The Future of Packaging Conference, co-hosted by L.E.K. Consulting and Smithers Pira, has been postponed until April 27, 2021. In lieu of this year’s conference, we are releasing four Executive Insights based on virtual interviews with conference panelists, which cover the following topics:

Packaging M&A: Where Is It Headed?

Packaging has been a highly active sector for mergers and acquisitions (M&A) over the past two or three years, with active involvement from both private equity (PE) and corporate buyers. But not surprisingly, the COVID-19 pandemic has led to an about-face. Nearly all deal processes have been paused or postponed indefinitely due to market uncertainty and a lack of financing. Only a small number of deals (e.g., tuck-ins, public company noncore assets) are continuing.

COVID-19 has had an especially negative impact on foodservice (mostly institutional foodservice) and sustainable packaging demand, and companies focused in these areas are expected to experience a slower recovery. Overall packaging demand, which has spiked at times during the pandemic, is expected to steady business performance, enabling diversified packaging company sellers to return more quickly to financial health.

Top-tier assets that have proved to be more insulated from the impact of COVID-19 are likely to maintain their pre-crisis-level multiples. More-volatile assets will probably see compression of multiples given their less positive outlook, but overall expectations for future valuations vary.

Almost certainly, we can expect to see buyers take more time to conduct due diligence and complete deals — reversing the recent trend toward shorter timelines. Many will need some time to acclimate to the new risk outlook for businesses. They will want to understand a company’s performance through COVID-19, and their diligence efforts will include COVID-19-specific adjustments. To accommodate this focus, sellers will need to be able to offer precise and accurate information on the pandemic’s impact on their business.

The uncertainty of the current deal landscape can be unnerving, and it can be hard to read the tea leaves. To help make sense of it all, L.E.K. recently sat down with a distinguished panel of experts from corporate M&A, private equity and banking as part of our virtual Future of Packaging Conference:

  • Mike Palm, Senior Managing Director, Evercore
  • Mike Denvir, Partner, The Jordan Company
  • Suj Mehta, Senior Vice President, Tekni-Plex
  • Eric Kanter, Partner, Morgan Stanley Capital Partners

Excerpts from our conversation paint a detailed picture of where the M&A landscape for packaging is heading.

L.E.K.: How has COVID-19 impacted packaging M&A to date?
 

Suj Mehta (Tekni-Plex): It’s not a surprise that COVID-19 has had a profound impact on deal flow. Nearly all of the processes that have been launched have been suspended. Additionally, there is a general pause on new processes and a suspension of some deals that were in the earlier stages of the deal cycle. You have to attribute this slowdown to a ton of market uncertainty and a lack of financing. COVID-19 has just created a lot of uncertainty in the market.

Mike Denvir (The Jordan Company): The headline on deal flow due to COVID-19 is that M&A has come to a halt. For deals that are paused, there are potential buyers, but banks are trying to bring more people into the room as potential buyers. This will hopefully keep parties interested and result in a more competitive process when the deals eventually come back online. Private owners are also feeling uncertainty that they didn’t expect, so they’re more receptive to having conversations and engaging with potential buyers.

While regular-course PE deals will stop for a period of time, most processes that were paused are going to come back when the market opens up. As things begin to normalize, companies will begin to focus more on where the best opportunities lie. I think that the first wave of deals will be smaller, add-on acquisitions.

L.E.K.: Is there any activity at all, and if so, where is it happening?
 

Suj Mehta (Tekni-Plex): There has been minimal M&A activity in packaging; the deals that are still happening are few and far between. You can attribute it to one thing only, the broader uncertainty in the market. This outlook is impacting the debt markets, driving financing uncertainty. The deals that are ongoing are either very low leverage deals or sales of distressed assets. The deals getting financing are at a very low leverage level, but that’s really it. While there may be buyers able to transact either with all-cash or bridge type financing, the bigger obstacle to M&A deal activity will be [the] willingness on the part of the sellers to market their business given uncertainty around valuation.

