Selling Points: Mergers and acquisitions in the COVID-19 environment

Kevin Mullaney, CEO, PDF Print Communications Inc.

Kevin Mullaney is no stranger to the deal-making process. The CEO at PDF Print Communications Inc. has overseen a string of acquisitions for his Signal Hill, California-based company, with six of those transactions occurring in the last four years alone.

While Mullaney doesn’t like to play favorites when it comes to acquisitions, he is excited about his recent purchase of Bestforms. As published in Print+Promo’s 2019 Top 50 Suppliers list, the Camarillo, California-based trade printer put forth annual revenue totaling $10 million and is expected to push its new parent company’s sales near the $35 million mark. However, keeping true to his objectives, Mullaney is more focused on the big picture—specifically what Bestforms’ expertise in integrated card applications can do for his customers.

“Bestforms has been more of a national competitor selling to the trade just as we do, but there was not much overlap between our customer base and theirs,” said Mullaney, who hopes to cross-sell to Bestforms’ clients as well. “[They] have some incredibly unique pieces of equipment and capabilities that will both complement and enhance what we already have in our SoCal, NorCal, Phoenix and Madison, Wisconsin, plants.”

There is a mutual respect between Mullaney and Joe Valdez, president and minority owner of Bestforms. According to Mullaney, the two have had informal conversations about Bestforms for a while. Talks turned serious in March when majority owner Ron Eisele decided to explore retirement options. The transaction was finalized in June under the cloud of COVID-19.

The COVID Effect

It’s easy to forget that just a few months ago, we were all monitoring a flurry of mergers and acquisitions that signaled good economic health. Thanks to the coronavirus pandemic, the country has been thrown into financial disarray and suddenly everything looks different.

Naturally, there was an immediate focus shift to employee safety and business preservation actions, so leadership paused some of its longer-term strategic plans.

“A couple transactions that I had in play pre-COVID have stalled because the buyers want to wait and see if the sellers can recover back to pre-COVID financial results,” said Casey Campbell, president of PathQuest Group Inc., a private consulting and intermediary firm serving the print and print distribution industries, based in Fayetteville, Ga. “Over the past couple of months, valuations are in flux. Sellers want pre-COVID valuations and buyers want assurances that all lost business will return.”

Mullaney admitted that the pandemic does concern him, and he’s tracking the industries that have been heavily impacted to gauge how their performance may affect his business in those verticals moving forward. Even though the Bestforms deal was ongoing during the height of the initial pandemic response, Mullaney wasn’t willing to abandon a company with a “great reputation.”

“COVID-19 makes you think twice about doing anything merger related, but we felt this would add value to our existing clients and better position our footprint on the West Coast,” he said.

Like Mullaney, Brian D. Gale, president and CEO of I.D. Images LLC, Brunswick, Ohio, has embraced an acquisition-minded growth strategy. Under his watch, the pressure-sensitive label converter has welcomed roughly five companies in five years to its family. Where Gale differs is that he employs a mix of acquisitions and green field operations to expand his bottom line.

“The label industry is incredibly fragmented,” he observed. “I believe companies have two choices: Be small and nimble or have scale. Our largest market is variable information labels. I think that market requires scale. We are using scale in that market to enter other markets. Acquisitions give us scale, knowledge, customers and equipment. We have used a combination of acquisitions and green field operations to grow. ... We will continue to do so.”

When identifying potential targets, Gale considers several factors, starting with the impact on the base business. Will it help or hurt? Next, what is he hoping to accomplish—does the need center around geographic location, capabilities, customers or workforce? In a perfect world, an acquisition brings all of those, Gale said. Take, for example, the August closing of I.D. Images’ acquisition of Kieran Label Corporation.

In response to exponential demand on the West Coast, I.D. Images added manufacturing assets to its facility in Rancho Cucamonga, Calif., in 2016. The company quickly outgrew this location, leaving Gale with the decision of whether or not to move to a bigger facility and purchase extra equipment. But when a mutual friend introduced him to the Vanier family, owners of the San Diego-based vertically integrated and ISO-certified label manufacturer, the better choice became clear.

