To acquire or be acquired; is that the question?

Mergers and acquisitions, the art of bringing together two companies either as equals (merger) or unequals (one acquiring the other), has been transforming the commercial landscape for generations. * Utah got a close-hand view of the power of M&A activity during the late 1970s and 1980s, when locally based drugstore chain Skaggs acquired a number of supermarket and drugstore chains, including American Stores in Philadelphia, Lucky in California and Jewel in Chicago, took the name of American Stores, and for a time became the largest operator of supermarkets in the country. * M&A activity, which tends to wax and wane with corporate trends and the economic climate, is still able to transform industries--as well as the economic vibrancy of the cities where the companies are based. Anyone interested in running or owning a business, moving up the corporate ladder, or just wanting to better understand the strength and character of the local economy needs an understanding of the M&A world.

M&A Activity of Note

The past several years have seen a number of notable national mergers and acquisitions, including Boeing's purchase of McDonnell Douglas, Hewlett-Packard's buyout of Compaq Computer, American Airlines' acquisition of TWA, Nations-Bank's takeover of Bank of America (while keeping the B of A name), the merger of Time-Warner and America Online, and Daimler-Benz's so-called "merger of equals" with (some would say acquisition of) Chrysler. All of these significantly affected their respective industries.

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ASSOCIATED FOOD STORES CEO RICH PARKINSON

Utah has not been immune. American Stores was purchased by Albertson's, which is headquartered in Boise. Smith's Supermarkets was bought by Fred Meyer of Portland, Oregon, which was subsequently acquired by Cincinnati-based Kroger, the country's largest supermarket operator. ZCMI, the department store chain owned by the LDS Church, was bought by May Department Stores of St. Louis, and the stores became part of May's Meier & Frank division, based in Portland, Oregon.

Brigham City-based Thiokol Propulsion, maker of solid propellant rocket motors, was purchased (as part of Cordant Technologies) by aluminum producer Alcoa and quickly sold to aerospace and defense company ATK (Alliant Techsystems Inc.) of Edina, Minnesota. Campus Pipeline was acquired by SCT Corp., and its headquarters are now in Malvern, Pennsylvania. And in early December of last year, California-based Symantec completed its acquisition of one of Utah's more successful technology companies, PowerQuest, the Orem-based software publisher.

But there have also been notable Utah success stories of growth by acquisition. Salt Lake-headquartered Associated Food Stores, traditionally a wholesaler, now owns 23 retail grocery stores, including Macey's, Dan's, Lynn's in Southern Utah, and Dick's and Winegar's in Davis County. And five acquisitions since 2000--including the recent $43 million acquisition of Michigan-based Wise Solutions, a vibrant application management technology developer on pace to earn over $20 million in 2003 revenues at the time of the acquisition--have helped put Lindon-based Altiris, a developer of IT management software solutions, on pace to exceed $100 million in revenue for 2003, only the company's fifth full year in operation.

Still, interestingly, some of the most troubled M&A deals of recent years involved deals with Utah companies sitting on both sides of the table. Provo-based Novell's acquisition of Orem-headquartered WordPerfect is an example of a deal that quickly went bad, forcing Novell to sell off its acquisition (to Corel of Canada) and take a big loss. Salt Lake City-based Franklin Quest bought Provo-based Covey Leadership Center (the combination is now called FranklinCovey), and the culture clash of the two entities caused considerable indigestion within the organization.

Perhaps the most notable (notorious?) example was the public squabble that grew out of the proposed merger of Zions Bank with First Security Bank. Though the two financial institutions had their headquarters on the same block in downtown Salt Lake City, neighborliness did not characterize the deal. The chief executives started butting heads before the merger was completed, and the deal fell apart, even though the parties had already begun merging their operations. This resulted in First Security quickly selling out to San Francisco-based Wells Fargo Bank.

Typical Utah M&A Activity

In Utah M&A activity, local companies tend to be acquisition targets rather than acquirers themselves. "In my experience, there are more business owners looking to sell in Utah, not buy," comments Thomas B. Stringham, Salt Lake City-based vice president at the investment banking firm Roth Capital, which is headquartered in Newport Beach, California (and partially owned by Zions Bank).

