Acquiring Now To Cash Out Later Acquisitions as an exit strategy?

New research into middle-market m&a suggests the emergence of an increasingly popular end game in which entrepreneurs bulk up with acquisitions as part of a long-range plan for eventually selling their companies. The trend appears to be a function of the liquidity of the late 1990s m&a market in which companies enjoy unsurpassed opportunity to both buy and sell and where top dollar is paid for critical mass, consolidation plays, and deliverable values. A survey sponsored by The DAK Group, Rochelle Park, N.J.-based m&a intermediary firm, and the Rutgers University School of Business covered 159 privately held companies with annual sales of $5 million to $50 million. More than three-quarters of the owners in the sample, or 77%, said that they expect to do acquisitions or be acquired themselves in the next few years. And better than a quarter of those who plan to be in the m&a market, or 27.9%, reported that they planned to acquire as a prelude to putting themselves on the block. Alan J. Scharfstein, DAK president, said that these strategically oriented business people “are trying to build critical mass that will make the company more attractive to buyers.” The DAK-Rutgers canvass is one of two recently released reports pointing to the middle market as a continued strong point for mergers and acquisitions. In the other, Fleet Capital Corp., a major provider of m&a financing, surveyed the chief financial officers of 300 mid-sized manufacturers ranging in volume from $75 million to $500 million a year. Better than one in five companies, 21%, plans an acquisition and more than four-fifths of the buying-minded firms, or 82%, expect to cement a deal in 1999. Acquisition ardor, Fleet said, escalates with the size of the company. Thus, the heaviest interest in going external is in the top rung of the sample $200 million to $500 million in annual sales. Of the 21% beating bushes for deals, 36% were in that tier, a quarter hailed from the $75 million to $199 million category, and less than a fifth involved companies logging less than $75 million a year in sales. Fleet also noted that 13% of the companies in the sample were both planning to make acquisitions and to sell the entire firm or expendable parts. Scharfstein also pointed to the higher incidence of younger entrepreneurs as a driver of sell-side activity. He estimated that the average age of a selling owner a decade ago was in his or her late 60s and early 70s. By contrast, the current average age in DAK’s client base is in the late 40s and early 50s. These younger people are plugged into the growth-accelerating power of acquisitions and the changing market conditions that indicate that a firm will have trouble remaining a stand-alone entity. “They tend to sell for highly strategic reasons,” Scharfstein said. “And the younger people are saying they are not married to the business.” Out the Window Communications Deals Go Haywire The complex union of USA Networks Inc. and Lycos Inc. unraveled while telecommunications powerhouse MCI WorldCom Inc. put a quick entrance into the wireless phone business on hold after failing to buy Nextel Inc. Pricing controversies triggered by investors figured in both fizzles. USA and Lycos threw in the sponge after major Lycos shareholders vehemently criticized the value they were to get in the complicated transaction. MCIWorldCom and Nextel dropped negotiations after they could not agree on price. USA’s plan was to merge Internet access provider Lycos with its majority-owned subsidiary TicketMaster Online-CitySearch Inc., which sells tickets and community information on the Internet. The deal was valued at between $17 million and $18 million but major Lycos shareholders said that better value could be obtained from another buyer. MCIWorldCom, which was pieced together through a long string of mergers and acquisitions in several communications tiers, decided that it could wait before adding wireless communications when it refused Nextel’s asking price. MCIWorldCom is the only major telecom company without a significant wireless business. MCI WorldCom stock had been pummeled before negotiations were halted. Like many wireless firms, Nextel loses money and has a mountain of debt a combination that spelled earnings dilution in the view of investors. In another industry undergoing great consolidation, the Defense Department torpedoed a proposal to merge two of the nation’s largest shipbuilding operations. General Dynamics Corp., which makes a wide range of electronics systems as well as submarines and other ships, yanked its $1.4 billion bid for Newport News Shipbuilding Inc. after the military howled about a company that would have controlled 70% of shipbuilding for the Navy and would have produced all nuclear-powered vessels. Pentagon opposition affirmed a basic shift in position on defense mergers. During the 1980s, the military rarely opposed big defense mergers, regardless of how the various segments were consolidated, on the grounds that its paramount need was the assured supply of equipment and materials. But as deals and firms have grown, the