EXTERNAL EXPANSION: ACQUIRING A FIRM, INCLUDING CRITERIA FOR A LBO AND FINDING A LBO TARGET Chapter

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EXTERNAL EXPANSION ACQUIRING A FIRM, INCLUDING
CRITERIA FOR A LBO AND FINDING A LBO
TARGETChapter 15
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EXTERNAL EXPANSION

• Before we discuss acquiring a closely held firm
  lets take a look at how conglomerates were
  created with a publicly held firm. The trick was
  to get a Pop in Earnings.

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EXTERNAL EXPANSION

• Assume Co. A wants to acquire Co. B. Co. A
  pays 5,000,000 in stock for all of Co. Bs
  shares.

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EXTERNAL EXPANSION

• How did the stock price go up to 24.00?

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HOW TO GET A POP IN EARNINGS

• No its not slight of hand. Co. A paid a lower
  P/E for Co. Bs stock than Co. As stock was
  priced in the market!
• Any time you pay a lower P/E than your P/E, you
  get a POP in earnings. If you pay a higher P/E
  you get a PLOP - dilution.

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CRITERIA FOR A LBO

• HOCKABLE ASSETS - Assets that have a high
  borrowing rate inventory, on the other hand,
  has very low hockability, so avoid companies
  with heavy inventory if that represents a large
  proportion of assets. This criteria mostly
  excludes service companies and distribution
  companies.
• NO or LOW LONG TERM DEBT - How can you borrow on
  an asset that is already Hocked?
• PROBABLY AN OLD FIRM - Older firms usually have
  low or no debt owner may want to retire.

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CRITERIA FOR A LBO - Contd.

• GOOD, DEPENDABLE CASH FLOW - We have discussed
  the importance of this a number of times! No
  Turn arounds if the firm is loosing money, you
  probably cant do a LBO on it.
• SIZE - Is the company too small for you? Dont
  forget that much of NOCF is going to go for debt
  service will there be enough left for you? Or
  too large for your track record?

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CRITERIA FOR A LBO - Contd

• TYPE OF COMPANY AND MANAGEMENT- Is this the type
  of company you would be happy to manage and own?
  If you are not happy and proud to be associated
  with this type of company, why are you even
  looking at it?
• COMPELLING REASON TO SELL? - A lot of business
  owners want to sell - at a ridiculous price - but
  what you need is a thoroughly motivated seller -
  because this is the only way you will get
  concessions.

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CRITERIA FOR A LBO - Contd

• NO INSURMOUNTABLE ENVIRONMENTAL PROBLEMS- Many
  companies, especially manufacturing companies,
  have pollution problems, e.g., land that is
  polluted or company puts out pollution in air. If
  problems can be cured easily, this may be OK, but
  some problems are too big to handle.
• Problem is exacerbated if you have to buy the
  real property may be better to just buy the
  company without the land.

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CRITERIA FOR A LBO - Contd

• And finally, A QUIET DEAL- You really do not want
  competition competition may drive up the price,
  to be sure, but the bigger problem is that
  competition drives down the terms and drives up
  the cash down payment. Ideally, you would like to
  be the only potential buyer if you are told
  others are bidding on the business, maybe, you
  had better pass until they are out of the way.

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CRITERIA FOR A LBO - Contd

• REMEMBER THE NAME OF THE GAME IN DOING A LBO DEAL
  IS TERMS PRICE IS NOT NEARLY AS IMPORTANT AS
  TERMS. THE RIGHT TERMS WILL MAKE THE DEAL TOO
  TOUGH TERMS WILL KILL THE DEAL!

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FINDING A LBO TARGET

• Once you understand the criteria for a LBO, the
  best means of finding a Target company may be
  your own acquaintances or personal knowledge. If
  you know of a owner who is quite ill or wants to
  retire, you may have your target. As will be
  explained later, this is the process of logical
  deduction.
• Ads in Wall Street Journal and L.A.Times - With
  L.A.. Times look under the section for
  manufacturing may find a company owned by
  parties in divorce or death problem with WSJ is
  that there is too much competition not a quiet
  deal.

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FINDING A LBO TARGET, Contd

• Business BROKERS
• Business opportunity (Real Estate) brokers - not
  much use for middle market firms OK for Mom and
  Pop stores, etc.. Can be harmful in middle
  market deal.
• Merger Acquisition brokers - Probably not very
  helpful because they have established customers
  they know that LBO buyer may not be able to do
  the deal for lack of money. But they are worth
  while using if possible!

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FINDING A LBO TARGET, Contd.

• Corporate finance /M A departments of banks and
  major accounting firms. May be an excellent
  source as target may be customer of bank or
  accounting firm who want to sell. Banks not doing
  as much of this as they used to do.
• Trust companies - if someone dies and leaves
  his/her stock in trust then you can be almost
  certain that the trust company has the company up
  for sale. Trust Cos. do not want to manage
  companies - can get sued for mismanagement. Trust
  Cos. usually will not take a note may be a big
  problem - if you have someone else - a Third
  Party- who will take the subordinated note, this
  may be good!

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FINDING A LBO TARGET, Contd.

• Manufacturers Directory - My best suggestion.
  Directory lists companies three ways SIC code,
  regionally and Alphabetically. Look at name of
  company, e.g., Brown Co. then look for the
  president - A. Brown if A. Brown Jr. listed as
  V.P., keep going. Look for age of firm - if 20 or
  more years old, probably is for sale as owner may
  want to retire. Look at nature of business and
  ask Are there hockable assets in Co.? Look
  for size of firm right for you? Process of
  Logical Deduction!

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APPROACH LETTER

• Seek the sellers hot buttons.
• Offer all cash or a substantial amount of cash.
• Offer to make the deal tax advantageous to
  seller.
• Emphasize confidentiality.

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DUE DILLIGENCE PROCESS

• Very difficult to do. Beginners want to overdo
  the process.
• Why are you interested in this business? Do what
  it takes to confirm why you want the company.
• Verify financial statements.
• Asset verification and appraisal.
• Customer satisfaction?

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EXTERNAL EXPANSION ACQUIRING A FIRM
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