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Shaping up for resurgent M&A market

Five to 10 years ago it was a beautiful time for the would-be seller of the middle-market plastics company to cash in his chips. Today, buyers are back, and pricing is on the rise.

Before the crash, earnings were strong and buyers were hungry. Well-run plastics companies routinely traded for six to eight times their pretax earnings.

Then, somewhere in the year or so before September 11, 2001, plastics manufacturers began to feel pain. Margins tightened up. Customers expected quick drops in pricing when resin prices dropped, but were not nearly so quick to let the increase back in when raw materials prices increased. And buyers who used to turn to Mexico for the occasional big purchase moved even further away-to China or Taiwan.

Suddenly, buyers weren''t so sure that plastics manufacturing was a great place to be. Smaller processing companies began selling for three to four times pretax earnings, and buyers were thin.

M&A on the rebound

Today, pricing is finally on the rise, and so is buyer confidence.That doesn''t mean offshore competition or tight pressure on margins are gone. Though often lessened a bit, they''re still worthy of caution. However, long-time holders of the private plastics manufacturer once again have options for exit. Earnings in many cases haven''t reached the high of five years ago, but they are decent-money is coming back into the market, along with fatter multiples for sale.

So what can today''s processor do to build and enhance value? To build value and maximize marketplace strength, consider the following.

1. Strengthen your niche

When you have real niche strength, you have "competition resistance"; pricing needn''t be shaved to the last penny possible to survive and keep customers.

How do you achieve this? You ensure that the team within your organization listens to customers and does the special things for customers that others can''t duplicate, whether it''s performing to quality specs that others can''t match or doing the "extra thing"-in packaging, finish work, or assembly and/or delivery to end users-that makes you special, knowledgeable, and beloved by your customers. The stronger you can bind certain segments of customers to your organization, the stronger you are in that niche of the market.

2. Stay attentive to cost-effectiveness

One of the things that weakened U.S. manufacturers 10 years ago was a tendency to become complacent and more than a little bit fat. Our firm has seen plastic manufacturers with almost identical product mixes that show wild differences in cost structure. Sometimes such differences amount to as much as 10% to 20% of sales in a given cost segment. Take, for example, two specific injection molders we represented almost 10 years ago in sale, both making products of about the same size and complexity: one had direct labor costs of 45% in the same year, while the other kept direct labor to slightly more than 20%.

It is very easy with an older, established company to become lethargic about increasing efficiency. It is easy to raise staff pay rates year after year without changing the work mix or the required performance level expected .

In today''s world companies simply don''t have an extra 20% to play with if they want to stay healthy. Work together with your team, those great long-term people, to find ways to evolve and enhance what they do to make it worth more to the company. And, when you must, thin the ranks. Keep those costs in line if you want to keep your company healthy and competitive. If you do that well, there will be strong jobs for a long time to come for all of your top people.

3. Don''t neglect capital assets

When the time comes to consider new investor equity, one of the inevitable questions buyers will ask is, "What will be the cost to get or keep assets where they need to be to support the operation in the future?"

The natural tendency for the long-established owners of plastics processing companies is to get increasingly lax and inattentive to new and evolving technological changes. This happens because, a) management hasn''t "grown up" with the evolving technology, and is simply more comfortable doing things the old way, and b) owners hate to invest in equipment that may take years to pay for itself, especially when they aren''t sure how many more years they want to work.

Take the time, at least once a year, to plan your capital enhancement and maintenance needs for the future. Don''t wait until catch-up or replacements are needed on multiple fronts in one short time period. Digest the updates gradually and steadily as you go.

4. Keep that balance sheet getting stronger every year

Write off and move out bad inventory. Pay off and clean up debt. Hire a good CPA, and head toward the goal of producing high-quality internal financial statements quickly after each month-end. Aggregate adjustment of not more than 5% to net income at the end of the year is a reasonable target, and often has a major payoff. Also, final year-end financial statements should be audited or reviewed routinely, even if your bank doesn''t demand it.

If you''re an engineer by background, the improved and enhanced system of financial management controls may not seem like the most important element of business control to you. Worse yet, it may be the element of business management that you like least (perhaps second only to personnel matters). However, it does, undoubtedly, add value.

Also, regardless of how you cash in on the ending value of your company, it will be worth more, dollar for dollar, if you have less debt. And the reliable and fast interim accounting mechanisms that you build for your company add value via the enhanced confidence and reliability buyers feel in setting a price.

5. Work yourself out of a job

Buyers, and any type of equity investor, feel a certain measure of insecurity about a long-time owner leaving. If you build independence within your management team, you build value in your company, you build security for your staff and greater likelihood of good jobs with a new owner, and you build greater personal freedom for yourself today.

All of these things can help you take advantage of the solidifying business-equity markets available today. There is far more demand today for would-be sellers than there is supply available. Additionally, with a 15% capital gains rate, it may never be this good again.

Average pricing for the mid-size plastic processor is averaging probably four to six times pretax earnings, with the possible premium in those segments where buyer competition drives desire. Once again it is possible to reap a reasonable reward for all of those years of hard work, and to ensure s strong future for the people who have stood by your side.

Deborah Douglas ([email protected]) is the managing director of the Douglas Group (St. Louis, MO), a leader in plastics company mergers and acquisitions that represents middle-market business owners in the sale of their businesses, and periodically assists large corporate acquirers in acquisition planning and very specific and focused business search endeavors. Douglas is the author of a new book, Cashing In, published by Word Assn. Publishing.

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