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M&A upside: private equity, packaging & medical deals

By: Frank Esposito

January 25, 2010

After a few years in the wilderness, plastics mergers and acquisitions might be returning to civilization in 2010.

Although raw transaction numbers for 2009 were up vs. 2008, a number of M&A executives interviewed by Plastics News said that distressed deals made up a good portion of the 2009 global total. For 2010, more deals of higher quality should be available.

“There's going to be more opportunity for both sides of the table heading into 2010,” said Graham Schindler, a director at Houlihan Lokey Financial Advisors in Chicago. “For sellers, there's more interest in their business, and for buyers, there are more viable businesses available.”

“We expect an increase in non-distressed and quality transactions in the plastics and packaging industries in 2010,” added John Hart, plastics and packaging group director at P&M Corporate Finance LLC in Southfield, Mich. “We believe the positive signs shown in the second half of 2009 will continue in 2010, with the major variables being economic recovery and credit market improvement.”

First, the data: Blaige & Co. LLC of Chicago tracked 480 global plastics industry deals last year, up 7 percent from 2008. P&M charted 315 plastics and packaging deals, up 4.7 percent from 2008.

But taking distressed deals out of the P&M totals leaves a drop of more than 6 percent between 2008 and 2009. Thomas Blaige, CEO and managing partner of Blaige & Co., does not separate distressed deals in his firm's totals, but he said the percentage of those deals in the overall total did increase between 2008 and 2009. Blaige added that the number of quality deals was up in 2009 vs. 2008, even when distressed deals are removed.

That's not the viewpoint of Ken Brooks, senior vice president with Ernst & Young Orenda Corporate Finance Inc. in Montreal, who said, “If not for distressed activity, we wouldn't have seen much of anything in 2009.

“A lot of deals that were completed in '09 were started in '08, so that affected the total,” Brooks said. “It's indicative of those who don't want to, or don't need to, not selling.”

And even with the number of quality deals expected to rise, numerous distressed properties could be hitting the market in 2010 and beyond, according to M&A pros Bill Ridenour and Nick Chini.

“There are still a lot of sick companies out there, and I think we'll see more of them in the first six months of 2010,” said Ridenour, president of Polymer Transaction Advisors Inc. in Newbury, Ohio. “A lot of them will drop in the first and second quarter when they fail to meet loan payments.”

Chini, managing principal with Bainbridge Inc. in San Diego, goes a step further saying increased levels of distressed plastics firms might be available through the end of 2011.

“We're still going to see more than we would in a normal year,” Chini said. “Some markets and business models no longer make sense. The industry needs a correction.”

P&M's Hart listed several reasons why distressed deals held sway in 2009, including:

* Credit markets being effectively closed for the first part of the year and bank lending down dramatically.

* Private equity buyers being reluctant to bridge valuation gaps that resulted from the lack of credit, low debt availability or the decline in earnings of sellers impacted by the recession.

* Valuations were adversely impacted, and many sellers were not willing to accept lower valuations because of the decline in earnings from the recession or the lower debt availability. As a result, they decided to sit on the sidelines until their earnings increased or pricing improved.

Injection molding was the most significant processing sector tracked by P&M in 2010, accounting for 24 percent of total deals. The largest product segment in the P&M report was rigid and flexible packaging, which combined for a 31 percent market share. In the Blaige report, injection molding again led the way with a 20 percent share of sector deals.

Blaige also reported a somewhat surprising increase in deals in the machinery and tooling segment in 2010. The firm said deals in that area jumped from 30 in 2008 to 48 in 2009 — a 60 percent increase.

Machinery and tooling “is one of the most fragmented markets, with a lot of small businesses,” Blaige said. “That segment needs consolidation. There also were more distressed deals there than in other segments. Earnings are less consistent and there's too much capacity.”

P&M's Hart pointed out that 266 quality deals for 2009 “is still a strong level of transaction activity when you consider the market conditions.”

