From its founding in Chicago in 1996, Lincoln International has grown into a global mid-market investment bank serving a variety of industries and employing more than 200 investment bankers across 12 offices in 10 countries. In 2011, Lincoln International completed more than 100 M&A (mergers and acquisitions), capital raising, restructuring and other advisory transactions worldwide.
Saurin Mehta, who works for Lincoln International’s Environmental Services Group out of Chicago, has been with the company since 2000. He says roughly 75 percent of what Lincoln International does is M&A advisory services, 90 percent of which is advising sellers. “Our client base today includes private equity groups, publicly traded companies and private businesses,” Mehta says. “I sit in our business services group, of which environmental services is one critical sub-sector; we’ve done a number of mergers and acquisitions in that space, specifically in recycling.”
Mehta speaks with Recycling Today’s Brian Taylor about how the recycling sector is ripe for M&A activity and provides his advice for business owners who may be considering selling.
Recycling Today (RT): Does Lincoln International view recycling as an industry sector likely to experience considerable M&A activity?
Saurin Mehta (SM): We really do think so. Look at 2006 and 2007, [when there was] nice growth and 130 deals per year getting done. That number dropped in 2009, but is rising back from 75 to 95 deals, specifically within the recycling sector. We’ve seen a nice rebound.
Multiples have rebounded to where they were pre-recession.
We expect M&A activity to continue because there are favorable industry dynamics and good market conditions for recycling. The industry dynamics mean there is heightened environmental awareness and tighter waste regulations—the whole green movement. Buyers like businesses that are regulation-driven because they provide a higher resiliency to macro-economic conditions. Recycling, with stringent regulation, is not something that a business can stop doing as the general economy ebbs and flows.
It’s still a pretty fragmented market. There are several larger strategic parties and then a lot of regional smaller players. I think consolidation will continue.
According to industry statistics, the average transaction size for disclosed deals from 2006 to 2008 was more than $100 million. From 2010 to 2011 transactions are more in the $40 to $50 million range. We are seeing more middle-market consolidation.
The third thing is there is a lot of private equity (PE) interest in this space. A lot of private equity money is being put to work in environmental services in general and in recycling, specifically. There have been a number of PE transactions that have occurred, and we expect that to continue. Commodity prices have recovered, so a lot of scrap recyclers are rebounding and are more apt to sell in this kind of market.
Our view is that it’s a favorable M&A market for sellers right now. There is a scarcity of good companies for sale right now, and demand is outstripping supply.
PE groups also have capital overhang. They raised a lot of money in 2005 to 2007 and didn’t put much of it to work in 2009 and 2010. Today they are sitting on more than $400 billion in capital. They are heading toward fund expirations and they need to put the money to work soon.
As for the strategic buyers, their corporate balance sheets also have record levels of cash. They lean-sized and cut back on capital expenditures. Today there is a lack of internal uses for that cash, so they are supplementing their organic growth by making acquisitions.
Internationally, the weaker dollar and the size and relative health of the U.S. market makes it attractive to international, especially to European, buyers.
There also is confidence that things are getting better in the U.S. The stock market is high, and lenders want to deploy capital, meaning credit markets are stronger.
The tax law is likely to change in 2013. The thought that capital gains could go up is prompting some owners to sell sooner rather than later. The 2010 belief that tax laws would change prompted a 30 percent increase in M&A activity in the second half of that year. The second half of this year could be similar.
RT: Are there specific pitfalls or miscalculations that recycling company owners need to avoid when selling their businesses?
SM: One is clearly evaluating and understanding the key considerations prior to getting into the process. Ask what’s most important. Is it value? Often, when you dig in, you’ll find there are other considerations. What are the interests and incentives of each owner if there is more than one?
The cultural fit of the buyer is important. Are they going to retain employees? Close the plant? How do you tell your employees and when do you disclose your plans? Clearly, assessing the two or three most important things is critical.
Secondly, sometimes you see owners not hiring professional advisors, not wanting to pay a fee. We would suggest that if you’re going to go forward, hire an advisor with the capabilities to maximize the value of your business.
The other key, especially with privately held companies, is that the owners are already wearing multiple hats. They need to continue to operate the business and hit the numbers while this process is occurring. You can’t do the same quality job on operations while you’re trying to sell.
We advise business owners not to approach buyers in a serial process. You want to run a competitive process and contact buyers at the same time…if nothing else to keep a buyer’s feet to the fire.
Sometimes you see owners start to manage a business for a sale rather than for long-term ownership. If you’re thinking about operational improvements, 99 percent of the time we say to continue to operate the business as if you’re the owner. However, we may ask if the potential buyers want that specific machine in place. We like to have an active discussion to determine how we approach that. This also can mean not entering new service areas to increase revenue close to the sale.
The last pitfall is commodity pricing and how quickly it can turn—trying to time the market based on copper prices, say. We were selling a business a few years ago that went from highly profitable to needing new capital after one turn of commodity prices. A risk management or hedge strategy is important. Don’t try to time the market based on where you think commodity prices are going.
Think like a buyer when acknowledging potential concerns. That allows you to start preparing. Time always works against the seller. As soon as you launch a marketing process, you want to move as quickly as you can. Take as much time as you need to organize your business before you begin contacting potential buyers. Take steps to mitigate potential concerns (It could be an audit; it could be a legal or environmental issue.).
Get all the skeletons out on the table. Don’t try to hide anything and think the buyer won’t find out. Sophisticated buyers will uncover everything. Get any environmental issues out while you’re still talking to multiple parties. If you wait until you’re down to one final buyer, now you’re at the mercy of that buyer.
The last thing is the transaction structure. This gets back to hiring an advisor. Are you doing a stock sale or an asset sale? Who retains the liabilities? If you don’t structure the transaction properly, you may have liabilities you didn’t anticipate down the road.
RT: When providing advice to buyers in recycling sector M&A activity, are there common due diligence oversights or misunderstandings that Lincoln International can warn about?
SM: First, is it part of your core strategy? Do you have systems and processes in place to successfully integrate the firm?
Too often, a buyer just doesn’t know how to integrate an acquired company. It looked like slam dunk on paper, but it ends up either not being a cultural fit, or the systems don’t integrate well.
Secondly, is there a good strategic rationale or fit? Is it either the exact same thing or a potential new market, new service line, new geography? Will it enhance the value of your business?
Think about the seller. Is it a business where the current owners need to stay on? There is a whole list of considerations, such as cultural fit and if you get along well personally, in determining the seller’s future role.
And, of course, valuation—Are you paying a fair price? Here are the earnings you’re acquiring based on stand-alone. If you incorporate the business, what does that mean for earnings? Can you increase the top line? Or can you trim some expenses through consolidation?
If I’m buying a business that has $2 million in earnings, I want to consider how difficult it will be to grow it to $5 million.
Saurin Mehta works for the environmental services group of Lincoln International, an M&A advisory group headquartered in Chicago.