An M&A Perspective on the Current Market

Barry Matties and Nolan Johnson spoke to Tom Kastner about what he sees from an M&A perspective in company leadership resistance to change, as well as the current state of the M&A market and how it’s been affected by the COVID-19 outbreak.

Nolan Johnson: Tom, why is change so hard for some people? In your role, I’m sure that you deal with companies going through the M&A process and managing change all the time. For some, it is fairly easy, but it’s difficult for others.

Tom Kastner: Absolutely. It’s a huge concern for all parties. It’s a big part of what we work with. Typically, it is easier for the buyer. They may have some change, but most likely, the buyer has done it before. The buyer is a larger company. It’s usually not the buyer’s personal money; it’s not coming out of the buyer’s pockets, and there’s less stress for the buyer. Meanwhile, for the seller, there could be a tremendous amount of stress. One thing we do from the beginning when we first start talking to potential sellers is to walk them through the process and keep things confidential. We’ll give them suggestions based on how they’ve run the business and how they should proceed. There’s a number of tricks of the trade that we employ, but a lot of those are pretty common to our industry. It’s a huge topic.

Barry Matties: As people are looking to change, the COVID-19 outbreak has an impact on a lot of deals across all industries. What interest was building in this industry for acquisitions? Were there more companies looking to acquire, or what sort of trends were you seeing?

Kastner: There was a trend in both PCBs and contract manufacturing for sellers to want to go to the market. One of the issues on the bare board side is that there are fewer prime buyers. Those prime buyers only want to acquire larger companies. For companies with $5–10 million in revenue, it’s not as easy to get attention from larger companies. For companies that already have 5–10 facilities, you don’t want another facility in a remote location that has $5–10 million in revenue if you already have $100 million in revenue. One of the trends we see is that in both sectors—both bare boards and contract manufacturing—unless you’re of a certain size, most buyers would be very interested in moving your business into their facility but not as interested in acquiring a facility in a new location.

Matties: How many years have you been working in the PCB sector now?

Kastner: Since ’96, so it has been 24 years.

Matties: You realize the demographics of our industry. There are a lot of the small- to medium-sized shops, and many of the owners are of retirement age. There’s a need for many to modernize their facilities and become smart factories. That takes a lot of energy, so some of them are looking for an exit strategy. What you’re describing is if they’re in that $5–10 million range, it may be very difficult for them to sell.

Kastner: It’s difficult for them to sell at a price that makes sense for them because a lot of them have invested $5–15 million since 1985, for instance. It’s all completely depreciated. If you went to auction, you might get 100,000 or 200,000 net from all that investment. Emotionally, it’s hard to accept what fair market value would be for the business. We’re not in a situation where there’s a scarcity of PCB manufacturers or contract manufacturers. There are so many. I just did a column titled “Down to 199,” which is the number of bare board companies in North American. Who knows if the coronavirus situation is going to be part of the catalyst or other things are going to happen, but I think it’s going to go down to at least 100, if not lower, in the next 10 years or so. It could be quicker than that, but until we get a real scarcity of North American PCB shops, the valuation is not going to be very good.

Matties: When you say it goes down, do you mean doors will close and not necessarily be sold in a transaction?

Kastner: There will be a combination of the two.

Matties: It seems to me that with the COVID-19 outbreak and the vulnerabilities of the supply chain coming to light, we may start seeing more and more captive facilities open in North America.

Kastner: One thing I do not see is an appetite from contract manufacturers to buy bare board companies. There’s very little appetite at all. It is possible that certain companies—especially defense manufacturers and possibly medical companies—would consider shoring up that supply chain, but I don’t see it yet. Again, if we go from 199 to 100, maybe we’ll see more of that. Typically, what you see is there’s somebody on the board of directors—whether it’s an OEM or a contract manufacturer—who got burned by the PCB industry as an investor, so there’s no way they’re going to get into bare board production. It could happen. There are a couple of other things going on out there that I don’t know have been publicly disclosed that hint at people dipping their toes into looking at captive. But for the most part, especially CMs are not that interested, and I don’t see much interest from OEMs.