military is more wary, a stance first signaled in 1998 when it succeeded in blocking the aerospace merger of Lockheed Martin Corp. and Northrop Grumman Corp. World Scene Olivetti Takes Telecom Prize The takeover struggle engulfing three European telecommunications titans ended in a victory for interloper Olivetti SpA and set the stage for the largest deal in history outside of the U.S. Olivetti claimed victory after paying some $33 billion to acquire just over 51% of Telecom Italia SpA in a hostile tender offer. In winning control, Olivetti busted the merger agreement between Telecom Italia SpA and Deutsche Telekom AG, which would have accelerated cross-border consolidation of European telecommunications companies. Despite the strategic implications of a two-country alliance in the telecom field, Telecom Italia’s $76 billion accord with Deutsch Telekom was in large part a defensive strike against Olivetti’s unwelcome offer. The Italia-Deutsch agreement was jinxed from the time it was hammered out. Olivetti hung in while the deal was attacked on political and competition grounds in both Germany and Italy and large investors claimed that Telecom Italia could have gotten a better price. The largest transatlantic deal involving a South American company, priced at $13.4 billion, was agreed to and will mark another stride in consolidation of the world oil industry. Under the agreement, Spain’s Repsol SA is acquiring Argentina-based YPF SA in an all-cash transaction. Repsol, which already owned nearly 15% of YPF, made an unsolicited offer to buy the rest. YPF acquiesced after initially expressing displeasure with the bid. Sell-Offs Major Acquirers In Reverse Gear Major companies intensified the culling of their portfolios as they marked major businesses for disposal in moves that would reverse prior aggressive acquisition programs. Key restructurings included: AlliedSignal Inc. mapped plans to cut back its automotive business by selling its consumer products lines and its friction-materials operation which, combined, have more than $1.9 billion in sales. Allied is increasingly concentrating on aerospace and higher technology auto components. Harris Corp., in a bid to put all bets on communications equipment, put its power-semiconductor unit on the black atop a plan to spin off the Lanier Worldwide office equipment operation. The semiconductor unit produces chips to regulate power flows, an industry that has been in a state of flux in the last year because of technological advancements and changing customer demands. Primedia Inc., the highly acquisitive specialty publisher and online information provider, put its supplemental education group up for sale and said that proceeds would help pay down debt. The unit makes classroom information products and provides testing services. Bausch & Lomb Inc. cut its ties with the flagging Ray-Ban brand, by agreeing to sell its sunglasses business to a leading competitor, Luxottica Group SpA, for $640 million. The sale of the formerly “in” label for sunglasses aficionados is part of B&L’s plan to refocus on eye care. Other B&L operations that are expendable under the reconfiguration are Miracle-Ear hearing aids and Charles River Laboratories, which breeds animals for research. Washington Update Financial Services Bill Clears Hurdle After surviving an intense pounding for decades, the Glass-Steagall wall appears closer to the wrecking ball. A significant step in demolishing a restriction on financial services companies that was born in the Great Depression and allowing these firms to operate an allfinanz model was notched in early May when the Senate passed legislation overhauling the nation’s financial system. But no one says that it will be easy to get from Senate endorsement to actual repeal. In fact, lawmakers, Clinton administration officials, and financial industry spokespeople were hunkering down for hard skirmishing because the Senate measure carries regulatory baggage opposed by the president and not included in a version of the bill that the House had under consideration. Clinton has threatened to veto the Senate bill if it hits his desk in its present form. Passed 56 to 44, with only one Democrat voting aye, the bill would allow a company to operate simultaneously in the commercial banking, investment banking, and insurance fields a business mix barred by Glass-Steagall. Stirring hopes for eventual enactment is that all major players the administration, Senate, House, Federal Reserve, and financial industries are on the same page on the core of the proposal, which plants the Europe-devised allfinanz model in the U.S. But there are sticking points on the fringe. The Senate measure contains two regulatory relaxations vehemently opposed by Clinton and resigning Treasury Secretary Robert E. Rubin watering down Treasury regulation of banks and pulling teeth from the Community Reinvestment Act, which requires banks to lend into depressed city neighborhoods and other areas where credit can be very tough to get. Some observers expressed hope that the differences could be worked out after the House passes its version of the bill and the bill goes to a joint