Then there are some assets that may have to sell. They would be those that are typically in distress and could be those largely impacted by COVID-19. For companies that may have been on the fence about selling, COVID-19 impacts could push them into selling. You may also have a different type of buyer that comes to market for this type of deal, such as funds focused on distressed assets, who is willing to take on the risk of buying companies that may have been overexposed to COVID-19 impacts, such as foodservice, for example.

Mike Palm (Evercore): The only deal processes I’m aware of that are ongoing are distressed situations, including rescue financings/private investment in public equity (PIPEs), and in one particular situation, a small, noncore asset of a public company. Distressed assets are in a situation due to COVID-19 where they need to find capital to de-lever/provide sufficient runway, which may include selling assets in an effort to preserve equity optionality and value.

Narrowing the focus to the traditional packaging space, the good news is most packaging companies are experiencing solid demand in the COVID-19 environment given the principal end markets of food and beverage (F&B), household, personal care, and pharma. The key areas of focus have been addressing operational challenges — meeting orders, protecting employees, dealing with COVID-19 in a facility effectively [and] labor and supply chain challenges. These are relatively high-class problems. Where we have seen weakness is in select industrial packaging end markets and areas affected directly by social distancing such as foodservice packaging. The good news for the short list of companies that have demand challenges is that, with rare exception, there appears to be sufficient liquidity/balance sheet flexibility to weather the storm, depending on its length.

For public companies with noncore assets, they may be motivated by selling for another reason than maximizing proceeds. These companies may be hoping that the public markets will reward them for selling a noncore businesses and that given their size and noncore nature, [it is] better to divest, de-lever and reduce the complexity of the overall business. 

When we arrive at a better understanding of what the new normal will look like, we do see the sequencing of M&A activity to start first with relative value trades (both public and private), where the benefits of the combination and the structure provide both risk mitigation and sharing. We would also include minority interest sales in this category, to include potential PIPEs to support transformational M&A. The return of what I would describe as regular-way M&A with an orientation toward cash buyers will take longer to develop, with the potential exception for assets that are high quality and are performing exceptionally well if not benefiting from the COVID-19 crisis.

Mike Denvir (The Jordan Company): Financing has just been difficult to get among all this market uncertainty, which means there are very few deals that are progressing. Deals that are progressing are either a target that has a strategic buyer or carve-outs from larger, typically public companies. Both of these types of deals are driven by liquidity and financing dynamics. For corporate strategic buyers that don’t need financing, they don’t have to overcome the challenges with uncertainty in the debt market, and carve-outs may be driven by a larger company needing liquidity for other parts of their business.

L.E.K.: What will be the impact of end-market exposure when sellers come back to the market? Are certain sectors likely to outperform others?
 

Eric Kanter (Morgan Stanley Capital Partners): COVID-19 has had an interesting impact on the packaging sector. Certain sectors have outperformed while others are clearly challenged — foodservice certainly falls into the challenged segment. Obviously, with in-restaurant dining being virtually nonexistent right now, companies that focus on foodservice and have big fast casual restaurant chains or quick-service restaurants, etc., as their top customers are going to be down.

Further, sustainable packaging is also getting impacted negatively as it is most prominent in foodservice. The question with sustainable packaging turns to what is actionable and needed in foodservice given the current COVID-19 pandemic and cost-cutting measures by companies. The reduced demand for foodservice and specifically sustainable packaging is likely hurting companies specifically focused there.

Mike Denvir (The Jordan Company): There are certain subsectors within packaging that are recession resistant, but they aren’t necessarily pandemic resistant. As a result, foodservice is getting hit harder than in a typical recession because a typical recession doesn’t force people to stay in their homes.

These types of foodservice companies, I don’t necessarily see them rushing back for a traditional sale — instead, they may have to explore some more creative options (e.g., joint ventures, trades between different owners).

Mike Palm (Evercore): The subsectors of the packaging market that have been hit the hardest are industrial and select areas of foodservice packaging. On the other hand, businesses that are focused on F&B consumption in the home and/or ecommerce are seeing solid demand and are likely candidates to lead the M&A cycle. 

