December 4, 2017
It seems that all anyone in the converting business wants to talk to me about these days is “What is my business worth?” This question is usually followed by “and who might the likely buyers be?” M&A (mergers and acquisitions) fever has ripped through the industry like an epidemic with no cure in sight. Public companies have difficulty hiding the economics of most of their acquisitions, so when their deals are announced, there is the usual reporting of economic value and multiples. Private company deals are generally announced with very few details, which always gets the rumor mill going with all kinds of conjecture. There have been a host of announcements of deals in the last year running the gamut from a few million dollars to more than a billion dollars and everything in between. Is there an end in sight?
The key dynamics that are driving this phenomenon are:
- The quantum leaps that technology has offered in converting speeds and the overall converting capacity of each plant.
- An imbalance in the supply of and demand for paper in North America.
Converting Capacities
As you can see below, the corrugating capacity has increased by almost 250 percent, and the converting capacity has increased by almost 550 percent. Since there are now corrugator installations with widths of more than 130 inches and speeds approaching 1,500 linear feet per minute, this disparity is accelerating. This, coupled with the slow growth in the demand for corrugated products, means the economy needs far fewer corrugated plants.
Supply of and Demand for Containerboard
In 1980, approximately 40 percent of the world’s demand for containerboard was in North America. Today this number is closer to 20 percent, as so much manufacturing has gone elsewhere. Yet almost all of the mills that were around then are still in operation, and many more mills have been constructed since. Because the absolute demand for corrugated products has grown modestly, we find ourselves in the unenviable position of having a containerboard supply of approximately 36 million tons per year and containerboard consumption of approximately 30 million tons per year. Based upon the latest data, approximately 18 percent of the containerboard manufactured in North America is for export.
The key are the profitability associated with these export tons and whether these export levels are sustainable in the long run. According to most of the industry analysts, much of this tonnage is, at best, marginally profitable, although the reports have indicated pricing has improved recently. In any event, the paper producers make a lot more money on tons that are consumed domestically. As to the issue of sustainability, much of the world has been actively building high-tech, state-of-the-art mills, geared to produce lighter-weight, higher-performance paper than most of the older mills here in North America. Lower-weight recycled paper offers customers a potentially significant competitive advantage over heavier-weight kraft paper, which over time may seriously erode the profitability of North America’s existing mills. While the output of our pulp-based mills is both desirable and necessary in other parts of the world, this disparity is also being made up by new mills in emerging economies that also have significant forestry resources.
North American paper producers are therefore trying to become more vertically integrated by owning more North America-based converting operations. The continuing increase in the price of containerboard by the North American producers without significant increases in the input costs associated with manufacturing the containerboard has given these companies almost unprecedented profits. Their perceived need to be more integrated with North American converters, coupled with their concerns over the long-term sustainability of export markets and availability of significant profits to invest, has fueled this M&A fever.
Is This a Good Thing?
If you are an independent converter looking for an exit strategy, this is an excellent thing. The change in the dynamic here is that in past years, an acquirer would only look at paying you a return on the profits produced in your operation. Integrated buyers today will also add the increased profitability on the tons they are currently exporting at lower profit levels to the consideration that they are willing to pay. When multiples get reported, they are generally very high based upon the profits generated by the converter, but very reasonable when looked at from the point of view of the integrated purchaser.
If you look at this from a global perspective, it simply represents one domestic mill-based company taking domestic converting business away from another domestic mill-based company. It is not really creating any more value within the overall domestic containerboard business, so billions of dollars are being spent without them representing any real investment in the containerboard business. North America is in dire need of new investment into containerboard and converting businesses. European producers are eager to enter this market, and they possess technological and operational knowledge that may eventually cause a quantum change in how this business is conducted here. Yet the major integrated producers seem to be chasing short-term profits by chasing higher levels of integration.
It is also questionable as to whether integrated companies with a need to cut up tons domestically will have the ability to keep the bulk of the business that they are acquiring with their purchases of independent converters. How much appetite they will exhibit for shorter orders that go over multiple machines and require tighter tolerances and shorter delivery schedules remains to be seen. An independent business is sold at a higher price because it is generally harder to do. The typical target independent company’s earnings that exist and the tons that go along with them are usually dependent on a much higher level of service than most integrated companies are willing and able to give. Will the gains associated with these acquisitions be permanent? Only time will tell.
Is There an End in Sight?
It is difficult to say now how long this will last. Mill-based companies have a lot of cash, and many are still actively looking for acquisition targets. Unless there is a major change in the economics of the export markets or they realize that they may have a challenging time servicing business currently run by independent producers, I would expect it to continue for the foreseeable future.
Mitch Klingher is a partner at Klingher Nadler LLP. He can be reached at 201-731-3025 or mitch@klinghernadler.com.