conference committee. Despite the intensity of the legislative effort, the Glass-Steagall wall has been porous in recent years. The Fed has allowed several larger commercial banks to operate investment banks, leading to a wave of absorptions of regional investment banks. And Citigroup was put together by banker Citicorp and insurer/investment bank Travelers Group under a loophole in the law which allows them to stay together for five years if Glass-Steagall is not repealed in the interim. Joint Ventures Tripartite Accord On Steel Bar Firm A unique partnership of an American firm, a Japanese firm, and a U.S. financial buyer has been formed to produce an important manufacturer of specialty steel bars. The arrangement centers on a Lorain, Ohio, steel mill jointly owned by USX-U.S. Steel Group and Kobe Steel Ltd., which operates under the corporate logo of USS/Kobe Steel Co. Joining the mix is Blackstone Capital, which already owns two steel bar manufacturers. Under the plan, the bar-making sector of USS/Kobe will be combined with Blackstone’s Republic Engineered Steels Inc. and Bar Technologies Inc. and will create an important supplier of bars used in automobiles, farm machines, and other capital types of equipment. USX and Kobe would own about 30% of the combined new entity. Takeover Defenses Victories Over “Dead-Hand” Pills After taking its lumps in the Delaware courts, the “dead-hand” poison pill is being trashed by stockholders as well. During showdown votes at annual meetings, stockholders endorsed repeal of pills at Lubrizol Corp. and Bergen Brunswig Corp. Bringing the issue to a head at both companies was Teachers Insurance & Annuity Association-College Retirement Equities Fund (TIAA-CREF), which is mounting an aggressive campaign to bury “dead-hand” pills. In most cases, a “dead-hand” pill can be removed only by the directors that installed it, even though they may have left the board, been defeated for reelection, or died. The Delaware courts last year outlawed the “dead-hand” pill for companies incorporated in that state but the decision does not touch firms chartered in other states, a principal reason for the attack by TIAA-CREF and other investors. The organization took aim at 10 companies with “dead-hand” pills, winning recession at seven, capturing the tallies at Lubrizol and Bergen Brunswig, and continuing its discussion with the tenth. While usual battles over pills proceeded during the annual meeting season, other companies companies joined the list of firms with so-called shareholders rights plans in the spring: Andrea Electronics; Barrett Resources; Baxter International; Cadillac Fairview; Chubb Corp.; Consolidated Stores; Deluxe Corp.; Emons Transportation Group; Flowers Industries; Footstar Inc.; Franchise Finance Corp. of America, Furon Co.; Great Lakes Chemical; and HomeBase. Also: KeySpan Energy; Lodigian Inc.; Marshall Industries; Morgan’s Foods; Navistar International; Northeast Utilities; Pall Corp.; J.C. Penney; Pennsylvania Real Estate Investment Trust; Philips International Realty; QMS Inc.; Raychem Corp.; Rental Service; Shaw Industries; J.M. Smucker; Southwestern Energy; Synovus Financial; Teco Energy; Trinity Industries; UniSource Energy; Vintage Petroleum; and Willbros Group. Middle Market Private Firm Prices Holding Steady Selling prices for small to mid-sized private companies have leveled out over the last few years, according to the annual survey of the International Association of Mergers & Acquisitions Professionals (IMAP). The median multiple of EBIT for deals covered by the survey was 5.2 in 1998, little changed from the two previous years. IMAP conducted the survey in conjunction with the online m&a service, Finenet. However, the latest survey confirmed previous findings that selling price multiples may vary widely from the median based on the size of the target and the nature of its operations. Trending to the high side were proprietary consumer products, 6.0, and proprietary industrial products, 5.9. Distribution businesses fetched a median multiple of 5.4. Proprietary consumer products sported the same multiple as in 1996 but proprietary industrial products advanced from 5.1 in that year. Distribution was flat in 1997. As for size, the rule that the bigger the target, the better the multiple was reaffirmed. Companies with $50 million or more in revenues drew a median multiple of 6.5, unchanged from 1996. The 1998 median in both the $20 million to $50 million and $10 million to $20 million classes was 5.5, the $20 million-plus grouping dropping from 6.0 in 1996 and the $10 million-plus tier staying even with the 1996 level. Peter Provenzale, senior vice president of Fleet Capital, also pointed to an easing in mid-market pricing and agreed that lenders had become somewhat choosier about the selling prices they will finance. Not long ago, he said, the high price point was four times EBIT-DA. “We’re still at the high end,” he said, “but the multiple now is closer to 3.5 to 3.75.” He noted that cash-rich buyout funds still are pricing their deals gingerly with no indication that they will throw caution to the wind just to get their money to work.