Mergers, Acquisitions: Tools for Building Business, Liquidity<@VM>Chart

Jerry Grossman

by Jerry Grossman

It has become essential for business owners and executives to revisit and re-examine their business strategy much more frequently than in the last century, way back in the 1990s.

Examining and fine-tuning strategy are critical, both for owners seeking shareholder liquidity alternatives and for owners developing a growth plan for their companies. Pursuing either of these options requires buy-in to your company's strategy by sources of capital and (often) strategic partners ? buyers, sellers or joint venturers.

The perception ? and, in many cases, the reality ? is that static business models aren't sustainable in many industries. The pace of change is accelerating, primarily due to technology.

Intuitively, these trends suggest that more fluid and dynamic organizational structures will be more effective. The customer is still important, but finding and satisfying customers involves more creative ways of mobilizing and coordinating resources.

Public-sector technology companies have a substantial lineage in resource mobilization and coordinated delivery of both services and products. What's critical today for owners and executives is to build the organizational capabilities and solutions that will differentiate their companies in the eyes of the market. These market differentiators provide the foundation for branding, cost efficiency and value-added pricing.

For government IT companies, the Internet and state-of-the-art communications technologies are being incorporated into business. Typically, electronic government and e-business labels are being deployed to characterize the companies as Internet-savvy businesses, equipped with the skills and experience to transform client systems and connect them to the Web.

In the defense technology segment, companies are replacing custom and constructed systems and platforms with modern systems designed to deploy off-the-shelf components. Systems integrators must integrate these components and enhance them with customized software to meet customer requirements.

These newer business models provide the basis for more rapid deployment of solutions, at competitive costs, in a technically challenging work environment. Through strategic assessments, most companies identify holes to fill in their organizational structures and addressable resource bases. Realigning strategies and implementing effective business models must be done quickly, "on Internet time" in current nomenclature.

Accordingly, organic growth initiatives often are not sufficient to remain competitive as an "early to market" provider. Acquisitions can help to fill these holes and provide added capabilities and contracts.

An updated review of merger and acquisition activity and the mindset of capital markets participants suggests three things:

? Capital availability remains strong, albeit more expensive than in the past few years.

? Capital providers and acquirers are becoming more discerning in their investment decision-making processes.
? Making strategic acquisitions has become a fundamental component of business building and company disposition strategy.

For business owners who are actively seeking liquidity or are unprepared to move ahead aggressively with business refinements, selling their businesses may be the best path to pursue.

From the chart on the left, it is clear that the environment for business building and shareholder liquidity remains good. Capital raised by private equity buyout funds declined to $33 billion in 1999 after reaching $55 billion in 1998, but did keep pace with 1997 and remained well above historical levels.

However, with softening in public-market pricing and more discerning review of technology offerings, private equity professionals are migrating toward traditional levels of scrutiny and selectivity. Banks are also retreating to more traditional lending criteria.

In the government technology sector, the pace of transactions continued to rise in the 12 months ended June 30, with 57 announced acquisitions, up from about 45 in each of the previous three years. Transaction pricing for the government technology services sector continues to be strong through mid-year 2000, with enterprise value to EBITDA multiples in the 9.0x to 10.0x range.

The increasing proportion of cash consideration in transactions, relative to stock, in 1999 as compared to 1994, reflects changes to stock market pricing and (in 1999) readily available debt at modest cost. Debt costs have risen materially in 2000.

Whether on the buy side or sell side, it is critical for owners and executives to understand how external markets and capital providers will interpret their business strategies and the implications of their acquisition and divestiture plans on investment risk and shareholder value.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va.

Source: Mergerstat, a division of Houlihan Lokey

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