PI 400 -- M&A Activity - Acquisitions Yield To Slow Economy

BY HARRIS DEWESE

Have you been thinking now is the time to sell your printing company, buy a 60-foot Hatteras yacht and retire to Boca Raton? Forget it!

Merger and acquisition activity in the printing industry is at a standstill. But, you say, "DeWese, you are crazy! My company is much better than my competitor, Smart Al's Lithographing. Al sold his print shop to a consolidator less than two years ago and he is living in Key Largo where he fishes on his 42-foot Chris Craft. He told me that he was paid more than six times earnings before interest, taxes, depreciation and amortization (EBITDA)."

And I answer, "Smart Al saw the bus leaving, made a dash to catch it and was paid handsomely in 1999. You missed the bus."

"The 1999 Compass Report" reported nearly 190 deals for calendar 1998. "The 2000 Compass Report" reported a decline of nearly 30 percent to 131 deals for 1999. The year 2000, however, saw the number of deals slide to 44—a decline of 66 percent. This year, deals will drop to less than 20. This slide is a 90 percent decline in the number of printing industry transactions from 1998 through 2001.

(Source: Compass Capital Partners—"The 2001 Compass Report")

There are virtually no buyers for printing companies in December of 2001. Some buyers think about doing deals, lick their chops at their perceived ability to buy cheap, but then yawn and roll over for a nap.

Still, you ache for the Hatteras, the sun, the sea and you ask, "How did this happen? What happened to all the buyers?"

In a mere two years, several events and economic changes turned a vibrant sellers' market to a sluggish buyers' market. I'll tell you about the more important ones.

First, there is a perception among stock market analysts, investors and lenders that (1.) the printing industry is flawed, (2.) the people in the printing industry are flawed and (3.) the concept of "roll-up consolidation plays" in the printing industry (and many other industries, for that matter) is flawed.

This perception is a fallacious argument, or an argumentum ad hominem to those of you who passed Logic 101. The fallacious argument goes like this: Master Graphics and Printing Arts America were printing company roll-ups. Master Graphics and Printing Arts America lost money and went bankrupt, therefore all printing company roll-ups will be losers and go bankrupt.

The failures of Master Graphics and Printing Arts America were attributable to flawed management and leadership that conceived and chased flawed strategies. These two companies did not fail because the printing industry is bad, because the companies they acquired are bad or because the roll-up concept is flawed. They failed for the number one reason that most companies fail—lousy management.

Success Is Possible
In fact, Integrated Graphics and Consolidated Graphics have proven that roll-ups of printing companies can make money, grow and succeed. Integrated Graphics, a privately held company, is performing well, I am told. It is a New York market roll-up of 12 companies. It has superb management in Robert Kashan and has the largest market share in the largest graphic arts market in the world. Integrated sales are estimated at $200 million.

Consolidated Graphics (CGX) owns 63 companies and has a superb income statement and balance sheet. CGX has missed the Wall Street analysts' consensus earnings estimates for a few quarters, but its stock appreciation for the past 12 months is ranked third on the PI/Compass 28 Stock Report with stock price appreciation of 45.3 percent for the past 52 weeks. Despite its recent stock performance, CGX is still priced about $6 per share below its book value of $22 per share. Theoretically, this means CGX management could liquidate the assets, pay off the liabilities and send the shareholders $22 per share.

Both of these companies have proven that, with good management, a disciplined acquisition program and planned integration, roll-ups in the printing industry can work rather well.

Business conditions among some formerly active buyers have led to their withdrawal from the M&A market. One example, Mail-Well, has announced that it is out of the acquisition game pending the divestiture of its label and forms divisions. The proceeds of these transactions will enable the company to pay down debt; CEO Paul Reilly has indicated that he hopes to be back in the M&A arena in 2002. Mail-Well was the most active of all buyers in 1998 when it completed 28 transactions.

Kelmscott Communications and Nationwide Graphics were active buyers in the 1998-1999 M&A frenzy. Nationwide worked the phones and cold-called potential sellers. Kelmscott had a full-time scout on the road looking for good target companies. Both companies ran space ads touting their acquisition programs and asking sellers to call in. Both made several acquisitions each year. Now, they are dormant buyers. Both are private companies and only their managers, shareholders and their lenders know their financial performance.

The eventual success or failure of Kelmscott and Nationwide remains in the hands of their managers and customers. I am told that Nationwide is performing well and has benefited from a change in direction, which has moved the company heavily into the profitable fulfillment business.

Private company buyers, strapped by a weak economy and an unfavorable lending environment, find it too difficult to finance deals. The weak economy and bad lending decisions have caused banks and other lenders to severely constrict their lending ratios to 21⁄2 times EBITDA of the target company.

Buyers can generally borrow another one times EBITDA in mezzanine sub debt for a total of 31⁄2 times, leaving the balance of a deal, generally no more than one times EBITDA, to be financed by equity. Banks and mezzanine lenders, however, will only extend these levels of financing for superb companies with histories of solid earnings. But the buyers aren't even sniffing at high-performance companies.

So, in part, M&A activity in the printing industry has come to a virtual halt due to Wall Street's perception of the industry, poor management performance, lenders' reluctance and our weak economy.

On the other hand, the 28 public companies in the PI/Compass 28 Index have greatly outperformed the S&P 500 Composite Index over the past 52 weeks. Our publicly traded printing companies were punished as being "tired, slow and smoke stack" during the technology stock and dotcom stock frenzy. Beginning in late 1999, printing stocks went into a free fall. Now, however, printing stocks are being rewarded for cash generation and ROI potential by investors who seek safer investments.

Unfortunately, even though the printing stocks have begun to perform, many of the formerly active public company consolidators, such as Consolidated Graphics and Mail-Well, are being rewarded with multiples of EBITDA for their stocks that are less than four times.

So what happens now?

First, you will see an upsurge in tuck-in "assets accounts" transactions where a local or regional printer buys another local company and simply moves the sales into the buyer's plant. In these transactions, the seller must be able to liquidate assets, pay off liabilities and pocket some cash. But it's not over; the seller then receives royalties ranging from as little as 3 percent to as much as 10 percent on sales for two to five years.

The ranges usually depend on the sales profitability and account loyalty history coming over from the seller. These transactions will occur because motivations to sell, get liquid and move on don't dissipate just because the regular buyers are hiding in the hills and the economy is weak. Given the right circumstances, these can provide a timely option and enough money to buy a fully equipped, 32-foot Blackfin Sportfisherman. Time and our ages march on without regard to the present value of printing companies.

Then, along about July or August of 2002, we will begin to see a handful of acquisition announcements by the more traditional buyers and a few new buyers. The pace of deals will steadily accelerate and it's likely that deals will peak up again around 2006. I said deals will peak up. I don't ever expect valuations to reach the levels of 1997-99 during my lifetime. They will improve, as more buyers enter the market, but too much has been learned from the overpayments, so buyers will be more discriminating.

Here's my most controversial prediction. Some new buyer will come along that is founded by and managed by printers. These people will tap into the genius of their customers and their plant managers. They will be great listeners. And, you know what? They will be believers in "sharing the wealth" when they are successful. Employees up and down the line will be rewarded for their performance and their ideas. This buyer will be a company where you won't find a speck of greed—none of the avarice that centers the wealth on just a few at the top.

The attempts to consolidate the fragmented segments of the printing industry are inevitable. It's a kind of Darwinian economic force that will constantly try to adjust supply and demand, in order to achieve equilibrium between printers and their customers.