Plastics M&A slumps in uncertain economy

The number of plastics merger and acquisition deals declined in the first half of 2023 as higher interest rates and economic uncertainty impacted the market.

In the first half of 2023, the number of plastics M&A deals came in at 170, down 17 percent vs. the 205 that were seen in the same period in 2022, according to deal data compiled by P&M Corporate Finance of Southfield, Mich. That puts the market on pace to complete 340 deals in 2023 — a total that would be less than 2021 and 2022 but more than the 2020 pandemic year and essentially equal to the deal total from 2019.

The context of a red-hot 2021 M&A year — which featured deals pushed back from 2020, as well as deals pulled forward from 2022 out of a fear of higher taxes — also changes the perception of 2023 data, just as it did in 2022.

"The key message is that plastics M&A had kind of a down second half in 2022 and is up since then, even if it's lower than the first half of 2022," PMCF Managing Director John Hart said. "The first half of 2022 kind of caught the tail end of that crazy 2021 year. Now we're trending to be a little bit higher than we were pre-COVID."

Based on product segment, custom molding and rigid packaging surprisingly saw gains in the first half. Custom molding deal volume was up 21 percent, with rigid packaging increasing 14 percent. Building products and flexible packaging saw the largest first-half declines, with deal volume dropping 46 percent and 58 percent, respectively.

Financial pros contacted recently by Plastics News shared their opinions on where the plastics M&A market stands in mid-2023 and where it might be going for the rest of the year.

Interest rates are the elephant — or elephants — in the room when talking about plastics or any other kind of M&A. The federal funds interest rate began 2023 at between 4.25 and 4.5 percent before three hikes sent it to between 5.0 and 5.25. The rate had been 0.25 percent at the start of 2022, before the Federal Reserve began a series of rate hikes designed to slow inflation.

Those moves have cooled inflation, which peaked at 9.1 percent in June 2022. The rate has declined every month since then, reaching 4 percent in May. Inflation had averaged around a 2 percent annual rate for most of the 2000s and 2010s.

But higher interest rates lead to higher borrowing costs, which in turn drive down earnings multiples paid in M&A deals and lead to lower selling prices.

Among economic indicators, U.S. gross domestic product growth was just over 2 percent in 2022, down from COVID-fueled growth of almost 6 percent in 2021. GDP growth in the first quarter of 2023 was lower at 1.3 percent.

The Dow Jones Industrial Average began 2023 near 33,100 but closed around 34,050 on June 20 for a gain of almost 3 percent. The broader S&P 500 has showed much stronger growth, starting the year around 3,820 and closing at just under 4,390 on June 20 for a surge of almost 15 percent.

All of these financial factors have played a role in plastics deal volume in 2023.

"There doesn't seem to be as much activity, which isn't a surprise," said Andrew Petryk, managing director with Brown Gibbons Lang in Cleveland. "There's some level of hesitancy to bring deals to market right now. … There are questions about what's going on with the economy and if there might be a recession now or in 2024."

"Interest rates are the driver in lower deal volume," said Peter Schmitt, managing director with Montesino Associates LLC in Wilmington, Del. "If rates stay high, it will cool things off a bit and make buyers more selective in doing deals."

"We're in a weird time, but [lower deal volume] is what happens when interest rates go up," added Andrew Munson, a partner at MBS Advisors in Florence, Mass. "When multiples go down, deal volume goes down. For really good companies, multiples haven't changed a whole lot, but for the average deal, there's been a downtick."

Although several observers expected private equity buyers to be more impacted by higher interest rates — since they finance large amounts of any sale price — the percentage of first-half deals involving private equity or other financial firms actually jumped from 47 percent in 2022 to 53 percent in 2023. PMCF officials said that's the first time since 2018 that financial deals accounted for more than half of first-half activity.

Hart said that increase was because of macroeconomic uncertainty affecting strategic buyers.

"Private equity is still figuring out ways to get deals done, even if some bigger deals have been harder to do," Hart added.