Hart added that 2009 also saw a higher percentage of smaller transactions, which are easier to get financed and completed in a challenging M&A market.

Eye-catchers

A handful of deals from the second half of 2009 caught the attention of the M&A pros who talked with Plastics News.

Globally, London-based Rio Tinto plc's sale of parts of its Alcan packaging business — to Bemis Co. Inc. and Amcor Ltd. — for a total of more than $3 billion made the biggest splash. Bemis is acquiring Alcan's Food Americas unit, while Amcor snagged its food packaging in Europe and Asia and its global tobacco business. Both Bemis and Amcor are strategic buyers already in the packaging business.

Brooks, at Ernst & Young, described those deals as “the evolution of Rio Tinto's mining assets,” which made packaging less important to the firm. The Alcan business was broken up because “as a whole, it would have been tough for anybody to acquire,” Brooks said.

At Houlihan Lokey, Schindler singled out Fortis Plastics LLC as an active buyer. Fortis in October added an injection molding plant in Chihuahua, Mexico, to its holdings after buying the operation from Nypro Inc. Fortis was formed in 2008 when New York private equity firm Monomoy Capital Partners LP combined the molding assets of Atlantis Plastics Inc. and Leggett & Platt Inc.

In materials, compounder/distributor A. Schulman Inc. opened its vaults and spent almost $200 million in cash and stock to acquire compounder ICO Inc. And Citadel Plastic Holdings Inc. — backed by Chicago private equity firm Wind Point Partners — made its fifth plastics acquisition since 2007, buying compounder Fiberfil Engineered Plastics Inc. (See related story on Page 8.)

More than one market watcher cited Berry Plastics Corp.'s $82 million purchase of the assets of packaging injection molder Superfos Packaging Inc. as a quality deal.

“Berry was the best possible buyer for Superfos,” PTA's Ridenour said.

And few buyers have been more active in recent months than film manufacturer Sigma Plastics Group of Lyndhurst, N.J. Sigma made three film acquisitions in 2009 — Santa Fe Extruders Inc., FlexSol Packaging Corp. and ISO Poly Films Inc. — and opened 2010 with another deal, this time for McNeely Plastic Products Inc.

“Sigma will buy a majority of a business and allow the owner to keep a minority stake,” said Blaige. “This allows the acquired companies to prosper over several years. Sigma has seen an opportunity with quality businesses out there.”

Still coveted

Packaging and medical markets remained attractive to M&A shoppers in 2009 and should remain so in 2010. Packaging accounted for almost 30 percent of the deals tracked by Blaige in 2009. P&M had packaging's share at 36 percent.

Packaging's market share of plastics M&A deals grew by 6 percentage points between 2008 and 2009, according to P&M, with Blaige saying it grew 7 percentage points.

“Packaging is clearly one of those segments where volume isn't off as badly as it is in others,” according to Schindler.

“Markets always are in need of local packaging for food and pharmaceuticals,” said Brooks. Blaige added that financial buyers “like packaging because it's consumable and reliable.”

Medical plastics M&A activity also remained high, averaging more than 50 deals per year from 2007-09 after averaging only 14 deals per year from 2004-06, according to Blaige.

Ready to pounce?

So where's this M&A money going to come from in 2010? Many point to private equity. Some market pros describe the amount of cash in the private equity market like it's a balloon overinflated by a hyperactive 5-year-old at a birthday party.

“We have $3 billion under management, and we'd like to make more investments somewhere,” said Stewart Kohl, co-CEO at private equity firm Riverside Co. in Cleveland. Riverside bought medical injection molder Coeur Inc. in late 2008 and owns four other plastics-related businesses as well.

“We've been active in plastics for 20 years and are likely to find more opportunities there, as long as it's not 'me-too' plastic molding,” Kohl added. “In general, manufacturing has been an underappreciated sector — people might not be not running from it, but they're not running to it either.”

At Bainbridge, Chini said that private equity buyers “have said 2009 was a buying year, and that's continued into 2010.”