One interesting topic in the wake of COVID-19 to watch is the interest in sustainability. Pre-COVID-19, this was an appropriately hot topic driven by large CPGs and supported by consumers showing an increased willingness to pay for a sustainable package. We don’t expect this trend to go away long term, but we do anticipate a pause in its importance given the economic realities on the ground and the likely appeal of lower-cost alternative packaging.

L.E.K.: What are we seeing in terms of packaging demand? It seems as if COVID-19 may be increasing demand in some areas while tamping it down in others.
 

Eric Kanter (Morgan Stanley Capital Partners): COVID-19 has had an interesting impact on overall packaging demand. There has certainly been pull-through demand for packaging based on increased consumer spend on essentials and groceries. From March to April, this created a tug of war between surges in consumer demand and packaging supply and production.

This has ebbed and flowed as consumers have fluctuated between making runs on the grocery store to stock up on items, followed by quieter periods as they work through their backlog of supplies and groceries. The right level of sustained packaging demand to expect throughout this cycle and recovery is somewhere in between the stockpiling of toilet paper and the at-home American Joe sitting on the couch snacking while watching “Tiger King.”

Assuming a relatively benign Q3/Q4 from a health perspective, this moderation of demand should enable packaging deals to start coming back around [in] Q4, after a quiet Q2 and Q3. The real wild card is whether or not a second wave hits again in the fall — that could have a big impact on deal flow.

L.E.K.: What impact do you expect COVID-19 to have on transaction multiples? Are certain types of assets likely to experience a bigger hit than others? Will some even outperform?
 

Eric Kanter (Morgan Stanley Capital Partners): If you think about packaging companies in the top decile, their multiples are likely to remain steady. These are your absolute grade A assets that will be strong prospects in nearly any market. Combine that profile with strong performance and beating out competitors through this market cycle, and these assets may be able to achieve a slight premium in their valuation as a result.

Mike Palm (Evercore): I think there will be a bifurcation in the market. For businesses that are top quartile/decile that have made money for all of their owners and will have performed well through this crisis, there is a case to be made that the multiples they achieve may be consistent with pre-COVID-19 valuations. Underpinning this belief is the tremendous dry powder in the hands of private equity, estimated at ~$2.5 trillion. They are in the business of doing deals, and I expect there to be a “flight to quality” benefit for top tier businesses given the supply/demand imbalance.

Mike Denvir (The Jordan Company): At the end of the day, in all markets, we’re seeing that companies with great performance, historically and through COVID-19, will continue to do well. How companies fare in Q2, as only the last two weeks or so of Q1 were impacted by COVID-19, will have a big influence on their multiples coming out of this situation. Whether a company was able to perform well under this test will have big implications on how investors think about their valuation in future transactions. Companies that are less impacted will be the easiest going forward from a sales process and valuation perspective.

Mike Palm (Evercore): For the broader packaging sector, our current bias is for some multiple compression. How much remains to be seen and will be a function of a business’s competitive position, the end market exposure/underlying growth rates, the platform M&A opportunity set and the quality — both breadth and depth — of the management teams. While the state of the financing markets will have an impact on valuation based on quantum and rate of financing available, I believe the prior issues will have a more profound impact.

Suj Mehta (Tekni-Plex): The expectation of valuation adjustments will be there. Buyers will insist on a new normal — valuations for companies where their downside risk has been exposed due to COVID-19 will be impacted. You’ll see bullet wounds in what may otherwise have been thought to be clean and shiny. This is going to expose where businesses are most vulnerable. PE guys may think about investments differently now that they have a true test of resiliency — for companies that fail that test, there may be greater downside and potential multiple compression. On the flip side, for companies that show true resiliency, there is potential for resiliency valuation premiums.