“We had an introductory phone call about what they wanted to accomplish and what I was looking for,” Gale relayed. “That call led to signing a nondisclosure agreement. They shared some information and we talked in high levels about what a transaction might look like.

“I then flew to San Diego, did a plant tour and met with [CEO Denis Vanier and his son André Vanier],” he continued, noting that COVID-19 elongated the process. “They shared more information. We then prepared a letter of intent (LOI) outlining the deal terms.”

Although the pandemic makes Gale apprehensive, he tries to focus on what he can control. I.D. Images has adapted by carrying extra inventory and implementing safety protocols in its plants.

“As long as we treat our employees and customers well, our business will be fine,” Gale said. “I cannot control shutdowns or supply chain issues. Both worry me.”

In the short term, it’s hard to guess how COVID-19 will shape the M&A scene. The upheaval was sudden, and experts are trying to measure the losses it is causing. We do know that our industry is tied to the economy, so as the threat of the virus fades and the economy begins to rebound, M&A activity will do the same.

It is also important to mention the differences between the current crisis and the housing market collapse in 2008, the event that triggered the Great Recession—a time when industry revenues softened, forcing many firms to merge with other businesses or to permanently close their doors.

“Leading up to the 2008 financial crisis, easy credit and rising home prices resulted in a speculative real estate bubble and caught most by surprise,” Campbell explained. “While the market crashed in 2008, the problem started many years earlier and was primarily a domestic issue.

“COVID is a worldwide issue,” he went on to say. “Prior to COVID, the U.S. had a healthy economy, largely due to what we learned from 2008. Like many, I feel reassured that we will return to a healthy economy and an improved M&A landscape once a vaccine is available to all.”

Another reason to be hopeful about favorable M&A trends is an aging workforce. As Campbell pointed out, business owners who were 60 years old in 2008 are now 72 years old and nearing retirement. PathQuest Group’s last transaction to close was in February; however, Campbell has signed three listing agreements in the past four weeks, a clear demonstration of confidence in the long-term economic recovery.

Jim Anderson, founder and president of Corporate Development Associates, a private intermediary firm located in Scottsdale, Ariz., believes the coronavirus might push owners to speed up exit strategies. He hinted at potential deal closings for September and “certainly by December.”

“I am very optimistic, probably more so due to COVID,” emphasized Anderson, who has been an M&A consultant for over 33 years, having closed more than 200 transactions. “Owners still get older and the additional threat of COVID makes them think even more about selling.”

Both Anderson and Campbell said most owners fail to put a proper exit strategy in place, which can be a costly mistake. Anderson encouraged executives to get serious about this around the age of 60. He did clarify that they do not have to implement plans at that time. In fact, a deal itself might not happen for “five or 10 years-plus if they remain healthy.”

“Every business owner should have some idea of what his or her company is worth and whether or not that amount can let him or her live out his or her golden years in the manner to which they have become accustomed,” he said.

According to Campbell, timing is more than the “when.” The best exit strategies, he said, focus on timing related to personal goals, as well as achieving pre-established performance objectives like revenue, gross margins, operating expense, EBITDA and debt reduction targets.

“Do not forget that your balance sheet needs to be as clean as possible,” he reminded potential sellers. “Most deals we see are asset purchases, and lingering liabilities will impact what you walk away with.”

For this and other reasons, buyers and sellers should hire an intermediary firm, especially one with specific industry knowledge and experience, along with M&A know-how.

All in Due Time

“Keep in mind that most buyers have bought before and this could be the very first transaction in which a seller has been involved,” Anderson cautioned. “As a buyer, you can afford to make some mistakes, but I think another set of eyes on a deal is always a good thing.”

And do expect to make mistakes. Mullaney, who has completed nine transactions (including the Bestforms deal) with Anderson’s assistance, has made his fair share. But, his takeaway from repeated experience with M&As is to learn from those mistakes. With Bestforms, he involved Anderson in the early phases of the process.

“Compared to other transactions, this one went pretty smoothly,” Anderson said. “Probably the biggest challenge was Bestforms’ receipt of some Paycheck Protection Program money, and discussions ensued regarding whose money it actually was since PDF Print Communications would be the new employer during the eight-week period after Bestforms (the legal entity) received the government funding.”

