Plastics M&A market cools, higher interest rates take the blame

Dec 16, 2023

After cruising on a high-speed highway, plastics mergers and acquisitions hit a speed bump in the second half of 2022.

And now there are some questions as to whether deal activity can get back up to speed in 2023.

For full-year 2022, the number of plastics M&A deals came in at 363, down almost 34 percent vs. the 485 that were seen in a record-breaking 2021. That's according to deal data compiled by P&M Corporate Finance of Southfield, Mich.

Pent-up demand from the 2020 pandemic year and concern about potential tax hikes in 2022 sent deal volume soaring last year. The 2022 plastics M&A total was almost 8 percent higher than 2019, the last full year before the pandemic.

Financial pros contacted recently by Plastics News cited higher interest rates as a major reason for the slowdown in M&A activity. The federal funds interest rate began 2022 at 0.25 percent, but the Federal Reserve then began a series of rate hikes designed to slow inflation. By the end of the year, the rate was between 4.25 and 4.5 percent.

The rate had been near zero since late 2008, when it was lowered to help the economy recover from the financial crisis of 2007-08. It began to increase slightly in 2016 and had reached 2.5 in 2019 before declining again and being dropped back to near zero to help the economy recover from the COVID-19 pandemic.

Those moves have slightly cooled inflation, which was at 6.5 percent for the 12 months ending December, down from 7.1 percent for the previous month. Inflation had averaged around a 2 percent annual rate for most of the 2000s and 2010s.

Several reasons have been given for the surge in inflation, including strong demand during the pandemic, supply chain problems and the impact of the federal stimulus program, which provided funding to businesses and individuals.

"Interest rates were part of the issue," PMCF Managing Director John Hart said. "In the second half, we started to see the impact of higher interest rates on the broader economy. There were lower levels of M&A activity as buyers became more cautious and debt markets contracted."

"In general, we've seen a change in the market staring in mid-2022," added Andrew Petryk, managing director with Brown Gibbons Lang in Cleveland. "Pricing is down, and buyers are fleeing to quality."

In Wilmington, Del., Montesino Associates LLC "is seeing much more carefully thought-out activity," according to Managing Director Peter Schmitt. "It's not the free-for-all that it's been in recent years," he said.

Comparisons to 2021 also affected the perception of 2022, added Rick Weil, managing director with Mesirow Financial in Chicago.

"2021 was an absolutely epic year," Weil said. "We closed 19 packaging deals, which was more than double our previous record. But in 2022, people expected the world to fall apart after the first six months."

Andrew Munson, a partner at MBS Advisors in Florence, Mass., described the current market climate as Economics 101.

"Interest rates go up, multiples go down, and deal activity goes down," he said.

Strategic clients and buyers at Polymer Transaction Advisors Inc. in Foxfire, N.C., are concerned about price volatility, according to President Bill Ridenour. "A lot of businesses are treading water now, so it's hard to predict how they're going to perform," he said.

Interest rates "have started to bite for the first time in a long time," said Phil Karig, managing director with Mathelin Bay Associates in St. Louis. "Suddenly, there's a question of who will finance a deal for you."

"Clearly there was more uncertainty in the second half of 2022," added Andrew Hinz, managing director with Grace Matthews Inc. in Milwaukee. "To some degree, it was caused by interest rates. The appetite to lend was down as lenders pulled back and became more conservative. They're increasingly more concerned about the general economic outlook."

"Interest rates are a key component to any debt financing," said Matt Yohe of investment firm MPE Partners in Cleveland. "They affect what private equity firms can pay for businesses through a combination of price and leverage. And the amount they can borrow is down."

Based on end market, the number of construction deals surprisingly increased by 32 percent in 2022. Most other end markets were down, including drops of more than 50 percent in food/beverage and auto/transportation.

In subsectors, the specialty category was the only one that showed growth in 2022, up 4 percent. That subsector includes foam, composites, distribution and other categories. Drops of more than 40 percent were seen in resin/color/compounds and sheet/thermoforming.

Based on product segment, industrial was the only growth area in 2022, with a gain of 15 percent. Custom molding deals were down 55 percent, with resin deals down more than 40 percent.

The percentage of deals involving private equity or other financial firms increased slightly from 47 percent in 2021 to 49 percent in 2022. The percentage of deals involving non-U.S. buyers or sellers fell slightly from 58 percent to 55 percent in the same comparison.

Among economic indicators, U.S. gross domestic product was slightly negative in the first half of 2022 before improving in the second half. Market watchers expect full-year GDP growth to be around 2 percent. But expectations for 2023 aren't as optimistic, with many economists, including PN Economics Editor Bill Wood, expecting growth to be flat for full-year 2023.

The Dow Jones Industrial Average bottomed out near 28,700 in late September before reaching 34,200 on Jan. 12, a gain of more than 19 percent. But it tumbled from that point to near 33,000 on Jan. 19 — a one-week drop of 3.5 percent.

The broader S&P 500 followed a similar arc, falling to 3,600 in late September before rebounding almost 14 percent to 4,100 in late November. Since that point, it's fallen almost 5 percent to 3,900 on Jan. 19.

