As a member of an investment banking firm that specializes in plastics transactions, I found your March 11 front-page article on the state of mergers and acquisitions in the plastics industry very timely. Given the tightening of the credit markets in 2000 (which has reduced financial buyer pricing) and the pullback in the economy in 2001 (which has negatively impacted public stocks), there has been an expected corresponding decline in across-the-board transactional activity.
However, while it may generally be concluded that, all other things being equal, pricing is softer today than it was a couple of years ago, it is important to guard against overgeneralization. I am concerned that some of your readers may have drawn inappropriate conclusions from the article.
The term “buyers' market” as used in the article is intended to denote a situation where prices are at a depressed state. This well-written article then goes on to discuss sales prices as a multiple of earnings. Business owners may erroneously conclude that the sale price for their business is a set multiple of earnings or EBITDA (earnings before interest, taxes, depreciation and amortization) and that, since multiples have gone down, so has the value of their business, especially if the business' earnings are lower. That would be a rather unfortunate conclusion based on oversimplified generalizations. Most worrisome, it would not serve as a particularly useful planning tool for an owner who is planning to consider transition.
Our experience tells us that transaction pricing is a function of the specific characteristics of a company, buyer fit, the preparation of marketing materials and the sale process, all of which have contributed to our firm's selling companies in excess of the pricing multiples suggested in your table.
We call multiples the lazy man's valuation. From a purely financial point of view, a typical buyer will construct a projection of future earnings, capitalize those earnings into perpetuity and then discount all those results to their present value using an appropriate cost of capital. If this amount or some negotiated derivative thereof then becomes the price, one can divide this price by earnings and, voila, there you have the resultant multiple.
So, let's take the focus off of multiples then, and consider the earning power of the business. The more predictable and secure a company's earnings, the greater the going concern value and the resultant price. However, the perceived dependability of the earnings stream will differ from one business to another. Myriad characteristics distinguish one business from the next and influence valuation, including: history; stability; sales and profit growth; profit margins; engineering capabilities; value-added secondary operations; trademarks, patents and proprietary processes; management quality; tenure and loyalty of the work force; and good financial, administrative and operating systems.
How a business is sold can have the greatest effect on valuation. Your readers must not underestimate the importance of the investment bankers' assemblage of a bona fide, strategic set of buyers who can be introduced to the selling company. Each buyer brings a unique perspective on synergies and therefore a different valuation.
Billow is managing director and principal with Billow Butler & Co. LLC in Chicago.