Buyers are going to have questions—most of which can, and should be, answered during due diligence. This phase of an M&A transaction commences after the acquirer presents the seller with an LOI to purchase. Remember that clean balance sheet Campbell mentioned? In layman’s terms, due diligence is an investigation, audit or review performed to confirm the facts of the matter under consideration. In the financial world, it requires an examination of financial records before entering a proposed transaction with another party. Understanding what the seller wants out of the transaction falls under due diligence as well.

Acquirers are sensitive to red lights. For Gale, lack of transparency is a negative indicator and, ultimately, a deal-breaker.

“The biggest deal-breaker is not getting a good feeling from the seller,” he said. “If the seller is not forthcoming in providing information, I get concerned. Fortunately, every deal we have signed an LOI for has closed.”

Due diligence is necessary, but, for Mullaney, interviewing key employees and key clients is equally crucial. Doing so can eliminate unwanted surprises after the deal closes. Surprises can range from key employees wanting to retire sooner than expected to clients eliminating a specific product line or order that can have a negative effect on the business going forward.

“If we do not have good management that wants to join our organization, it usually is a deal-breaker,” said Mullaney, who aims to retain approximately 90% of staff in the acquired company.

It Takes Two

In these stories, both buyers built an acquisition wish list specific to their individual needs. Yet, they were unanimous in identifying an intangible element that cannot be measured, but rather mastered if the deal is to work. This is the fit of company cultures.

“Kieran Label shares a similar ‘customers first, employees always’ attitude that we strive for at I.D. Images,” Gale said. “Cultural fit ... is hard to measure, but it is more important than the financials. ... If a company has a poor culture, the only way to really fix it is to replace the team. That is not how we operate. We are growers, not shrinkers.”

Assuming these issues have been addressed, the deal can proceed, but next comes what some say is the toughest part of all: combining operations, aligning workforces and harmonizing everyone’s way of getting things done. Even when visions are aligned and personalities gel, there still can be kinks to iron out.

One challenge that Mullaney has faced of late is unusual perks. He described this as a vague concept, but, typically, it involves merging conflicting management styles that can otherwise become cumbersome to track. In the case of Bestforms, one company policy didn’t sit well with Mullaney.

“Bestforms had a lot of weird things they did for their employees [such as giving them] one hour per week bonus for showing up to work on time,” he said. “To me, this is nonsense. You’re expected to be at work on time each day. Having all these scenarios makes accounting a nightmare.”

Gale credits his executive team with easing the transition.

“As I tell [my team], ‘I pay you a lot to deal with all these challenges!’ My real words are much more colorful, but not fit for a family-friendly publication,” he joked. “They are really good at addressing employee and customer concerns. We also have a track record. I have had employees that came via acquisition answer questions for new employees. That helps.”

He confessed that the pandemic has complicated the integration process with Kieran Label. With California currently deemed a COVID-19 hotspot, it hasn’t been safe for employees to make the trip to the West Coast.

“I did not fly to San Diego to introduce myself to the team as I usually do when we do an acquisition, due to potential quarantine concerns,” Gale said. “But, our team and [the] Kieran team adapted. [Microsoft] Teams is our friend! Our directors, Richie Muniak, finance and information technology; Maria Davis, human resources; Tim Mlnarik, sales and marketing; and Tom Kubis, production, have been great at adapting. Our plant manager at Kieran, Allen Henry, and one of the former owners, André Vanier, have been great at helping us communicate with the team.”

How You Know

Pandemic aside, selling a business is a major decision that should be well thought out. In addition to seeking counsel from your CPA, attorney or intermediary, Anderson encouraged owners to consult with members of their inner circle.

“Friends that have nothing to gain can be of assistance,” he suggested. “And don’t forget your spouse and other members of your family.”

Gale posed the following question to potential sellers: Can your base business run without you and without a few key employees that need to help with the acquisition? If the answer is “no,” then you’re not ready to sell.

“One of my sayings is, ‘We can’t forget the golden goose,’” he said. “Everyone likes the shiny new toy, but the existing business is what makes payroll and funds acquisitions. You can’t lose sight of that. As a leader, it is my responsibility to make sure we never lose that focus.”