FOREWORD: Much has been written about the current economic environment and the depressed merger and acquisition climate. Valuations are very low compared to the late 1990s and are forecasted to remain low through the first half of 2003. Regardless, excellent opportunities exist for buyers and sellers alike who apply certain disciplines.
In the first article below, Marshall Graham, founder and Chairman of Focus Enterprises, Inc. defines the first six of 12 proven value components or "Value Drivers" that can mean the difference between success and failure in the current economic climate. (Value Drivers seven through 12 will be discussed in the May issue of this newsletter.)
Successful participation in the current M&A climate is achieved by finding value and then integrating it into current company platforms or existing corporate portfolios.
It is a great time to buy, especially for buyers who can close for all or almost all cash. Although M&A transactions are substantially off in the large company segment, excellent opportunities exist both to buy and to sell in mid-market and smaller company segments. There also are outstanding opportunities for acquiring selected assets, intellectual property and average and/or under-performing companies.
THE M&A PROCESS HAS CHANGED
Today, buyers and sellers are more cautious than ever before. Pre-LOI due diligence is lasting much longer prior to firm deal terms being agreed upon. There is much more focus on forecasted revenues and stable and growing customer bases. Integration planning on paper is taking longer prior to the execution of a Letter of Intent. Finally, management teams, while extremely important in all M&A activity, are becoming much more central to success in today’s M&A transactions.
For buyers and sellers alike, the key to achieving successful M&A transactions, with the assistance of intermediaries, is to identify the value components or "value drivers" of the transaction and then to make certain a plan is in place to integrate these components at the least cost.
TWELVE VALUE DRIVERS SUPPORT SUCCESS
At Focus Enterprises, we assist our clients in carefully evaluating 12 specific Value Drivers when considering a buy-side transaction. The first six are described in this issue:
Value Driver #1: The Customer Base
The customer base of the company being acquired is extraordinarily important. What is the buying trend from these customers over the past five years? What is the extent of customer churn? How many new customers have been acquired annually over the past few years? What is forecasted revenue from these customers over a specific forecast period? How stable is the customer base? What is the profile of the customer base? Are the customers large, medium or small? How vulnerable are these customers to economic fluctuations? What is the revenue distribution of these customers over the entire revenue base of the company to be acquired?
Value Driver #2: Recurring Revenue
One of the top value drivers to consider is the recurring revenue coming from the customer base of the company to be acquired. Of total revenue, what percentage is recurring? This portion of total revenue is valued more highly than so-called "one-time revenue." Will the combination of revenues from the acquiring company and the acquired company create an opportunity for a higher recurring revenue percentage of the total when the deal is completed? Finally, is there an opportunity to change the business model of the acquired company to result in stronger recurring revenue?
Value Driver #3: Product Integration
A major reason for making an acquisition is to acquire a new and complementary product line(s) so that the acquiring company can leverage its current distribution system and therefore increase gross margins. Great attention must be paid to technical platforms of different products. Even more attention and analysis needs to be completed on whether products are complementary or competitive. Product/market segment research often must be completed before a product integration advantage can be substantiated.
Value Driver #4: Gross Margin
At Focus Enterprises, we believe this is most important line item on the P&L. In-depth analysis on paper needs to be completed to determine whether acquiring the target company will ultimately improve or degrade gross margins. Manufacturing processes need to be analyzed to accommodate more--and presumably complementary--product sets as well as items such as customer installation/training and service/warranty commitments.
Value Driver #5: Intellectual Property
"Intellectual property" is a catchall term meaning one thing to one person and something entirely different to another. Generally, at Focus Enterprises, we use the term in its broadest sense when assisting a client with a transaction. Intellectual property certainly means trademarks, patents and copyrights but it also can mean a "developed process" such as a unique way to generate sales leads and then close sales using only the Internet. Accordingly, proprietary processes should be closely examined when evaluating a company for acquisition.
Value Driver #6: Human Capital
Today, this area is being looked at and evaluated to a much greater extent than ever before. During the late 1990s, a common approach was to acquire a company, assume that management and other key employees would stay for a while and then, the acquiring company would expect to augment or replace management as employment agreements expired. Today, buyers look for situations where management wants to stay for the long term. Post-sale integration failures of the past are largely the result of management departing after the deal is closed.
Value Drivers #7 through #12 Coming in May
Next month, to complete the series, Value Drivers seven through 12 will be explained in detail.