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Driving Value for the Future
Optimizing Business Value
October 10, 2001
The Executive Committee – TEC
The OAK Group, Ltd.
Investment Bankers to the Entrepreneur
Today’s Goals
~ Discuss Merger and Acquisition Environment
~ Exit Strategy Alternatives
~ “Transaction Health Analysis”
~ Value Drivers
~ Transaction Process
~ Action Plan
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Ii Today’s M&A Environment
~ 90 of all U.S. transactions are between $5MM and
$200MM
~ Number and value of mid-market M&A deals continues to
grow
~ Mid-market M&A trends
~ Sellers motivation
Mid-Market M&A
Growth in Number of Deals
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10,000
8,000
6,000
4,000
2,000
o
1995
1996
1997
1998
1999
2000
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Mid-Market Drivers
~ Industry consolidation
~ Private companies are relative bargains
~ Growth in private equity capital
~ Growth in cross-border deals – Globalization
~ Change in stock market values
~ Implementation of common technology
~ Acquisition is more cost effective than development
Mid-Market M&A Trends
~ 2/3 of owners plan to sell within the next five years
~ Average age of owners has dropped 13 years since
1990
~ 50 of owners plan to remain with the company after
the sale in a non-ownership role
~ 1/3 of owners plan to retire after a sale
Conclusion: Most business owners plan to exercise an
exit strategy to optimize value and create liquidity in
their businesses
Data from the DAK/Rutger’s University Annual M&A Survey
Mid-Market Sellers’ Motivations
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Reduction
16
Capital
Expansion
7
Management
Issues
5
Outside
Forces
8
Estate
Changes
28
Exit Strategy Issues
~ Planning your exit
~ How long will it take to exit?
~ An exit opportunity may find you – how to cope?
~ You do not always control exit timing …..
If you were approached today would you be
ready?
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Value Drivers
“In order to optimize a business’s
value you must understand and
identify opportunities and
minimize the purchaser’s risk”
Value Drivers Determining Multiple
ifferentiated product
Management depth
Broad customer base
Substitute suppliers
Customer concentration
Supplier dependency
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|
OAK’s “Transaction Health Analysis” |
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How Does Your Company Stack Up? |
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~ Sales Trends |
1 |
2 |
3 |
cY |
5 |
|
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~ Profitability – Recasting |
1 |
2 |
3 |
jI |
5 |
|
|
~ Balance Sheet Strength |
1 |
y |
3 |
4 |
5 |
|
|
~ Product Differentiation |
1 |
2 |
J |
4 |
5 |
|
|
~ Depth of Management |
1 |
2 |
4 |
5 |
||
|
~ Customer Concentration |
1 |
2 |
(j) |
4 |
5 |
|
|
~ Supplier Dependency |
1 |
2 |
3 |
4 |
Q |
|
|
~ Deal Killers |
1 |
2 |
3 |
4 |
(~ .~ |
|
|
Tht~Gtv“‘lJd_V |
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Sales Trend Issues
» How have your company’s sales compared to your
industry’s
» If you have outperformed
Why
Will it continue
At what cost
What is driving the performance
» If you have underperformed
Why
Can you reverse (retard) the trend
Is the trend short term or continuous
What changes can be implemented
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Sales Trends continued …
~ What can be done to improve company trend
Organic growth
Acquisition growth
Product innovation
• Increase-reconfigure sales force
Measure effectiveness of marketing and advertising
Enter new markets
• Expand geographically
Profitability – Recasting
In today’s environment, EBITDA is the single greatest
factor influencing a business value:
~ Presentation of Recast EBITDA is critical
Excess salary and bonuses
Inventory and other operating reserves
Personal expenses
Rent
~ Can you substantiate
Is there a documentable history
Inventory management issues
Take a physical inventory now for a baseline
Keep better records
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II Balancing Your Balance Sheet
More Sellers leave money on the table because of
excessive balance sheet strength than any other
reason …
~ The problems of plenty
~ Recast Balance Sheet
Inventory valuation / reserves
Market value of machinery / equipment / real estate
Shareholders loans / equity
Reserve for bad debts
Patents, copyrights, intangibles
Over / under funding of benefit plans
Product Differentiation
Business values increase in niche-differentiated markets
~ Non-commodity products mean greater protection for
income streams
~ Processes and operational techniques can create barriers
to competition
} How can you stand out from the field
What are your core competencies?
Can you move towards greater differentiation?
Can you buy/develop a proprietary product to
manufacture and market?
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Depth/Breadth of Management
Premium value is paid for strong management
> Are you vital to the business operation?
> How developed is management under you?
> Could the buyer do without you?
> Non-compete agreement with key management
> Does it make sense to employ stronger management?
Which positions
Identify anticipated benefits
KEY-Cost justification
II Customer Concentration Risks
>– How much concentration do you have?
>– 80-20 rule
>– Valuation impact depends on your industry
>– Contracts
} Transferability of contracts
>– What can you do about too much concentration?
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Supplier Dependency
~ How many suppliers do you utilize?