There are about two sellers to every buyer in Utah, estimates Daren Shaw, head of investment banking at D.A. Davidson & Co., a Montana-based regional investment brokerage and investment banking firm with offices in Utah. This doesn't surprise Shaw, given the size of many of Utah's businesses. While the state has few large companies, it has many so-called middle-market businesses, with revenues of $10 million to upwards of $200 million. Selling out, says Shaw, is "the most viable exit for most small- to medium-sized business owners."

Brian G. Lloyd, an attorney in the Salt Lake City office of the law firm Stoel Rives LLP, concurs. "Utah has not historically been a mecca for companies going out of state and acquiring." Instead, he says, a company with a great product but in need of additional capital often finds the most effective vehicle is to go outside the state to be acquired. He notes, "The effect is, we don't see as many businesses mature and grow in the state as we would hope for."

Adds Todd Stevens, managing director of Salt Lake City-based Wasatch Venture Fund, "Where we used to have a lot of publicly traded companies headquartered here, such as Novell and Iomega, there are now very few in Utah, and those that are promising tend to be acquired."

What this often means is that company headquarters, and most or all of the management positions based there, go out of state. "A few years ago, when we saw American Stores, First Security and ZCMI be acquired, there were a lot of high-paying positions that left the state," affirms Paul Childs, office managing partner at the accounting firm Deloitte & Touche.

But interestingly, a couple of Utah's more notable acquirers have been less than stellar at bringing high-paying, upper-level executive positions to the state. Novell has a long history of making acquisitions. In early November, it announced the $210 million acquisition of the German firm SUSE Linux, a major commercial distributor of the Linux computer operating system, which followed by three months the acquisition of Ximian, a Linux software developer in Boston. Neither will bring jobs to Utah. And despite Novell being the acquirer of Massachusetts-based consulting firm Cambridge Technology Partners in 2001, Cambridge executives of Cambridge now run the company. While the company's headquarters officially remain in Provo, where it has about 2,000 employees, its "executive offices"--employing 600, including most of the company's top management--are in Waltham, Mass.

Privately held Huntsman Chemical, run by Utah magnate Jon Huntsman, also has a strategy of growth through acquisitions. It now has annual revenues of $9 billion and about 15,000 employees, but it has no Utah operations, and its Salt Lake City headquarters has only about 80 employees.

Another local company, NPS Pharmaceuticals, a research-and-development company in Salt Lake City, was poised to acquire Enzon Pharmaceuticals in New Jersey in 2003 (though again, at the time it was termed a "merger of equals"). The deal fell through when NPS executives took a closer look at Enzon's products and potential and decided the value wasn't what they thought it would be. According to Dave Clark, NPS vice president for corporate affairs, NPS wanted to do the deal, but at a lower price, but Enzon's management refused, and eventually the deal fell through. On the surface, it sounds like Utah lost the opportunity for a local company to make an out-of-state acquisition, but had the deal gone through, the company's headquarters would have moved to New Jersey and Utah would have been left with its R&D activities.

All of this raises the question: Do merger and acquisition activities tend to help or hurt Utah's economy? Thorpe says, "I tend to see it as helping Utah, because a lot of the money given to selling shareholders will be redeployed in the venture community." While some operations go, some stay, along with many jobs and fresh capital, he adds.

Shaw of D.A. Davidson says it is difficult to gauge the effects on the local economy when a Utah-based company is purchased by one from out of state. In many cases, he says, owners gain significant liquid wealth as a result of the sale, and they often invest some of that wealth in the businesses of other entrepreneurs. However, when a company's headquarters is moved out of the state, what remains becomes something of an "outpost," and there are losses, not just in terms of executive-level jobs, but also support for community and charitable organizations.

David G. Angerbauer, chairman of the MountainWest Venture Group and a partner in the law firm Holland & Hart, argues that local M&A activity has a largely negative impact on the state's economy. "Utah is a market where most companies that get to be a good size, say 500 employees, that really establish their operations, [are] usually acquired by out-of-state firms. And I think has an unfavorable effect on the Utah economy. Upper management jobs are lost to the state, and Utah becomes just a division of a larger company. It would be great for the Utah economy if there were more national and multinational corporations headquartered here, but before they get to that level, they are acquired."

