When the calendar turned to 2023, it did not offer a promising outlook for mergers and acquisitions. Interest rates were spiking, inflation was reaching record levels, and fears of recession were rampant. A spate of bank failures further clouded the picture.
But as the second half of the year rolled around, optimism began to creep back into economic forecasts, thanks to waning inflation and hopes that interest rates were at or near their peak.
What hasn’t changed is the growing pressure on small and medium-sized label converters, a highly fragmented sector that is seen as ripe for consolidation.
“We think the bigger companies will continue to grow and continue to raise the bar,” says Thomas Blaige, founder, chair, and CEO of Blaige Industry Analytics LLC, an industry-focused investment bank with offices in Chicago and Miami. As a result, he says, “it’s going to be harder and harder for the small and medium-sized companies to compete.”
Pressure Cooker
Smaller label converters face a range of challenges, according to Blaige and Ron Giordano, a senior executive adviser at Blaige Industry Analytics LLC.
They include stiffening competition from larger companies, heavier demands from customers, and growing pressure to innovate. At the same time, larger companies have been integrating vertically and horizontally, allowing them to tackle two of today’s biggest problems, inflation and supply chain reliability.
Vertically, big companies are buying material suppliers, equipment makers, and other firms, Blaige and Giordano say. The deals translate into shorter lead times and better cost control.
Smaller companies, meanwhile, are continuing to struggle with the challenges that have plagued them since the COVID-19 pandemic, says Giordano, former CEO of H.S. Crocker Co., a lidding and label manufacturer purchased in 2021 by TC Transcontinental.
“It is an ongoing battle every day,” he says. “And that takes away from concentrating on your business.”
Larger companies also have been gaining advantages by adding diverse labeling capabilities and broader geographic coverage, enabling them to grow horizontally into one-stop shops for their customers.
Consumer packaged goods companies once contracted with multiple suppliers, Blaige says. But as they grow, they want larger suppliers that can offer multiple services at multiple locations around the world. “They’re telling the small ones, ‘Hey, you’ve been a supplier for 50 years. But we now have global suppliers, and you should be global, too.’”
Changing Expectations
Small companies have long taken pride in their ability to respond quickly to customers’ needs, but those needs are evolving, Blaige and Giordano say.
Customers, for example, are increasingly cost-conscious and often push label suppliers to lower their pricing, even in the middle of a contract. “That never used to be the case, but that pressure right now is out there,” Giordano says.
Many customers face cost constraints of their own, he says. Pharma companies, for example, are responding to government efforts to rein in the cost of prescription drugs, such as recent federal mandates capping the cost of insulin for Medicare beneficiaries.
Blockbuster mergers like the union of Albertsons and Kroger create similar pressures in the food business, Giordano says. Their suppliers are likely to be getting bid letters requesting new pricing.
The demands of sustainability and security also pose complications for smaller label converters. Brands are looking for creative solutions from their suppliers, putting a premium on investments in research and development, which are more affordable for larger companies.
“If you’re a company that doesn’t have the resources, people are going to pass you by,” Giordano says.
The M&A Picture
The label sector’s fragmentation is attracting companies and investors interested in consolidating it, Blaige says, noting that there are about 3,400 label-converting operations in North America. “I think it’s the most fragmented market out there.”
Larger converters already have been combining, he says. But the wave of consolidation is now reaching smaller players, 80% of whom have annual sales of less than $35 million.
Overall, M&A activity has kept close to its post-pandemic highs, according to research by PitchBook and PwC. The chief difference this year has been a decline in company valuations, meaning companies are selling for less than before.
According to PitchBook, the overall value of deals globally in the second quarter of 2023 was 49.1% below its peak in the fourth quarter of 2021. Rising interest rates are one of the culprits as they make it more expensive to finance a deal.
Given the unique characteristics of fragmentation and stable end markets in flexible packaging, the mergers and acquisitions volume are only off an estimated 10% this year, while multiples remain strong for profitable niche players as there has been a flight to quality, Blaige says.
And for label companies, higher interest rates have not had a significant impact, he adds. Most buyers are strategic and looking for a longer-term return when they make a purchase.
Still, label business owners can take steps to tilt the playing field to their advantage. Blaige and Giordano recommend that potential sellers burnish their businesses before entertaining offers, a move that can increase their value by 20% to 30%.
“Business owners spend a couple of years planning major purchases or a switch in suppliers,” Giordano says. “A potential sale also is something that they should invest time in as part of their strategic planning process.”
Joel Berg is a freelance writer and editor based in York, Pennsylvania.