Bill Ridenour, president of Polymer Transactions Inc. in Foxfire, N.C., said it was unclear how much interest rates were affecting dealmaking.

"We're seeing a pullback from strategic buyers, which is what you'd see in a recession," Ridenour added. "I think we're in one right now. People are waiting to see how much volatility there's going to be. They might not want to put big bucks into acquisitions."

At Blaige & Co. in Chicago, Chairman and CEO Tom Blaige said he's seeing deal volume down only 5-10 percent.

"There's an increase in corporate divestitures and spinoffs," Blaige said. "Private equity can draft off strategics like in a race and then move in at the end.

"But the pipeline [for deals] is shrinking as there's a flight to quality. Before, companies might look at 10 deals and do five; now they're looking at three and doing one. They don't want to get shot down by banks," he added.

Matt Miller, managing director at Cascade Partners LLC in Grand Rapids, Mich., said the market is adjusting to the higher level of interest rates. "For a long time, rates were so low it was like having free money," he added.

Deal activity at family-owned businesses "is down a little, but not as much as the overall market," according to Matt Yohe of investment firm MPE Partners in Cleveland. "Family dynamics still drive decisions."

Phil Karig, managing director with Mathelin Bay Associates in St. Louis, said higher interest rates "are starting to bite financial buyers, and there's a squeeze on the amount of credit available." He added that his firm has seen less interest in early-stage companies, as buyers want to find targets with established earnings histories.

Higher interest rates "may be an element" in lower deal volume, according to Andrew Hinz, managing director with Grace Matthews Inc. in Milwaukee, but the slowdown "also just comes down to company performance."

If a company isn't performing as well as they had hoped to when they started the process, then deals could be unfinished or pulled from the table, he said. As a result, companies in that situation may want to wait to sell until they can show continuous performance.

With borrowing costs higher, financial buyers "can stomach high interest rates for a while and hope to refinance down the road," said Rick Weil, managing director with Mesirow Financial in Chicago. He added that his firm has seen 14 or 15 first-round bids for a pair of plastics firms that it's now trying to sell.

From a geographic perspective, the percentage of first-half 2023 deals involving non-U.S. buyers or sellers increased slightly from 57 percent to 58 percent vs. the same period in 2022.

Based on end markets, the number of industrial deals fell only 10 percent in the first half. The construction sector — directly impacted by higher interest rates affecting building costs — was hardest hit, with the number of deals plunging 54 percent.

In individual sectors, the number of resin/color/compounds deals surprisingly ticked up from 20 to 22 for the half, a rise of 10 percent. The number of film deals saw a major decline of 56 percent.

Medical and packaging again were the two most attractive end markets mentioned by financial pros interviewed for this story.

"There's some activity in building and construction, but packaging and medical are still the gold standards," Mathelin Bay's Karig said.

Interest in medical deals is slightly ahead of packaging, according to Munson at MBS. He added that the automotive market "is tough right now."

Blaige is seeing buyers "default to essential industries" like medical and packaging, which are noncyclical.

BGL currently is working on an engineered composites deal, Petryk said, adding that building and construction is holding up better than many expected for 2023.

Hinz at Grace Matthews said buyers "are looking toward any end market that skews toward specialty."

In addition to medical and packaging, there's "a lot of good interest" in materials firms in mid-2023, according to David Evatz, managing director with Stout Investment Banking in Chicago.

"Specialty materials are getting a lot of attention because they can offer new applications and highly technical materials," he said. "And industrial companies have worked through their demand issues and are seeing more growth."

Sustainability has become a major topic in plastics circles, but its importance in M&A deals can vary.

"We're seeing a little more activity with recyclers, but environmental issues aren't a primary driver," Evatz said.

At Grace Matthews, Hinz said sustainability "is important, but it's not driving key decisions." But he added that "ESG [environmental, social and governance] considerations aren't going away. … Bigger chemical firms are looking to acquire recycled and green products."

