Why Private Firms Are Into M&As

Merger-and-acquisition activity is intensifying among privately owned companies, in large part due to industry consolidation. Most of the companies making M&A decisions are doing so for strategic reasons. Acquirers are attempting to broaden product lines and extend geographical reach to establish themselves as “single-source” suppliers to their customers. A surprising number appear to be making acquisitions as part of a two-step strategy; they first acquire a company to overcome weaknesses such as gaps in product lines or a small customer base, and then sell themselves to a strategic buyer at a premium price.

What sounds like a dog-eat-dog scenario has a bright side: The great majority of owners seem confident that their companies are growing in value. In the current, positive economic climate, most owners planning to sell are not being driven by economic pressure, but because they feel the time and price are right.

This picture arises from a recent national survey of 159 privately held companies, largely manufacturers and distributors, with annual sales from less than $5 million to more than $50 million. According to the survey, owners of 122 of these companies—77 percent—say they expect to acquire another company, or be acquired, within the next few years. Of these, 34 intend to make an acquisition first and then sell the company.

The survey was conducted during the first quarter of 1999 by the DAK Group, an investment bank in Rochelle Park, New Jersey, that focuses on entrepreneurial companies, and Rutgers University. The sample was drawn from several business lists. About 66 percent of the firms had been in business 20 years or more, and it was estimated that well over half are family owned or have family members working in the business.

Of the respondents, 47 percent were in manufacturing, 27 percent in distribution, and 11 percent in services, with 15 percent scattered across other industries. The majority—54 percent—had revenues in the $5 million to $25 million range; 28 percent were under $5 million, and 18 percent were over $25 million.

The survey found no signs of “growth for growth’s sake”—no would-be conglomerateurs. More than 90 percent of would-be acquirers say they are looking at their own industry, usually with the goal of adding strength or eliminating weakness. Even those looking for acquisitions outside their industry indicate they are looking at related industries. Clearly, they believe that sticking with what they know is good business.

In a number of industries, including packing, printing, and office supplies, companies are under pressure to offer large customers “one-stop shopping.” To meet such demand for much broader product lines, suppliers often have little choice but to make acquisitions. Building their own new plants or adding production lines takes too long and is simply too slow.

Companies are also being pressed to increase capacity utilization of existing plants and equipment. But because many companies are unable to grow sales fast enough to meet the output of their high-speed equipment, they must build their customer base through acquisitions.

In several industries where the number of major manufacturers has already been reduced through mergers and acquisitions, consolidation is now moving to smaller companies. This is apparent among office-product manufacturers, for example. Those with narrow product lines are alarmed by the growing strength of their competitors and the consolidation of their customers. For many, the strategy is either to grow through acquisition or to be acquired by a stronger company.

Here are some recent examples of successful strategic mergers and acquisitions:

• Seaboard Folding Box Co., a manufacturer of folding cartons in Fitchburg, Massachusetts, acquired Majestic Packaging in Bohemia, New York, which also makes folding cartons as well as blister cards. The acquisition gave Sea board a broader geograph ic reach and increased its critical mass. But the most important result was that the acquisition made Sea board a much more attractive target for acquirers. Soon after acquiring Majestic Packaging, Sea board was itself acquired by Jordan Industries, a major Chicago-based private equity fund that saw Seaboard as its platform in the packaging industry.

• To gain entry into the label and laser-print market for its office products subsidiaries, Fortune Brands, a major consumer products company in Greenwich, Connecticut, acquired May Tag and Label Co., a manufacturer of labels for home and office use in Hillside, New Jersey. Two brothers were the principal shareholders of May Tag.

• By acquiring Vantage Components with its five East-Coast operations, California-based Bell Microproducts, a fast growing distributor of semiconductor and computer products, was able to gain a nationwide franchise. The merger created the same national growth opportunities for Vantage, which was owned by a father and son and several other shareholders.

• MS Electronics, a regional distributor of electromechanical and electronic components in the Baltimore and Washington, D.C., market, gained broader product lines and access to growth capital when it was acquired by Richey Electronics, a public company in Gaithersburg, Maryland. The merger enabled Richey, a multi-regional distributor, to strengthen its operations in a key region. It was recently acquired by Arrow Electronics.

• Mechtronics of Arizona, a manufacturer of mechanical and electrical components with a growing niche market, realized that it could grow much faster with more capital and a greater market reach. Both needs were met when the founder, whose son works with him, sold the company to Ducommun, a California-based aerospace company.

While strategic acquisitions are driving much of today’s M&A activity, acquirers are also being encouraged by the disparity in price between private and public companies. Privately held companies typically sell at a sizable discount to comparable public companies. Now, with the stock of many public companies selling at record highs, the price disparity has widened. At the same time, private companies are rapidly increasing in value due to the economic boom, creating a tempting situation for the family company that wants to grow by acquisition.

The survey confirms that most private companies see their value growing and expect this trend to continue. More than two-thirds of the companies surveyed report that they had increased in value in 1998, and 79 percent say they expect to increase in value in 1999. By contrast, only 15 percent report a decrease in value in 1998, and just 3 percent expect a decrease this year.

Despite the “acquire-or-be acquired” atmosphere, M&A activity is being driven by success rather than fear or failure. Acquirers are bidding up the values of attractive niche companies, and owners are selling at a premium. More than half the sellers cite lifestyle changes, especially retirement, as their reason for selling, compared with 33 percent who cite competition or market changes.

There is concern, though, that too few owners understand the value of their company. The survey found that just 85 of the companies, or 53 percent, have actually had a professional valuation or assessment. The rest report that they are estimating the company’s value by such methods as prices paid for other companies in their industry, offers made by potential acquirers, and what they “feel” the company is worth. If owners undervalue the company, they may hurt themselves and their family by selling at a sharp discount. Conversely, if they reject a generous offer out of hand, they may never get the same opportunity again.

In many cases, owners have built their companies to the point where internal growth is no longer enough to sustain them. To keep growing, they have to make strategic acquisitions or be acquired. The alternative is stagnation. All in all, small business owners appear to see the current economic boom as an ideal time either to seize greater opportunities through acquisition, or to reward themselves and their families for years of hard work by selling at a premium.

Alan J. Scharfstein, is founder and president of the DAK Group Ltd. in Rochelle Park, NJ, which specializes in mergers and acquisitions of privately held companies. E-mail address: ascharfstein @ dakgroup.com.

Consolidation

Acquisition activity

Company value

— A.S.