feinstein says.

Quebecor World, once it has completed the debt pay down/restructuring phase stemming from its 1999 merger, will be an active participant in the second half of 2002, he adds. Feinstein expects larger transactions by both companies.

Harris DeWese, chairman of Compass Capital Partners, which offers M&A advisory services to the commercial printing industry, sees printers that have experienced a "plateauing" of sales that are seeking to "grow externally by absorbing smaller, weaker competitors."

DeWese also expects M&A action to increase in the second half of 2002. "We'll begin to see a pickup at relatively low multiples for average companies, multiples on the order of four times normalized EBITDA for rank-and-file, $10 to $20 million companies," DeWese says. "Most of the activity will be taking place in the commercial printing segment, labels and direct mail, with some of the bigger buyers announcing one or two big deals. Moore is already back with a big acquisition. The publicity associated with the bigger deals helps fuel smaller deals."

DeWese is expecting to see more consolidations by smaller firms pooling their assets under one roof to eliminate multiple overheads and enjoy increased equipment utilization.

Time for Survival

"It's getting tougher and tougher for the smaller printer to survive," he says. "It's tough to get financing. When the banks open up again—if and when they do—the boutiques, the smaller companies, have a chance to survive a little longer. We're definitely going to see some dissipation. On the other hand, I'm not talking about a huge, dramatic shift in a short period of time. Over the next 24 months, a deal or two in each major market that eliminates some competitors and makes someone who is already fairly substantial in that market, bigger. Once the idea catches on, then it could accelerate."

Consolidated Graphics, which has acquired 65 companies since 1985, didn't make any transactions in either 2000 or 2001, but closed three deals in February 2002. The company continues to evaluate potential deals, according to Joe Davis, chairman and CEO. The company is currently conducting various-level talks with 90 prospective partners.

"We believe our consolidation model works because we are an operator of printing companies," Davis says. "We've been in the commercial printing business a long time and we understand it. We've been fortunate enough to have bought some really, really good companies with great management teams. This has enabled us to continue to report good earnings and profits."

Maintaining a strong balance sheet has also been a critical factor, according to Chris Colville, the company's executive vice president and CFO. It is also a characteristic Consolidated Graphics seeks in other companies, along with sound management and those with an excellent customer service reputation and a sound footing in its marketplace.

"Consolidated Graphics never paid any crazy multiples," Colville notes. "We found that the good companies with really good management teams...understood what a fair valuation for their company was and that, long term, the prospect of joining the industry leader was what made sense.

"I would say that, in terms of their expectations, the companies that we're looking at buying...I think those owners would suggest that we're talking about fair valuations. I don't know if it's as much their expectations coming down to earth as much as it is two interested parties wanting to make a great deal that's of interest to both parties."

Davis is proud of the fact that Consolidated has developed a good reputation among the companies it has acquired, from the owners and employees to their customers. Consolidated Graphics has acquired companies that, according to Davis, were interested in joining a reputable organization, with the welfare of the company's future in mind as opposed to just 'cashing out.'

Looking All Over

While Consolidated Graphics is eyeing print markets in which it does not have a presence, such as Minneapolis, Cincinnati, St. Louis, Kansas City and Cleveland, any geographic market with good companies is attractive to the company, according to Cody Smith, vice president of mergers and acquisitions.

Many eyes are focused on Quebecor World which, while not a frequently active consolidator, tends to make a rather large splash with its mergers and acquisitions. According to Rick Lane, executive vice president at Quebecor World, the company is open to two types of acquisitions: "Those of a publisher/printer, as in our recent Hachette transaction, where we can have certainty of business going forward through a long-term contract. We are also open to niche acquisitions to strengthen a business line, or to fill in a geography, such as in our Retail Printing acquisition last year," he says.

"We remain cautious about large strategic acquisitions, as we still lack good visibility into the short- term market strength and therefore projections on project returns," Lane adds. "As well, there is a valuation gap created whenever there is market weakness, as buyers become cautious and sellers project a quick return to former levels. Over the next six to 12 months, we would look for strong evidence of a broad, sustained recovery to change this outlook."

Lane notes that Quebecor World always seeks to extend its franchise deeper into current customers' businesses, offering more services in more geographies "to drive down their costs of marketing and doing business. Our history has been one of constantly doing this, and we see no particular reason why we cannot continue to broaden our relationships with our customers across product lines, and around the globe. Our goal is to be there with whatever printing-related services that our customers need, across the globe."

Mail-Well Inc., Englewood, CO, has entered the second phase of its previously announced strategic plan, which is to relaunch a more focused acquisition strategy, according to Paul Reilly, president. The strategy includes a more narrowed focus.

"Potentially, relative to commercial printing, we have identified six markets where we would like to grow our local market share and the product offering we provide to our customers in that local market," Reilly states.

"When we evaluate a company, we're not only going to look at if it's accretive to earnings, but will use a more stringent filter—'Will we return an acceptable level of return on the investment?'—which will be 12 percent after-tax return. It's a much tighter filter than being accretive to earnings."

Unlike the previous generation of M&A activity, Reilly expects to see "a higher level of integration involved, with more emphasis on the operating and customer benefits of the acquisition versus, in the past, they tended to be more financial. Secondly, the prices that people will be paying will be lower."

Even if the activity level bounces back near the heights of 1998 and 1999—and Reilly, like most, is skeptical of these odds—he believes it would take a couple of years to happen.

The stock performances of many traditionally M&A-active printers—which have consistently outperformed the S&P 500 index for the last six months—will have a positive effect on their ability to conduct transactions, according to Feinstein.

"Printing stocks have enjoyed a remarkable recovery over the past 18 months from an era where printing was viewed as 'old economy' and whose business was at risk from the Internet revolution," he remarks. "Wall Street has once again embraced midcap, 'old economy' value plays and this has brought money back into the sector. Printing stocks are now trading at the high end of their historical range...on average, about seven times EBITDA.

"This will have a positive effect on M&A activity due to increased confidence, the use of stock as a currency in acquisitions and the return of financial buyers to the industry given the higher assumed exit multiples."