October 2022 - Tough times can lead to great deals
In a previous article, we looked into what makes for a good acquisition. It certainly was not a delve into complex theories, rather it looked to firmly anchor in some common sense notions. The guidelines for assessing the merits of an acquisition were about suitability and scale.
Was the acquired business complementary, would it integrate easily into the current business and add to the overall business. Was the scale of the acquisition appropriate both in terms of the size of the current business and in terms of a price that did not stress the balance sheet. The conclusion of that article was that large “transformational” acquisitions are dangerous, difficult to integrate, highly distracting for management and burdensome on the balance sheet, while sensible bolt-on acquisitions are much more attractive, being easier to integrate and requiring a whole lot less bank debt or new equity, if indeed any new capital is required at all.
The ideal acquisition, potentially only to be found in a world of magical realism, would then be one of a large and complementary “transformational” business that only cost as much as a bolt on acquisition. That of course only happens in an imagined world, that just shouldn’t happen in the real world. Owners just do not sell substantial businesses at a fraction of their intrinsic value. Well, they certainly never want to but sometimes circumstance dictates otherwise.
To make a point, let’s take an extreme example. IVE Group is an ASX listed company that prints, among other things, catalogues and glossy magazines. This used to be a great industry, but the arrival of PCs, tablets and smartphones have led to severe structural decline in that industry. And that decline has been rapid, just as recently as 2016 there were four large companies that competed with IVE Group. At that point in time, customers who needed printing services for catalogues and glossy magazines could use either IVE Group or Independent Print Media Group or Franklin Web or AIW or PMP. Jump forward to the beginning of 2020 and IVE have now acquired Franklin Web and AIW. Meanwhile Independent Print Media group had acquired PMP and changed its trading name to Ovato. So now the industry had consolidated from five suppliers to two. The structural decline in the industry has already taken a very heavy toll but there was even worse coming around the bend, the arrival of the virus which impacted demand and logistics nightmares and through 2021 led to spiralling costs of doing business.
These operating pressures combined with poor management decisions ultimately led to Ovato declaring bankruptcy earlier this year and its owners becoming forced sellers. IVE, as the last man standing, was the natural acquiror of Ovato, an acquisition which would give IVE a monopoly in the catalogue and magazine printing business. In theory that leads to the Australian Competition & Consumer Commission to blocking such a deal, it is after all one of their key functions to stop companies forming and then abusing the power of a monopoly. But here is the first amazing part of this deal, the ACCC approved the transaction allowing IVE to become a monopoly. This quote from the ACCC summed up the situation perfectly:
“The feedback we received from several customers was that while they were concerned that IVE would be their only option, they were more concerned with the impact on printing capacity if Ovato's assets were liquidated.” - Extract from the ACCC ruling.
This quote is also a strong indication that while the overall demand in the printing industry had declined significantly over the past decade, a base level of demand had formed and that customers were concerned that there would be insufficient capacity for their printing demands. Indeed, there are some signs that advertising campaigns are shifting back to using printed catalogues, for example in the US, Amazon has started printing an annual 100-page catalogue to promote toys and games in the run up to the holiday season. The print run for this catalogue alone ran to several million copies. Encouraging signs for a catalogue printing business.
So, IVE being allowed to form a monopoly in a steady state industry is a great development but surely they had to pay top dollar. Well, here is the second amazing part of this “transformational” acquisition, the actual price equates to buying Ovato on a price to earnings ratio of close to 1x, the holy grail that investors seek but seldom find. They purchased a business that in its first year they expect to generate revenues of $160m and a profit of $15m for a cost of $16m. IVE do expect to invest $20m extra in integration costs and capex as a result of the acquisition but even including those costs the purchase price is still only a price to earnings of just over 2x. And this for a business that is giving IVE a 35% uplift in group earnings and monopolistic power. “Transformational” for the price of a bolt on, it’s a truly amazing deal.
The moral of this story is that even the toughest times can be times of great opportunity. Particularly for the strongest player in an industry or sector. And these are shaping up to be tough times and not just for printers. But those companies that have a strong balance sheet and generate earnings throughout the cycle, no matter how tough, and think long-term may have opportunities like IVE to make “transformational” acquisitions at a bolt on price.