Mike Denvir (The Jordan Company): Our market before COVID-19 has been 10+ years without a reset. A recession will certainly reset things. Given it’s been a very seller-friendly market for a long time, I would guess that it’s going to tilt toward the other way for a period of time, but I honestly don’t think multiples come down significantly. Certainly, some assets and businesses are going to be more exposed than others and will not have performed as well as people would have thought. For these companies, there may be scenarios that people don’t get the multiples they had before. The old saying is that sunlight is the best disinfectant, and as a result of COVID-19, everything that’s rosy and perfect in these management presentations will be questioned even more.

Eric Kanter (Morgan Stanley Capital Partners): I think that even packaging companies operating in the middle third of the market might not see too much impact to their multiples as rates are low and there is high liquidity at the moment. I would largely expect that the median packaging company will do just fine and the companies that fall below that median line may fall a bit in their valuations. We may see some of the “frothiness” that existed in valuations pre-COVID-19 come down a bit as a result of this market cycle.

L.E.K.: How do you expect COVID-19 to impact the diligence process for future deals — in terms of both focus and timelines?
 

Eric Kanter (Morgan Stanley Capital Partners): When it comes to diligence timelines, I think the process overall may be a bit longer. The beginning will be shortened, but there will be a longer “wind up” on the sell side to get to the start of the deal process. Then, on the back end, things will be elongated a bit more to get buyers comfortable with the outlook in general and specifically on COVID-19 issues and risks, as well as all of the challenges of performing diligence remotely. You will no longer have the scenario where a buyer has a management meeting, reaffirms its conviction and then submits a bid to win based on their prework. Plus, you will have the added challenge of doing management meetings remotely, through Zoom, among other logistical hurdles if the pandemic restrictions continue.

Mike Palm (Evercore): While I don’t think there will be outsized increases in transaction timelines, I do think they will extend in the near term from where they were recently. Over the past couple of years, timelines have been compressed, particularly for highly sought-out assets, with process winners differentiating themselves on not just price but also speed. For all but the highest-quality assets, I see this approach waning given the increased market volatility as a result of the COVID-19 shock and a more “risk-off” posture. Practically, in the immediate term there may be logistical challenges — willingness for air travel as an example — which may have some impact on diligence timing such as site visits.

Suj Mehta (Tekni-Plex): Going forward, I would expect that the life cycle of a deal could expand. Diligence efforts could take longer for buyers to get comfortable with assets and risk of uncertainty, especially with the absence of in-person management presentations and site visits. It could just be much more difficult to understand a company’s operations.

When thinking about creating a sell-side document or evaluating a company’s financial statements, investors are going to want a more robust process, which could lengthen the time it takes to put together. Third parties will need to get to the bottom of how COVID-19 affected a target’s performance, earnings, etc.

L.E.K.: What about risk exposure as a result of the pandemic? How is that going to affect the kind of information that buyers demand from companies?
 

Eric Kanter (Morgan Stanley Capital Partners): When we are thinking about financials coming out of COVID-19, I think it is going to be more common to see heavy EBITDA adjustments related to the pandemic. However, we would expect other adjustments, which had previously been elevated in the deal environment, to decline. COVID-19 adjustments are going to be necessary to understand company performance on the other side of this. Everyone is hopeful that these adjustments become relatively clean as they are very relevant for some businesses, but may have less of an impact on other companies. Understanding the resilience a company presented during the COVID-19 crisis is going to be a key question.

Suj Mehta (Tekni-Plex): Sellers need to understand what the true impact of COVID-19 was to their business with intense precision. Buyers are going to be hyperfocused on what normalcy looks like in terms of normal operating on a post-COVID-19 basis. Sellers need to be able to explicitly detail the impact of the pandemic and how the business is expected to fare in the post-COVID-19 world.

I’m sure you will see EBITDAC — the C being “COVID-19 level adjustments.” As long as you are doing financials, normalization of financial statements, sellers have to intensely understand how COVID-19 impacted their business. If they are not completely transparent, it will raise higher uncertainty [and] impact valuations to the negative.

Every time I engage a third party, we will be focused on an element of “Tell me how an asset fared in the marketplace during COVID-19, how did the target compare to broader market trends?” If nothing else, there will be an additional work stream related to combination of market studies, quality of earnings, etc.