Schmitt is seeing sustainability play a bigger role at Montesino. "Every other phone call is about sustainability," he said. "It's almost an essential part of deal negotiations today. Buyers are asking when the industry is going to switch from petroleum to bio-based streams."

Sustainability "is starting to get to the tipping point," according to Karig, "more so in Europe. It's not as far along in the U.S."

Ridenour said sustainable products "can be a plus" in a deal. "Buyers like the idea of turning scrap into plastic," he said.

Hart added that interest in sustainability can vary based on end market. "If you're in single-use packaging, you better have a sustainability strategy," he said.

Blaige summarized the industry's longtime attitude toward sustainability: "People want it, but they don't want to pay for it."

The current market situation — with higher interest rates driving down multiples and sale prices — might not have much of an effect on longtime plastics business owners who are looking to sell.

"It's company-specific, but some owners aren't getting any younger," BGL's Petryk said. "They might want to sell unless they have a longer-term time frame."

Interest rates won't affect those decisions, according to Mesirow's Weil. "It comes down to an owner's personal situation more than getting the price they want," he added.

Ridenour said the decision to sell often comes down to the age of the seller. He's currently representing two older owners looking to sell. "Good companies are still getting good multiples," he said.

Higher interest rates "are an unusual trend," according to Blaige. "Clients are still deciding to sell for lifestyle or succession reasons," he said. "Those are more important than financial reasons. But when you sell, it's important that you position your company in the right way."

Strategic sellers such as founders or family members "are less sensitive to interest rates," Miller said. "They're not thinking as much about valuations as institutional investors or private equity groups that need to deliver returns to their investors are."

But Karig and Hinz both said there are times when buyers would be well advised to wait.

"I wouldn't be surprised if some [buyers] wait," Karig said. "There are still a lot of small companies out there that have a personal attachment. Selling represents their legacy, so they'll want to get a bigger multiple."

At Grace Matthews, Hinz said his firm has advised some buyers to wait, especially if they've had "a tough quarter" and need to show that those results are only temporary. Hart at PMCF said selling decisions can involve several factors, including an owner's need for liquidity and time horizon.

Evatz said decisions to sell vary from case to case, but he pointed out that buyers who wait to sell in the current environment could face higher costs and interest rates in 2024.

Looking to the second half of 2023, financial pros are seeing some encouraging signs, but it's still likely that deal volume for the year will fall short of matching the 2022 total. "It's a question of how soon we get back in line with what we've seen historically," Evatz said. "There's still a lot if interest in deals."

"It's already [past] June, so the key question is what [the Federal Reserve] does with interest rates," added Karig at Mathelin Bay. "If they keep rates flat, it might put a spark in deal activity, but if [rates] go up, all bets are off."

"At the end of the day, it's all about the economy," said Miller at Cascade. "Markets might need time to adjust to a new interest rate environment."

Hinz said the M&A market "might see some firming in trends in the back half of the year. ... High-quality companies are getting tons of attention, but they're also facing more scrutiny during due diligence."

At some point, private equity firms have to sell their holdings, MPE's Yohe said. "The [plastics M&A] segment is pretty healthy overall, but interest rates might push some of those deals into next year."

The M&A market "is in a holding pattern, hoping there's not some major event that could cause downside change," according to Munson.

Second-half deal volume should be stronger, Petryk said, but it "would have to be on a tear" to match or surpass the 2022 total. "It feels like the market is settling into a new reality," he added.

At PMCF, Hart said second-quarter sales trends "are encouraging. … It's still going to be a pretty strong year. … We should see improvement over the second half of 2022."

Packaging deals should continue to grow in the second half, according to Weil at Mesirow, and the plastics sector "will continue to be heavily invested" in M&A.

"2023 should end up being a good year, even if it's not a top-tier year," he said.

"The market could be flat for the rest of the year," Schmitt said. "People aren't going to make acquisitions just to make acquisitions. But plastics are still a viable investment area for a lot of companies."