The profit in 2010, Think Strategically

Mast advisors share an inside playbook

The collapse of the stock market. Trouble in the housing and banking industries. The fall of one financial giant after another “too big to fail.” Company valuations slightly above rock bottom.

That sounds like the economic crisis of 2007-2009, but Mark Taffet at Mast Advisors in Newark is describing the period from 1987 to 1990, when the same pileup of economic challenges from 1991 to 1996 offered buyers and sellers a “golden era for strategic purchases.” The current window of opportunity may be relatively brief, if you want to take advantage of lowered valuations; in the 90s, the technology bubble quickly drove prices beyond prudent levels, said Taffet, CEO of the M&A, corporate finance and strategic advisory firm.

For those who are sitting on the sidelines in 2010, hoping that the market will return to its 2006-2007 levels, he has a blunt message: A return to those days is “delusional.” “We think it’s time for people to realize that the bubble was not normal; normal is what we’re going into now. Normal middle market businesses sell for what they’re going to sell for now,” which is four to seven times EBITDA (earnings before interest,taxes,depreciation and amortization), a third and even a half less of the levels reached during the bubble, when multiples rose to seven and 12 times EBITDA.

If you don’t want to miss out this time around, “now may be a very good time for your company to make a strategic acquisition,” especially if you’re in a niche business, have the money for a strategic purchase and are looking ahead 12 to 18 months,” added Allen Kohan, Mast’s managing director. In 2009, if you focused on protecting your company’s balance sheet by cutting costs, reducing debt and taking other measures to survive, your company now may have excess borrowing capacity. That may put you in the perfect position in 2010 to acquire other companies or strategic assets.

Strategies can include: increasing your market share by attracting customers and suppliers previously tied to weakened competitors; upgrading your talent with superior employees; acquiring assets and/or competitors at valuations based on both lower multiples and earnings; enjoying less competition from private equity and venture capital firms that are unable to obtain financing; and using “operational leverage” to reduce costs by combining administrative, sales, technical, plant and other functions.

To help you decide whether you should consider a strategic acquisition, Taffet and Kohan put together the following playbook for NJBIZ readers:

Start with a realistic assessment. Put together a strategic profile of the markets you serve, your company’s product-line portfolio, the underlying industry dynamics and your company strengths and weaknesses. How do you cope with underlying market and technology trends, changes in customer and work force dynamics, competitive structure, financing capability and geographic factors? Then focus on developing where you want to go. Do you need to broaden your market focus or concentrate on more narrowly defined market niches? Should you diversify through new product or market platforms?
Decide on the right strategies. Expanding your company’s product line into new market segments can generate more growth for your business. As examples, if you want to become a full-line financial services provider, add high-value services to supplement your company’s offering. If you are a small medical device supplier to targeted markets, focus on developing a broader medical device offering to address both existing and complementary markets. If you want to have a more comprehensive chemical catalyst product line, then concentrate on high-growth industry segments.
Think about implementation. Once company goals and strategies are established, address the best ways for achieving that growth. Are there internal capabilities to develop new services, devices or catalyst products? Can current management and sales staff expand and diversify the company’s capabilities in the desired direction? Are new operational capabilities required? Does entry into a new market segment or the addition of a new product line require the acquisition of an entire company?

This strategic review asks if your company’s current management team has the capability to expand and/or acquire companies, product lines, intellectual property or specific assets. Companies interested in strategic growth are looking for synergies. Are there cost savings, operating efficiencies, complementary product lines, new market capabilities?

If so, buyers are willing to pay four to seven times EBITDA for smaller companies, and five to nine times EBITDA as transactions become larger. If a company can show that it has weathered the recession well, then pricing will be based on expected near-term income.

In 2009, Mast Advisors brokered the sale of a mid-sized company that designed and manufactured highly engineered engine subsystems. Although the company had reduced profitability because of the current economy, their strong market position and strong backlog allowed Mast to sell the company for two times book value and over 10 times 2009 EBITDA, said Taffet, who shared deal details. A multinational, multibillion-dollar company outside the U.S. paid $15 million in cash for the business, which sells subsystems to OEM manufacturers’ (original equipment manufacturer) engines for the marine industry.

Although industry sales were down 75 percent, the company’s results fell only 33 percent because the leading customers in the industry’s target market used their engines. Also, the company had won, and was poised to win, additional, attractive new contracts from leading OEM engine manufacturers.

When the market went down, the company felt it, said Taffet, but they were able to maintain their sales and even started to take market share from their competitors by locking in contracts. The buyer knew that when the economy improved, existing contracts would allow the seller to double sales, and accelerate further growth with new contracts because the seller offered the buyer three irresistible benefits:

Operational leverage. The buyer had been sending certain work out to a third party. They were now able to bring that work into their factories. Also, the seller had been selling only to the United States. Now, the buyer, which dominated a large, non-U.S. market, could increase its market share.
Long-term investment. The buyer acquired an asset that’s going to deliver a solid ROI (return on investment) in the long term because of the underlying supply agreements.
Synergy. There’s a sales and manufacturing synergy that’s going to happen as forces combine.

One last word, or actually two: Due diligence (See “Warning ahead” on Page 17). That’s a critical aspect of maximizing value. Before going to market, work with your company’s existing service suppliers (engineers, accountants, information technology), to assure that the due diligence process can be completed smoothly.

If you do, you’ll be ready to take advantage of a strategic acquisition when a buyer comes knocking. If not, you’ll either give the wrong answers, or no answer, which will reduce the price. Fail to supply important pieces of information, and you’ll lose the deal.-M&A