Kelly Devereaux, vice president of global marketing at PowerQuest, say his firm's acquisition by an out-of-state company will benefit Utah. PowerQuest, which has a few hundred employees, will become an independent business unit of Symantec, which has a workforce of 5,000. PowerQuest had considered making its own acquisitions during the past couple of years but found it very difficult to raise money in the current economy. Although at the time the acquisition was finalized, Symantec announced it would lay off 70 of PowerQuest's 270 Utah employees, Devereaux predicts that with the financial and marketing resources of Symantec behind it, PowerQuest will eventually grow faster and create more jobs in Utah than if it had remained independent.

Level of M&A Activity

Still, times are tough, nationally and locally, in the merger-and-acquisition field. California-based FactSet Mergerstat LLC, which tracks mergers and acquisitions, reports that the third quarter of 2003 saw 1,837 M&A transactions in the U.S., down from 1,983 in the second quarter and 1,899 in the third quarter of 2002. During the first three quarters of 2003, there were 289 fewer transactions than the previous year. The company reports that closing a transaction today takes six to nine months, twice as long as it did in recent years.

The last two or three years have seen fairly "slim pickins" for mergers and acquisitions, after the excitement of the late 1990s. According to the locally based MountainWest Venture Group, Utah had 36 M&A deals in 2002, with a total transaction value of $1,250,908,000. By comparison, 1999 saw 65 deals, worth an estimated $16,614,203,610. But the bursting of the technology bubble and the extended economic downturn have combined to cool M&A activity.

As the M&A market weakened, so too did the prices that business owners could get for their companies. That just made things worse. Stevens of Wasatch Venture Fund says that in the late 1990s and into 2000, technology companies were getting acquisition prices that equaled four to 10 times their revenues, and multiples of EBITDA (an accountant's number for earnings before interest, taxes, depreciation and amortization) of 10 to 30. Those multiples dropped in 2002, and even in 2003, to one or two times revenues and three to five times EBITDA. As prices dropped, some business owners stepped away from the plate and decided to wait until the market revived and they had a better chance to hit a home run. With the stock market up for 2003 and the economy showing signs of reviving, business owners can expect to get better prices for their businesses, which will encourage more of them to put their companies up for sale.

Devin Thorpe, managing director of the Salt Lake City-based investment banking firm Thorpe Capital Inc. makes another observation: "Some of the deals that were done in 2001 and 2002 were done at very low valuations and done as alternatives to bankruptcy. [In October 2003] a deal closed that fit that pattern." He says that in the near future, if the economy improves, "Our sense is these deals will diminish."

Fred Jones, a principal at the Salt Lake office of California-based business valuation firm Houlihan Valuation Advisors, agrees: "Over the past couple of years, most transactions we've seen have been mergers by necessity. They've run out of their funding, so they combined with another entity to keep going." He adds, "I'm sensing a shift from that right now."

Stringham of Roth Capital says he's seen an up tick in M&A activity in Utah this year, in part because VC firms themselves are motivated. "There's a lot of money sitting on the sidelines," he notes. "Buyout firms and equity funds are pretty hungry. They are being paid a management fee [by their investors], and their investors are looking for their money back if they don't invest." That puts pressure on the fund managers to put their money to work.

One more factor at play is psychological. In the heyday of M&A activity in the late 1990s, sellers developed rather lofty expectations about the value of their companies, notes Eric Petersen, managing director of Ridgeview Capital in Salt Lake City, a private equity and investment banking firm. As the economy slowed down, buyers were quick to adjust their expectations, but sellers were slower to react. Seller expectations are now more in line with the market, and that should help boost M&A activity going forward.

"Certainly the amount of merger and acquisition activity in the state over the last several years has been quite a bit lower than in the mid- to late '90s," notes Lloyd of Stoel Rives. But he too is seeing a revival. In the last few months, he reports, his firm has completed several deals.

Adding some spice to the outlook for 2004's VC is that another player has joined the field. In early 2003, Sorenson Capital, a leveraged buyout firm based in Sandy and headed by former Salt Lake Organizing Committee COO Fraser Bullock, was formed; it reportedly has raised at least $75 million. Utah is one of several states where the firm will invest. Says Bullock, "Utah is one of our primary markets. There are many attractive businesses in the region, especially in Utah, but there are limited alternatives for middle market companies to have a partial or full exit."

