Following a dearth of M&A deals in 2009-10, the packaging sector is getting ready for change, according to John Church, managing director and group head of industrials investment banking at Wells Fargo Securities LLC.
Packaging firms are fortunate to be in an industry with a strong and stable cash flow, said Church, who shared his views on consolidation trends and financing considerations at the 2010 AWA Mergers and Acquisitions Executive Forum, held June 7-8 in Chicago.
Wells Fargo underwrote Bemis Co. Inc.'s acquisition of Alcan Food Americas which Church said was one of the first bridge loans made after the credit crisis. The banking firm also has represented well-known packaging firms Printpack Inc., Exopack Holding Corp., Pactiv Corp. and Georgia-Pacific Corp.
Characterizing the packaging sector's readiness for rising M&A activity, Church noted the rebound of valuations across board. It's a safety-deposit box for investment capital, showing nice appreciation relative to the [Standard & Poor's indexes], Church said. Meantime, multiples are down but still at reasonable levels, he noted.
The real drive, however, is embedded in the lack of organic growth for all companies in the industrial sector. Companies and their shareholders have shifted their focus from managing core operations and pursing cost-cutting initiatives to exploring growth through acquisitions.
Another key element, he said, is balance-sheet strength. After a dramatic deleveraging in the past 24 months, balance sheets are flush with cash, with $16 billion of cash or unused credit facilities in the packaging sector just on the public side more than what organic growth needs. The cash-to-debt coverage ratio, which was running historically at 40 percent, now nears 200 percent.
Debt maturities also have been pushed out to beyond five years, and 80 percent of the balance sheets don't have any loans coming due in the next three to four years.
Church expects companies to be increasingly aggressive on the acquisition front, and financial markets are fully functional to finance the growth, albeit with increased volatility.
The take-away message for big and small issuers alike is to be ready to tap the windows when they open up, he said.
Church reviewed the current state of six debt-oriented markets that he called the go-to markets for industrial companies namely, the asset-based loan, bank (pro rata) loan, institutional term loan, high-yield bonds, and mezzanine and convertible loans.
The asset-based market remains open, albeit with higher prices. The floating-rate instrument is short term in nature, light on covenants, and secured by the working-capital assets of the company.
The asset-based market held out best throughout the credit crisis. It is stable, dependable, and a particularly important and viable source for smaller companies (those with less than $50 million in earnings before interest, taxes, depreciation and amortization).
The pro rata bank market is showing some signs of improvement, he said. The volume of bank loans decreased substantially over the time frame of 2007 to early 2010, but now default rates have started to drop and lenders are coming back. That market will continue to improve during the rest of 2010, and through the next five years.
The high-yield market and an improving economy have reopened the leveraged-finance markets and fueled the refinancing wave. High returns attracted investors and drove up liquidity. Bond yields then rallied significantly, leading to a record issuance in 2009 concentrated in the second half of the year. Proceeds were used to repay loans, and the liquidity, in turn, fueled the bank rally.
The high-yield market is now truly open for lower-rated issuers, first-time middle-market issuers, M&A financings and dividend financings. Compared to a year ago, issuers in the first quarter of 2010 had smaller EBITDA and lower ratings.
In the packaging space, in particular, many companies are around $50 million EBITDA, which has been the cutoff for the high-yield market.
It will be interesting to see whether that threshold increase, to, say $100 million, Church added.
Pricing of institutional term loans is improving, thanks to loan market liquidity. Yields range from 4.5 percent to more than 9 percent. Middle-market issuers may face a pricing premium.
Church noted that dividend and second-lien financings have returned, and acquisition financing is becoming prevalent again. Banks are once again providing underwritten financings for the right structure, but the source of junior capital has been limited.
The mezzanine debt market important for smaller firms remains largely unchanged, due to a low level of volatility. The overall lack of sponsor activity is the biggest difference between the most active period of 2006-07 and now. In addition, many larger mezzanine tranches are being refinanced with high-yield bonds. Mezzanine investors are actively searching for ways to put their money to work.
Although the convertible market has historically been a means for financing acquisitions, recent issuance has been much more skewed towards debt repayment. There is also a significant supply/demand imbalance created by massive redemptions and a light new issuance volume, according to Church.
There is a pipeline of maturing debt for corporate loans, Church said.
If we rely solely on pro rata banks or [the] high-yield market, half of the maturing wall is still unspoken for. We are counting on new [collateralized loan obligations] being restructured or starting up again.
New CLO formation is beginning, but at lower leverage levels. He estimated that the CLO market could top $5 billion in 2010, which is less than an average month in 2006-07.
He also questioned how much longer the high-yield market will be able to fuel the liquidity in the loan market. Is the historical high issuance really sustainable? he asked.
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