ServicePower Field Service Optimization Software

A Look at Merger and Acquisition Mania
within the High-Tech Service Industry
By
Michael R. Blumberg

As we come out of the economic doldrums that characterized the first half this decade, mergers and acquisitions appear to be an effective strategy to ensure revenue growth and good financial returns within the high-tech service industry. Indeed, during the second half of 2004, we observed an increased level of activity in the area of mergers and acquisitions (M&A) within the high-tech service industry. This activity will no doubt continue well into 2005.

The trend toward M&A is driven by the fact that the high-tech service industry is very fragmented, which makes it ripe for consolidation. The increased level of attention by corporations on the topics of closed-loop supply chain management, reverse logistics, e-waste management /e-recycling, and regulatory compliance is further fueling this trend. In essence, consolidation of our fragmented industry enables a strategic service buyer to very quickly build the economies of scale and create the critical mass needed to provide after-market services associated with closed-loop supply chain, reverse logistics, and e-waste /e-recycling on a profitable and efficient basis. In essence, these stylistic industry trends are the factors that are fueling the demand for companies to acquire. At the same time there are a number of mature companies serving this industry that are looking for a liquidity event as part of an overall exit strategy. This is particularly true of a number independent service organizations (ISOs) that were founded in the 1980s and whose owners are reaching retirement age; these individuals are ready to take their cash out of the business, thus creating the supply to fulfill demand.

To illustrate the level of activity in this area, we point to the following transactions that occurred in the second half of 2004:

Synstar acquisition by Hewlett-Packard
Compucom acquisition by Platinum Equity Holdings
Hays Logistics acquisition by Platinum Equity Holdings

In addition to these well publicized deals, there are another dozen or so firms who are actively involved in acquisitions. Many of these companies are U.S. based firms actively attempting to establish a business base elsewhere in North America, the U.K., or Europe. In fact, we believe that we have now entered the early stages of a “seller’s market.” In a seller’s market, companies can typically generate acquisition multiples in the range of 80% to 120% of revenue.

One of the most important steps in completing an acquisition is to arrive at appropriate valuation for the targeted acquisition. The major, measurable characteristics used in evaluating a service organization for acquisition include its size and existing economies of scale, geographic coverage, technology focus, service systems and infrastructure in place, public or private ownership, recent (4- 5 year) growth record, and revenue and profit record and forecasts for 3- 5 years.

A more specific approach to determining the relative value or worth of a service business to an acquirer involves the consideration of five major criteria:

High-density market and technology base
Focus on specialized vertical market segments and/or niches
Strong marketing and sales force in place
Understanding of market perception and requirements (focus on value-in-use pricing, value-added services)
Sophisticated infrastructure and systems, including call management, optimized scheduling, TAC/help desk, logistics management, and systems support.

In general, these and other criteria are then used to determine the acquisition price of a target company. Four general accepted acquisition-pricing models can be directly applied to service organizations:

Percent-of-revenue model: Involves setting the estimated acquisition price as a percentage of annual revenues received. Prices can range from 50% to 150% of revenues for private companies and 100% to 300% for public companies
Multiples-of-profits or operating income model: Price estimate is set as a multiple of operating income or cash flow. Prices can range from 5 to 15 times pretax profit for a private company and 10 to 25 times for a public company
EBITDA/Cash flow model: Price is determined as a multiple of cash flow or earnings before income tax, depreciation, and amortorization (EBITDA). Typically, observed multiples can range from profits and 3 to 11 times EBITDA for private companies and 6 to 10 for public companies
Value-in-use model: This is the most complex pricing model because it requires an estimated valuation reflective of an estimate of the incremental value of the acquisition to the purchaser as a flow or at a point in time.

A purchaser would typically determine which type of valuation model it prefers based on the financial data available and industry-comparable performance. The buyer and seller would then agree on an acquisition price taking into account the five criteria listed above. For example, under the percent-of-revenue model, a private organization meeting all five pricing criteria in a high-growth, low-competition market may be priced at or slightly over 150% of revenue, while an organization that meets none might barely command 50% of revenue.

It should also be noted that the valuation parameters presented here are generalized across service organizations, and variations exist between broad organizational categories. Low-tech equipment maintenance and repair operations may be at, or even below, the ranges given here. In contrast, high-tech niche players in “hot” markets may command multiples significantly higher than those presented. For example, organizations with strong performance in high-end professional services tend to sell at premium prices. In all cases, validations of public companies are more volatile than their private counterparts.

Given the range in price valuations for a service company and the emergence of a “sellers market,” potential buyers should have a very clear understanding of the marketplace in terms of its size, structure, and growth forecast, as well as the characteristics of potential acquisition candidates in the market. A clearly defined acquisition strategy that defines and profiles the optimal characteristics of an acquisition company is also recommended. This will ensure that ensure that: 1) the company is not looking for the proverbial “needle in the haystack” when pursuing acquisition targets, and 2) the buyer and seller can mutually agree on a realistic acquisition price. There is no reason why a premium price should not be paid if the acquisition candidate does indeed add considerable value to the buyer’s overall growth strategy. Likewise, a seller should also have a good sense of their valuation. Selling a company is not that much different than selling a product or service. The seller should anticipate a buyer’s needs and have a very good idea of the value they bring to the buyer. A clearly defined exit strategy or divestiture strategy is also recommended to potential sellers. The strategy should take into account the type of valuation the seller would like to obtain from the buyer as well as the identification of a specific company or category of companies that would provide an optimal valuation and thus represent a good buyer(s). This approach will also ensure that a qualified buyer is found and a realistic price is established, a key requirement to any transaction. In essence, knowledge of the market, industry comparables, financial metrics and operating benchmarks, and company characteristics is critical to both the buyer and the seller in any successful M&A transaction.

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Michael R. Blumberg, MBA, CMC, an authority on marketing research/strategy formulation in the high-technology service market, is president of D.F. Blumberg & Associates, Inc, a Fort Washington, PA based management consulting firm that provides client services in strategic planning, market research, productivity improvement, and management systems design and implementation. You may reach him at michaelb@dfba.com or (215) 643-9060.