Matties: When we look at the Whelen model, they made a great case because they were spending millions a year in China boards. For around a few million dollars more than what they were spending before, they built their first PCB factory in New Hampshire from the ground up—GreenSource Fabrication. They made it a zero-waste, fully automated smart factory and eliminated much of the labor cost with tight control on process and quality. The results were amazing. Many people have their eyes on that. If we have more models like that, maybe the trend will start to shift. Time will tell.

Kastner: That’s true. Right now, unfortunately, most companies are putting their investments into design and other aspects of their business—not so much on the supply chain side. I would love to see more companies do what Whelen did. Some companies are doing interesting things, but you don’t see too many replicating that. Most people prefer to buy from China, but we’ll see if that changes based on what’s happening today.

Matties: What advice would you give somebody who’s near the end of their career, holding onto a PCB shop?

Kastner: The main thing is to get prepared, and it takes time to do so. Prepare the business and yourself for an acquisition. There’s a lot of things you can do. You never know when an offer may come in unsolicited. I would also explore the options. Talk to an M&A advisor and explore going to management, and meet with your CPA or tax/wealth advisor to find what things you can do on the financial side and see what you might need if you were going to sell.

I’d also ask yourself, “Strategically, am I ready to invest in new equipment, systems, certifications, people, and training for the next 5–10 years?” Or are you done? If you’re not investing, the market will tell you that you’re done. You can survive, but if you’re not investing, your customers or the market will tell you that it’s time to shut down.

Johnson: I hear you saying that for company management in bare board fabrication or contract manufacturing, if you’re not investing in improving your equipment, processes, and capabilities right now, then you should be thinking about selling or shutting down. I’m being a little black and white in summarizing what you said, but you’re always preparing for the future, or preparing to sell, or preparing to be irrelevant; you’re always preparing.

Kastner: Exactly. Until recently, the economy was good, military budgets were good, and the medical side was doing well. Pretty much almost every sector was doing well except for oil, gas, and transportation. That has all changed. Nobody saw this coming, at least not the severity. It is possible to survive. I don’t mean to sound too harsh because anyone who’s running a bare board shop—and to a lesser extent, PCB assemblers—has been a survivor. They’ve survived two major recessions and a complete upheaval in the supply chain with China coming on board. That’s terrific, but it’s going to be harder to survive as is. You either invest or die. Some people will be able to survive, but the coronavirus situation is going to hurt a lot of people and companies. Even if you survive this, it’s going to be tougher to survive the next coming years due to technological change, end-customers having more demanding designs, and more demanding quality and certification standards.

Johnson: When you talk to company leadership, can you tell if they’re going to struggle with change or if they’re ready?

Kastner: When we talk to owners, we get a pretty good sense of their personalities and how they’re handling the whole situation. What we don’t get a good idea of is the executive team or the rest of the employees. We might be able to meet some of the top executives, but sometimes we don’t. It might not be until later in the process that we even meet the executive team. We’re a bit handicapped in that way.

Johnson: Right, because it takes the entire senior management team working together on the same page to make a transaction like that happen. You could have some key people who are reticent to hold outs. That could be a problem in the whole dynamic.

Kastner: Correct. We encourage the owners to let us at least talk to the top 2–4 executives to educate them about the process and let them know if the goal is to keep it in place. That’s what we’ll talk to buyers about. If the owner has been fairly open about the strategy and where the company is going, then they’re probably more open about us talking with the executive team. If they’ve kept everything very close to the vest, then we probably don’t meet the executive team until the buyer starts meeting the executive team, which is fairly late in the process. We don’t know how people are going to react. For employees, it’s natural to expect the worst. If you just got married, had a baby, bought a house, or have kids that are about to go to college, you’re concerned if something’s going to affect your future. The natural impulse is to immediately start drafting your resume. It depends on the situation, but often, we only have visibility into the owner’s thought process—not the executive team.