Mike Palm (Evercore): In recent years, the definition of an appropriate run-rate or pro forma adjustment has been stretched, to put it politely. While adjustments are not going away, I do expect both heightened scrutiny on the integrity of adjustments and also sellers taking a more constructive/conservative view in marketing in an effort to build credibility and expand interest from buyers. I also suspect that we will be learning a lot about market “COVID-19” adjustments to financial statements.

L.E.K.: It sounds like even when deal flow starts getting back to “normal,” it still won’t be the same. Buyers will be looking at companies’ risk exposures much more closely, and they’ll be especially concerned with business performance and resiliency during the pandemic. That may mean some sectors are far more attractive, while others that were attractive prior to the pandemic will have fallen out of favor. Thanks to all of you for helping us better understand the issues and what we should all be looking for once the dust settles.

Panelists

Michael-Palm Mike Palm, Senior Managing Director, Evercore

Michael Palm is a Senior Managing Director of Evercore’s corporate advisory business, providing strategic and financial advice to industrial companies with a focus on packaging, paper and forest products companies. Prior to joining Evercore in 2016, he was the Global Head of the Paper, Forest Products and Packaging Group at Barclays. With more than 20 years of corporate and investment banking experience focused in the paper, forest products and packaging sectors, Mike has advised on a number of notable strategic transactions for a range of clients, including Ball Corporation, Berlin Packaging, Berry Plastics, Multi Packaging Solutions, Pro Mach, Rexam and The Waddington Group. Prior to beginning his banking career, he served as an officer in the U.S. Navy for six years. Mike graduated from the University of Notre Dame with a Bachelor of Science in mechanical engineering and obtained an MBA from the University of North Carolina at Chapel Hill.

Mike-Denvir Mike Denvir, Partner, The Jordan Company 

Michael R. Denvir is a Partner at The Jordan Company, a New York-based middle-market private equity firm. He joined the firm in 1998 and is a member of the firm’s Partnership Board and Executive Committee. Michael focuses on the industrials industry and currently serves on the boards of directors of Anchor Packaging, Arch Global Precision, CFS Brands, Dimora Brands and Worldwide Clinical Trials. He is a graduate of the University of Notre Dame, where he received a Bachelor of Arts in economics.

Suj-Mehta Suj Mehta, Senior Vice President, Tekni-Plex

Suj Mehta is Senior Vice President, Corporate Development, M&A of Tekni-Plex, a private-equity-owned global leader in manufacturing of technically sophisticated, niche healthcare, specialty, and food packaging solutions. He joined Tekni in 2009 and was promoted to his current role in 2015, after serving as Vice President, Deputy General Counsel. Prior to joining Tekni, Suj was a principal and executive at New Generation Hospitality, a hotel management and development company, where he led the acquisition and business development efforts for more than 30 transactions. Prior to that, he served as a staff attorney at Verizon Wireless in the Governance and Business Development groups, and was a corporate associate at Parker McCay, a major law firm in southern New Jersey. Suj received his Bachelor of Science in finance from Rutgers University, his J.D. from Seton Hall School of Law and his LLM in banking, corporate and finance law from Fordham University Law School.

Eric-Kanter Eric Kanter, Partner, Morgan Stanley Capital Partners

Eric Kanter is a Partner of Morgan Stanley Capital Partners (MSCP) and is based in New York. He joined Morgan Stanley in 2003 and has been a member of MSCP since 2007. Eric was previously a Vice President in the firm’s Mergers and Acquisitions Group. Prior to joining Morgan Stanley, he was an associate at Ryan Enterprises Group, the private equity firm for the Patrick G. Ryan family. Eric began his career as a management consultant at A.T. Kearney. He serves on the board of directors of Smile America Partners, Comar and PPC Flexible Packaging and previously served on the board of directors of Tops Markets. Eric holds a Bachelor of Arts from Northwestern University and an MBA from The Wharton School of the University of Pennsylvania.

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