This comes on top of the Venture Capital Enhancement Act (HB240), which the State Legislature passed in 2003 to create a $100 million Utah fund-of-funds to invest in 10 to 15 venture capital funds with headquarters or a presence in Utah and will invest in Utah companies.

Ryan Patano, partner at Capital Advisory Group LLC, a Sandy-based merger and acquisition firm, looks for an increase in M&A deals in the first or second quarter of 2004 and expects to see a boom during the next five to 15 years as baby boomers retire and need an exit strategy. "We're seeing a real increase in venture capital funding," he says, "and that speaks well for future M&A activity, [because] venture capitalists are not in for the long term, so they will sell in the future."

Merger-and-acquisition activity will always play a key role in both the national and local economy. How well Utah will do because of this activity is unclear. Many of the state's largest businesses have been acquired. But new businesses are always being formed, and with the M&A market poised for a revival, expect to see even more changes locally and nationally in the coming years.

How Much is Your Small Business Worth?

It's hard to generalize about the value of businesses. That said, here
are "rule of thumb" valuations listed on the BizStats.com web site (from
The Business Reference Guide, published by Business Brokerage
Press in Concord, Mass.)

TYPE OF BUSINESS                    "RULE OF THUMB" VALUATION

Accounting Firms                    100% - 125% of annual revenues

Auto Dealers                        2-3 years net income + tangible
                                    assets

Courier Services                    70% of annual sales

Dental Practices                    60% - 70% of annual revenues

Dry Cleaners                        70% - 100% of annual sales

Employment & Personnel Agencies     50% - 100% of annual revenues

Engineering Practices               40% of annual revenues

Florists                            34% of annual sales + inventory

Food/Gourmet Shops                  20% of annual sales + inventory

Furniture & Appliance Stores        15% - 25% of annual sales +
                                    inventory

Gift & Card Shops                   32% - 40% of annual sales +
                                    inventory

Grocery Stores                      11% - 18% of annual sales +
                                    inventory

Insurance Agencies                  100% - 125% of annual commissions

Janitorial & Landscape Contractors  40% - 50% of annual sales

Law Practices                       40% - 100% of annual fees

Liquid Stores                       25% of annual sales + inventory

Property Management Companies       50% - 100% of annual revenues

Restaurants (non-franchised)        30% - 45% of annual sales

Sporting Goods stores               30% of annual sales + inventory

Travel Agencies                     40% - 60% of annual commissions

RELATED ARTICLE: Why Merge or Aquire?

Typically, buyers have one of two motivations for engaging in a merger or acquisition:

Financial: The buyer thinks the acquired company will prove to be a good investment. It's not uncommon for the buyer to bring money, expertise, contacts or other assets to the acquired company. With these, the acquired company is able to move to another level which it could not if it remained independent. With a financial buyer, there's the future goal of selling out and making money on its investment.

Strategic: Here's when the buyer wants to acquire or two companies want to merge because the businesses may work better together than separately. There's no future goal of selling out. General Motors bought several independent car companies nearly 100 years ago and still owns them because combining them was a good strategic fit. Albertson's purchase of American Stores, Symantec's buyout of PowerQuest and Novell's acquisition of WordPerfect are other examples where a purchase was based on a perceived strategic fit, though not all such acquisitions work out.

Sellers sell for a variety of reasons. Management may realize it can't raise enough capital to grow the business to the max, and it seeks to be acquired by a company with deep pockets. In this case, management may stay with the company after the acquisition. A company in financial trouble may sell out as the only way for parts of the company to survive. Often, especially with smaller businesses, owners want to retire, pursue other interests or otherwise have more liquid assets, which is why they sell. Sometimes the seller would prefer not to sell, but has to because he or she needs to raise money or another party forces the issue; divorces are an example

SEE THIS MONTH'S LEGAL BRIEFS (PP. 48-49) FOR A DISCUSSION OF ISSUES TO CONSIDER WHEN CONTEMPLATING M/A.

Alan Horowitz is a Salt Lake City-based freelance writer.