The other thing is that people don’t always tell the truth. We’ve had deals where people swear up and down, “I’m part of the team, and I’m going to stay forever. We’re looking forward to the process,” and then a few weeks or months after a deal has closed, they’re working for someone else. Other times, as soon as they hear about the process, they say, “I’ve seen this movie before. I’m moving to another company that made an offer. I wasn’t going to take it, but since you’re selling, I’m going to go over there.” It’s hard to control that process.

Matties: That’s better than trying to sabotage the deal, though.

Kastner: Absolutely. If too many key people are leaving, then the buyer would say, “I don’t have three people to pump into this company we’re buying,” and it could sabotage the deal. Or the buyer might still say, “We’re interested, but we’re going to have to move the business into ours now if you’ve lost your team.”

Matties: And they’re going to lower the offer.

Kastner: It would change the offer, but most likely, that would lower it too.

Johnson: Given the greater likelihood that your team will jump ship if you drop this on them suddenly, it would seem that the advice for ownership considering this is to be open and transparent, at least with the senior management.

Kastner: Absolutely. Now, I’ve known 85-year-old owners who were tremendously worried that their employees would find out that the business was for sale. Then, once they talked to the employees, they’re like, “Thank god. We thought you were going to die at your desk.” Some owners are very worried about it, but the employees see what’s going on in the industry. They see other companies being acquired and sold, both good situations and bad situations. They know that, at some point, the owner is going to do something. If you’re open with the team, then it could put in a little bit of uncertainty, but it eliminates a lot of guessing and rumors and so on.

In general, I would say to be open with the team. You can always provide some sort of incentive at least for the team, if not everybody in the company, as far as a bonus or some sort of compensation for helping with the process. Most companies should have some sort of bonus incentive anyway. This can be in addition to whatever incentive programs you already have. Every company and owner’s style is different. It has to be customized to the way they’ve been running the business.

Matties: What multiples do you see? Is there a trend up or down, or what should a seller expect?

Kastner: It depends. But I would say multiples do tend to be lower for smaller companies. That’s common knowledge. If something is going to be kept in place, generally, on the lower end, it’s a four to five multiple on EBITDA or adjusted EBITDA. You can get higher to six, seven, eight, or more. But those are larger businesses that are very well-run and profitable, have invested in people and equipment, and have a lot of growth opportunities.

Matties: What profit margins are typical these days in a PCB facility?

Kastner: Of course, there are some that are losing money and/or break even. A well-run PCB shop has EBITDA margins of 10–20%. There are very few public companies in the space. There’s TTM, FTG, and Advanced Circuits; as part of Compass Diversified, they publish their numbers. Otherwise, everybody is private. Generally, if somebody is in that 10–20% range, I consider that to be a well-run facility, which accounts for only 20% of the shops.

Matties: That’s not very much in terms of the percentage of shops. When you say well-run, are you looking at companies that are automated and digital factories? How would you define that?

Kastner: On the operational side, I would define it as being efficient. On the technology side, they have something that customers will pay more for. There’s less competition, or they have a technology edge.

Matties: The common sense things that you would expect leading in technology and keeping waste out of your processes.

Kastner: Yes. It takes investment in equipment and then investment in technology development to get to that point.

Matties: That’s where the emotional manufacturing mind comes in because these are choices you have to make. You have to choose to do these things; they don’t just happen.

Kastner: As an owner, you’re either reducing your compensation or taking on more debt. That’s a choice. You can choose to turn your PCB shop into a dairy farm and milk it into the sunset, or you can invest and look to grow the shop. For many shops, the ROI for equipment and technology is not very clear because it’s been tough to even survive. But for most of the top 25 shops, you can tell there’s been a tremendous amount of investment, and it’s paying off for them. Advanced Circuits just put in a new facility in Arizona, and TTM announced that they invested $15 million in Wisconsin. We already talked about GreenSource Fabrication, too. On the PCB assembly side, there’s been a ton of investment. Companies are investing, but it’s a choice.

Johnson: In a recent column, you described the quality of earnings report. Part of that discussion was of it being a tool to prepare for sale as well as to analyze and figure out how to optimize your sales and revenue stream to feed the factory. You have to pay attention to that part of the business, too—whether you’re going to sell or not.

