How to be acquired
by Stephen Hardy
So you say your VC angels have turned devilish about finally getting paid off. Or maybe your shareholders have grown bored with using your stocks for tax loss purposes. Overall the optical communications market is up, several companies in your space have recently launched successful IPOs-isn’t it time to plunk a “for sale” sign in the front lawn and finally embark on that comfortable retirement you envisioned when you founded your business back in 2000?
“Maybe,” say analysts in the financial community. But it will take more than a fresh coat of paint to make your enterprise attractive to would-be buyers. The number of companies on the prowl for acquisitions continues to grow-but they have a very specific list of attributes your business must possess before they give you the money to retire to that cabin by the lake.
With several systems vendors in good health and a few optical component/subsystem companies finally either in the black or a quarter or two away, a pool of buyers has finally begun to form. Paul Bowen, president of Bowen Advisors Inc. (www.bowenadvisors.com), reports that his business has evolved since 2002 from representing the sell side 100% to a current ratio of 60/40, with potential buyers representing the 40%. While he is active in markets outside what he terms “optical transport,” he says the 60/40 ratio holds for the “handful of projects” he currently has active in the optical space.
Kevin Slocum, managing director at Greenwich Technology Partners (www.gtadvisors.com), a company that operates on the sell side, also believes the improving prospects for optical communications have led more companies to fill out their shopping lists. “I think we’re enough past the bottom that purchasers are definitely on the hunt for areas that improve their growth prospects,” he relates. In many instances, healthy companies will use acquisitions to fill holes in their product portfolios, Slocum says.
However, the space’s economics haven’t improved to the point where sellers don’t significantly outnumber buyers. The buyer’s market means a company on the hunt for acquisitions can be as ruthless as it wishes in evaluating potential purchases. And one attribute is at the top of nearly every buyer’s wish list.
“I think profitability is very important,” says Slocum. “If you’re not profitable, you damn well better be EBITDA positive and cash flow positive, with profitability just around the corner. And for most buyers to make that leap, and step over the idea that you’re not making money right now, it’s going to be the more unusual circumstance than the norm; it’s going to be he’s got a hole that he really feels like he needs to fill. And by definition that means he knows that he can turn this [acquired asset] into something greater more quickly [than the seller can on its own].”
Chris Dewees, senior vice president of corporate development at JDSU (www.jdsu.com), backs up Slocum’s opinion. “Our company is focused on increased profitability and growth. We have also stated that we expect to do that through M&A that meets those end goals,” he explains. “The challenge is to find those companies that are sufficiently profitable and that will contribute to our profitability as well as to our revenue and technology growth.”
Another challenge is coming to an agreement about what the potential acquisition is worth. While the optical communications space has improved, valuations have not necessarily kept pace. This fact remains a point of pain for many boards considering whether or not to put their companies on the block. “I think there are still a lot of people who are running tech companies who are founders, and they have emotional ties to a value for their company that is driving them to feel that they are significantly undervalued and therefore are waiting and hoping that that valuation will change for the better,” Dewees observes.
Bowen believes that Infinera’s successful IPO may improve valuations for systems companies. However, both he and Slocum advise boards to forget about Bubble Era valuations. “I would argue if you got 3× sales on the systems side, you’re doing pretty well,” Bowen says. “On the subsystems side, I would argue 1.5× to 2× sales is pretty reasonable.”
Acquiring companies won’t pay excessive premiums because they can’t afford to, Slocum says. “Look at the companies. They’re not that well off,” he explains. “They’re all a lot healthier than they were a few years ago, but they’re not knocking the cover off the ball from the profitability perspective. So they have to be rational.”
Bowen and Slocum also advise potential sellers to forget about private equity companies paying premiums other optical equipment companies won’t. Private equity investors like big companies with lots of cash flow, and most optical communications companies, regardless of where on the food chain they operate, don’t fit that description. And even a private equity firm with big ambitions and pockets to match probably won’t attempt to roll up a half-dozen small companies in hopes of establishing market dominance in optical components, Bowen says. There are so many niches, each with a different roster of companies in play, that such a strategy would likely prove futile.
So the best bet for anyone looking to sell will likely be another optical communications company. “These are companies that are basically saying, ‘Hey, we survived; we’re not afraid of Company X, Y, or Z’s problems. If they’re struggling, we think we can improve them.’ And that, in the components and subsystems space-I haven’t heard people talk like that in five years, six years. So it’s definitely a different day with brighter skies ahead,” Bowen says.
So how do you improve your company’s chances of doing business with one of Bowen’s optimists? Slocum advises you to take a hard look at how close your company is to profitability-and whether you can cut costs to help get you there more quickly. Slocum says this advice pertains especially to venture-backed startups, many of whom established a cost structure ahead of revenues. Slocum observes that many VC-backed companies don’t look at reducing costs as closely as they should-some hoping that an acquirer will play the role of “bad guy” and take actions current management should perform themselves.
Since valuation is a combination of profitability and growth potential, a sharpened focus on profitability will also improve your chances of getting a price you and your backers or shareholders can stomach. The sources contacted for this story believe more potential sellers will take these steps which, combined with a growing list of acquirers, should accelerate mergers and acquisitions over the next 12 to 18 months.
“We’re signing up more [clients], and we don’t sign them up unless we think we can complete them,” Slocum concludes. “So I am expecting a pickup in the level of completed deals. I’m not sure how material everybody will feel it is, but I do think there will be more.”
Stephen Hardy is the editorial director and associate publisher of Lightwave.