~ Are you dependent on any suppliers?
~ Do you have contracts in–place with the suppliers?
~ Key Items:
~ Leases
~ Ownership of work for hire
~ Assignable-transferable
~ Are you “in the money”
Supplier Dependency
~ Changes that you may consider
Add back-up suppliers
Look outside the normal channels for suppliers
Try to sign supplier contracts
Try to lock-in pricing for long term
Obtain assignment rights from your key suppliers and
landlord
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Deal Killers
~ Environmental issues
~ Union and labor issues
~ Tax issues
~ Retention of key employees
~ Transferability of key contracts and relationships
~ Pension plan issues
~ Ownership of Intellectual property
Exit Decision
~ Determine your exit timing
~ Analyze your transaction health
~ Develop a plan to improve your transaction health
What you can and cannot change
What is the cost of making these changes
What is the risk in not implementing these changes
~ Implementation of the plan
~ Measure effectiveness of plan
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Preparing for a Business Sale
~ Formation and utilization of your team
• Roles and responsibilities
~ Know your goals and objectives
• Financial and non-financial
~ How long will the process take?
~ What are the critical steps along the way?
~ What major issues should you anticipate?
Different Types of Buyers
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~ Strategic
Same or related business lines
Seek sales and earnings growth, shareholder value
Expand for geographic diversity
Desire synergies that reduce overhead and
redundancies
Provide higher prices than financial buyers
~ Financial
Motivation is ROI – Leverage is key
More plentiful than strategic buyers
Operations talent often not provided
Higher multiples paid on a lower earnings base
Add-on versus platform
Transaction Case Study
~ Vector: Telephone Interconnect
Company
Revenue
Reported Net Income
Reported Pre Tax Profit
Reported EBITDA
Privately held C Corporation
NY headquarters
Strong east coast presence
Owners in their 40‘s
$60,000,000
$2,250,000
$3,750,000
$4,205,000
Average industry multiple: 5.2 times EBITDA & 10 times after-tax
Transaction Case Study
~ Recasting Income
Reported Net Income
Reported Pre Tax Profit
Adjustments:
Excess owner’s salary
Owner‘s perquisites
Excess rent
Non-recurring expenses
Recast Pre Tax Profit
Interest
Depreciation
Recast EBITDA
$2,250,000
$3,750,000
1,380,000
210,000
220,000
390,000
$5,950,000
75,000
380,000
$6,405,000
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Transaction Case Study
~ Target buyer profile
Financial/Strategic acquirers
Voice/data integration strategy
Foreign buyer searching for U.S. foothold
Appropriate size 5-20 times sellers revenues
~ Seller’s considerations
Owners willing to stay on for two to three years
Job security for management and employees
Earn-out
Cash versus stock
Transaction Case Study
~ Successful Acquirer
Morse Datacomm
• Revenue
• Corporate Structure
• Strategy
$800,000,000
Public, Foreign
Voice data integration
Develop U.S.foothold
Cross-sell services
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Transaction Case Study |
I |
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~ Value Creation |
|||
|
Vector |
Vector/Morse |
||
|
Current |
Projected |
||
|
Revenue |
$60,000,000 |
$82,000,000 |
|
|
Reported Pre Tax Profit |
3,750,000 |
||
|
Recast Pre Tax Profit |
5,950,000 |
10,170,000 |
|
|
Recast Net Income |
3,570,000 |
6,100,000 |
|
|
Recast EBITDA |
6,405,000 |
10,200,000 |
|
|
Times 7.1 |
Times 4.4 |
||
|
45,000,000 |
|||
Transaction Case Study
~ Deal Structure
Consideration
Payment terms
$45,000,000
55 Cash, 45 Stock
– Tax deferral via tax-free exchange addresses seller’s
tax concern
0.- Stock value: downside protection via contractual stock
put
––– Employment Agreement: includes options & incentives
based on post-closing performance; protects
buyer/provides upside for the seller
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Transaction Case Study
~ A Great Deal
“Based on synergies developed as a result of this
acquisition, we believe that a price of 4.4 times
projected first year EBITDA represents tremendous
value to our shareholders.”
Morse Datacomm
“With a purchase price equal to 12.6 times last year‘s
recast net income, we believe that optimum value was
realized for our Company.”
Vector
Multiples of What?
~ Transaction multiple based on $45MM purchase price
|
Multiple Source |
Actual Financials |
Recast Financials |
|
Revenue |
.75 times |
.75 times |
|
EBITDA* |
10.7 times |
7.1 times |
|
Projected EBITDA* |
4.4 times |
4.4 times |
|
Pre Tax Profit |
12.0 times |
7.6 times |
|
Net Income |
20.0 times |
12.6 times |
* Earnings Before Interest, Taxes, Depreciation and Amortization
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Summary
~ Growth in mid-market M&A continues
‘;> Need to be ready
~ Know where you are in the decision process
~ Know your “Transactional Health”
~ Form the action program
~ Build your team
~ Drive value and get paid for it
Driving Value for the Future – Optimizing Business Value – The DAK Group Ltd