Canny Strategic Buyers Pick Off Quality Companies From the IPO Rolls

One of the few companies tabbed for super-stardom in the depressed IPO market of 2002 was Ion Track Inc. This producer of drug and explosives detection equipment offers products that are in great demand in this security-conscious age and has leveraged the strength of its market for an impressive rate of growth. Ion was considered one of the top candidates not only to make it to market but to score with investors once it became publicly traded. But Ion isn’t going to make it to the public markets. The attributes that made it such a promising IPO also cast it as a highly attractive target for a strategic buyer – in Ion’s case General Electric Co. GE and Ion’s chief stockholder, private equity firm Castle Harlan Inc., reached an agreement in September for GE to buy Ion and weave it into the sprawling company’s GE Industrial Systems unit. The price was not disclosed. Scuttled IPOs are not distasteful to LBO firms Sales of Ion neared $50 million in the 12 months ended last March 29 after a $20 million first quarter but growth has been rocketing since the war on terrorism was accelerated. Ion is but the latest LBO portfolio company whose exit route was shifted from the IPO market to the m&a market during 2002. It was preceded by four other companies in varied sectors. In each case, the target company offered the eventual strategic buyer some competitive advantage that it did not already own. These are not turns of events that LBO sponsors dislike. In fact, they would rather sell a portfolio company entirely and cash out rather than brave the rigors of the IPO with a partial sale that most private equity players consider mostly a de-leveraging technique rather than a full exit. In the highest-priced pickoff of an IPO-bound firm, Quest Diagnostics Inc. bought American Medical Laboratories Inc. from GTCR Golder Rauner LLC for $500 million, including the assumption of $160 million in debt. Quest has been a major consolidator in the medical and clinical laboratories field and the acquisition of American gives it greater penetration of the esoteric testing and hospital segments as well as another $300 million a year in sales. An even more classic strategic play involved the Wendy’s International Inc. acquisition of Fresh Enterprises Inc. from Chatterton Partners for $275 million. Fresh Enterprises is better known by its primary operation, the Baja Fresh Mexican Grill restaurant chain, which had about 170 units and $78 million in sales when the deal was completed in June. More important than size was that Wendy’s was able to open an important new channel, which is becoming an increasingly vital factor in 21st Century competition in the restaurant industry. Wendy’s added the Mexican food corridor to its core Wendy’s hamburger chain and its fast-growing Tim Horton’s coffee shops, which also came in through an acquisition. The deal may have more far-reaching implications, considering that restaurant chains are popular portfolio companies for LBO firms and sales to large operators hungry for more channels may be more frequent exit mechanisms. An unusual diversion from the IPO market was one in which the target and acquirer were in the same family, the first deal of its type in memory. The buyer was United Defense Industries Inc., a producer of combat vehicles and artillery, which paid $316 million for United States Marine Repair Inc., which repairs and retrofits ships for the U.S. Navy. The unique feature of the deal is the presence of Carlyle Group, a private equity specialist in defense companies. Carlyle controls United Defense, which it took public last year, and owned United States Marine, which is it was preparing to take public. Skirting conflicts in a tricky deal The challenge was to avoid conflicts in this arrangement. Carlyle’s directors on the United Defense board recused themselves from considering the deal, completed in July, and a fairness opinion was obtained from Merrill Lynch. This could serve as a model if an in-house transaction of this type develops in the future. Rounding out the list was the purchase of Advantage Payroll Services Inc. by Paychex Inc. for $315 million. Advantage, controlled by Willis Stein & Partners, specializes in payroll processing and has revenues of $75 million a year.