Private equity firms “are buying sound companies at lower multiples and they've got mandates to spend in 2010,” he added. “Veteran private equity firms stayed on the sidelines in '07 and '08 and some in '09, but they've come back.”

Private equity's share of the plastics M&A market increased from 34 percent in both 2007 and 2008 to 42 percent in 2009, according to P&M.

“Private equity's percentage in 2009 was higher because fewer strategic buyers were doing deals,” P&M's Hart said. “They were restructuring their own liquidity situations rather than pursuing growth through acquisition.

“We think strategic buyers will come back in 2010, but there's still a lot of private equity money being raised. Private equity firms need to spend it to make money, so there could be a lot of deals in plastic industry.”

The price tag

As far as 2010 selling prices go, there's a difference of opinion. Earnings multiples could be up as more quality properties emerge, but lower debt-to-equity ratios allowed by lenders could dampen prices at the same time.

“We could see valuations of five to seven times (in 2010) depending on the quality of assets,” said Brooks at Ernst & Young. “Multiples for custom molders would be lower because they don't own the property or the brand.”

Riverside's Kohl anticipates that earnings multiples for plastic businesses will be 41/2-71/2, while at Bainbridge, Chini said some deals could land in a lower range of three to five.

“Valuations will increase as the credit markets and economy continue to improve, which will prompt sellers to come off the sidelines,” P&M's Hart said.

Blaige added that multiples “could go up if strategic buyers are active.”

Things could still be a bit contentious at the bargaining table, according to Schindler.

“If valuations are lower, that means sellers have adjusted their expectations,” he said. “In industrial markets, volumes are down massively, because profits are nowhere near where they once were. That can create a wedge between buyer and seller.”

Banks lightening up?

Banks might be loosening the purse strings a little, but they're not emptying their safes like they did in the high-flying days of 2007.

“Banks still aren't seeing scenarios that are less risky,” said PTA's Ridenour. “They're still seeing a lot of deals that are fraught with high risk.”

“Deals are taking longer to get done and there's less credit available than before,” said Brooks at Ernst & Young. “There's a lot more emphasis on due diligence. Now, instead of visiting one or two plants, a buyer is visiting all the plants of someone they're looking to acquire.”

And although Riverside's Kohl said that banks are “a little more accommodating” in 2010, he added that they're unwilling to go beyond a 60-40 debt-to-equity ratio when financing deals — less than the 65-70 debt levels they have taken in recent years.

Brooks sees debt-to-equity levels even lower, saying that most are at 50-50 and the days of 70-30 ratios “are gone for now.”

Seller's dilemma

Some owners of plastics processing firms are kicking themselves for not exiting the market in 2007 when valuations were sky-high. Would selling in 2010 make them feel any better?

At Bainbridge, Chini said doing so would be their best option.

“If you need to sell, sell now,” he said. “Post-2010, we're concerned about inflation going through the roof. That would change the investment game by scaring away buyers.”

Riverside's Kohl wasn't as sure, saying that only owners of “special businesses” should be determined to sell in 2010. “In general, when buyers can borrow less, they pay less for what they're buying,” he said.

2010 could offer a mixed bag of attributes, seeming like a seller's market at times and a buyer's market at others.

“Four or five months ago, I would have said it was going to be a buyer's market (in 2010),” Kohl said. “But if there aren't as many quality deals, that could drive up prices and help sellers.”

Blaige almost sounds like Dr. Phil or another self-help guru when talking about the decisions that owners of plastics firms face in 2010.

“There's the internal, the external and the psychological,” he said. “Internally, business has improved. They're seeing better results. They can do a deal without giving their business away, and are seeing more options than they did a year ago.

“Then there's the psychological, where they might be under less stress, allowing them to think more about strategy. But externally, there's still market uncertainty and the possibility of lower valuations.

“Taking $40 million instead of $50 million for your business doesn't make it a distressed deal, but it's fear-based selling,” Blaige said.

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