Packaging remains attractive to plastics investors, as does the medical field, even as other sectors continue to struggle. "There's more demand in packaging," Karig said. "People can cut back on home renovations, but they're not going to cut back on food.

"There's also interest in recycled markets because of the focus on a circular economy," he added.

David Evatz, managing director with Stout Investment Banking in Chicago, added that although demand is down in consumer products, automotive and appliance, medical and packaging "have remained stable; there's still a lot of interest there." At MBS, Munson said medical, aerospace, defense and electric vehicle markets "are seeing huge growth." According to Petryk at BGL, supply chain issues have improved for building products, such as PVC windows and doors.

Overall, plastic packaging is still a solid market, Hinz said. "Packaging trends support growth," he added. "That market can be more attractive in uncertain times."

The market is responding to a harsher economic environment in a multitude of ways, with buyers and sellers adopting new strategies.

"If you're a B- or C-[grade] business, it can be a difficult M&A market," Petryk said. "But if you're a B-plus or higher, with strong cash flow and growth, you can find plenty of buyers. Strategic buyers especially tend to have strong balance sheets and can understand a long play."

Private equity firms "still want to buy packaging companies, but they may have to put in more equity now," added Weil. "Strategic buyers might not be able to pursue deals as aggressively as private equity."

MBS already is seeing more distressed deals than it has in several years, according to Munson, as processors struggle with reduced demand. Ridenour added that materials deals have declined as the number of available midsized compounders and concentrates makers has been reduced.

"Seller expectations are still high, but they might be asked to hold on to a bigger piece of the company for a while as an earnout," said Karig at Mathelin Bay. "And buyers might want to do more bargain-hunting."

"There's a scarcity factor, with not as many high-quality companies available," added Grace Matthews' Hinz. "And we're seeing a bifurcation in the market between North America and Europe, which has been hit harder by the economy."

Strategic buyers "are as active as ever, looking for new technologies and new geographies," he said. And a lot of strategic buyers are well positioned in this market because they don't require debt and have fundamentally strong balance sheets."

But a higher cost of capital "affects a buyer's ability to pay, and a valuation then might not be in sync with what a seller looking for," according to Evatz. "Inflation also affects a company's performance, so an owner might put the decision to sell on hold."

Buyers and sellers "are grappling with the increased cost of capital," said Matt Miller, managing director of BlueWater Partners LLC in Grand Rapids, Mich. "Sellers were excited at record multiples, but now buyers are more sensitive to cost." He added that the market has "a weird dichotomy" between financial and strategic buyers, with strategics more focused on the economy.

Banks and lenders are "looking more critically at marginal deals," added Thomas Blaige, chairman and CEO of Blaige & Co. in Chicago. "It's a groupthink effect, with banks and boards becoming more conservative. But some headline deals and trophy deals still might get done because there are tons of money uninvested."

With multiples down, sellers "need to be flexible" and look at deferred compensation or rollover equity, according to Yohe.

Opinion was mixed among financial pros as to how higher interest rates would affect plastics business owners' decisions to sell or not sell their companies in 2023.

"We're still seeing a lot of companies doing well at attractive multiples," said Hart at PMCF. "But it depends on how the macroeconomy is affecting your business. If you have a business that's doing well and you want to be done and retire, you can still do a good deal."

"Some owners might wait if multiples are down," Montesino's Schmitt added. "They might ask if this is the right time or if they should hang on for a while."

"That conversation is driven by life cycle events, not necessarily the economy," added Miller. And many sellers "don't have an unlimited time horizon," according to Hinz.

"Trying to time the market is extremely difficult," he said. "If your company is doing well, you can still get a great outcome."

Buyers also have to consider their approach, Evatz said. "At the end of the day, if a buyer has conviction, cost of capital shouldn't be a deciding factor," he added. "It shouldn't come down to an interest rate." Yohe added that owners doing retirement or estate planning "still can get a great deal" through an earnout or a similar move.

For owners, Blaige said, the current environment is like the TV show Shark Tank: "If you're not prepared, you're going to get a bad deal. You can get the number you want if you're in the right process and the right market. You might need to keep more equity or change the deal structure, but it can be done.

"But at the same time, be aware that investors aren't throwing money at processors anymore, so you might have to talk to more people than you did a year ago."

Even with so many challenges, financial pros were optimistic about plastics M&A for 2023.

"[2023] should be a pretty good year for M&A," BGL's Petryk said. "At the higher end of the market, there are going to be opportunities to achieve attractive valuations."

Deal volume "should come up some from where it is, after the initial shock of higher interest rates," added Karig. "Sellers will back off of higher expectations as long as rates go up or they're uncertain about the economy."

At PTA, Ridenour said buyers are "befuddled" by the economic environment. He added that he's concerned the U.S. government paralysis will affect energy prices that then will affect plastics prices.

Hinz is more optimistic: "My sense is that we'll see activity improve as the year goes on. If we get more clarity on the economic situation and the supply chain improves, the second half should improve even more."

"I don't see plastics and packaging cooling off," added Miller at BlueWater. "We expect activity to stabilize and then pick up in the second half."

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