Kastner: Absolutely. The folks doing the quality of earnings reports see hundreds of companies, if not thousands. You can benefit from their breadth of knowledge looking over different manufacturing sectors and services to see how your business compares not only to your industry but to a wide range of other companies. That can be very eye-opening. A lot of owners think, “Because I invested $10 million, my baby must be worth $15 million.” Then, they hear from me that maybe they’re worth $2–3 million. They think, “Kastner is an idiot.” Then, they get an evaluation or a quality of earnings report and think, “Kastner’s evaluation was too high or low.” It gives you another perspective on both how people would value the business and what they’re looking at.

Matties: It seems to me that there’s a great opportunity in this time and space that we’re in with the supply chain, the amount of money that’s going to be flowing into the economy, and the low interest rates. If you were ever to make a choice of either improving and fixing your business, finding the right markets, bringing in efficiencies, lowering the waste, tuning the process, and becoming digital, now is a great time to do it.

Kastner: Whenever there’s disruption, there are a lot of opportunities. Who knows where exactly the market will go and how quickly the economy will recover, but again, there are a lot of opportunities if you’re open to them. North American board shops and EMS markets have been pretty beat up over the years and may not think of it as an opportunity, but if you look at the top companies in those industries, they’ve shown some pretty good growth. The whole cliché of the owner has to be busy working on the business, not in the business, applies today more so than ever.

Johnson: A big takeaway from this conversation so far is that management needs to embrace change one way or the other. Like the rock and roll lyrics from the ‘70s, “If you choose not to decide, you still have made a choice.” Can a team be too embracing of change in these times?

Kastner: Yes. You don’t want to throw the baby out with the bath water, and you don’t want to get too far away from your core competitive advantages. There are examples of companies that went too far, such as AOL Time Warner or New Coke when they threw out the real thing.

For large companies, you can swing for the fences, and you’re not going to kill the company. For smaller companies, you have to decide whether you’re biting off more than you can chew. I’ve seen a few examples so far this year make moves where you think, “Does that make sense given what might be on the horizon and with the coronavirus cloud over us?” You can over-invest and get overextended. You have to be careful, but the worst thing would be sitting around and doing nothing. You must do something, but each company has to decide whether you’re doing enough or you’re doing too much.

Matties: It’s up to the strategy. You start with a smart strategy and go from there. If you’re at a point where your strategy is unclear, you have to go seek advice.

Kastner: I’m a big fan of peer groups. I know a lot of owners don’t think they have time, and they don’t want to open up in front of strangers. They’re like, “Why am I in a group with an insurance broker, a CPA, and a coffee shop owner? What do their worlds have to do with mine?” But peer groups can be helpful as far as talking about your issues and hearing how other people respond to their issues. For example, if you’re currently running using QuickBooks, and you try to go to SAP or Oracle, that may be a ridiculous example, but you see people doing that kind of leap in other aspects of their business, and think, “That’s pretty risky to go that far.”

In the M&A world, acquiring a business can be risky. You have to be very careful about the type of business you’re buying, how much you’re paying, and how much you’re borrowing to buy the business. Is it going to stretch out the owner or the core of the team too much? Will customers stay? In general, acquisitions are a great way to grow, but you have to do it carefully.

Matties: What is your favorite business book?

Kastner: The flippant answer is M&A for Dummies. That’s the book that I recommend the most. I have it, I’ve read it, and I review it every year or so. It’s very well laid out. It’s written by a competitor, but he’s a good guy. I also like anything by Jack Welch.

Matties: When you look at what Jack Welch did with GE, that was amazing. He just passed away in March of this year.

Kastner: Right. He’s one of my favorite business book authors. Some of his key principles are to be in the top three of anything you do, and to hold people accountable. There’s so much wisdom in those books.

Johnson: Thanks for taking the time and sharing your insight.

Kastner: You bet. Thanks, and I hope everybody stays well.

Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. He is a registered representative of StillPoint Capital, LLC—a Tampa, Florida member of FINRA and SIPC—and securities transactions are conducted through it. StillPoint Capital is not affiliated with GP Ventures.