Much has been written about the current economic environment and the depressed merger and acquisition climate. Valuations are very low compared to the late 1990s and are forecasted to remain low through the first half of 2003. Regardless, excellent opportunities exist for buyers and sellers alike who apply certain disciplines.

In the first article below, Marshall Graham, founder and Chairman of Focus Enterprises, Inc. defines the first six of 12 proven value components or "Value Drivers" that can mean the difference between success and failure in the current economic climate. (Value Drivers seven through 12 will be discussed in the May issue of this newsletter.)

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Twelve Value Drivers Help Ensure Success in Today’s Tough M&A Environment: PART 1
By Marshall Graham

Successful participation in the current M&A climate is achieved by finding value and then integrating it into current company platforms or existing corporate portfolios.

It is a great time to buy, especially for buyers who can close for all or almost all cash. Although M&A transactions are substantially off in the large company segment, excellent opportunities exist both to buy and to sell in mid-market and smaller company segments. There also are outstanding opportunities for acquiring selected assets, intellectual property and average and/or under-performing companies.

THE M&A PROCESS HAS CHANGED
Today, buyers and sellers are more cautious than ever before. Pre-LOI due diligence is lasting much longer prior to firm deal terms being agreed upon. There is much more focus on forecasted revenues and stable and growing customer bases. Integration planning on paper is taking longer prior to the execution of a Letter of Intent. Finally, management teams, while extremely important in all M&A activity, are becoming much more central to success in today’s M&A transactions.

For buyers and sellers alike, the key to achieving successful M&A transactions, with the assistance of intermediaries, is to identify the value components or "value drivers" of the transaction and then to make certain a plan is in place to integrate these components at the least cost.

TWELVE VALUE DRIVERS SUPPORT SUCCESS
At Focus Enterprises, we assist our clients in carefully evaluating 12 specific Value Drivers when considering a buy-side transaction. The first six are described in this issue:

Value Driver #1: The Customer Base
The customer base of the company being acquired is extraordinarily important. What is the buying trend from these customers over the past five years? What is the extent of customer churn? How many new customers have been acquired annually over the past few years? What is forecasted revenue from these customers over a specific forecast period? How stable is the customer base? What is the profile of the customer base? Are the customers large, medium or small? How vulnerable are these customers to economic fluctuations? What is the revenue distribution of these customers over the entire revenue base of the company to be acquired?

Value Driver #2: Recurring Revenue
One of the top value drivers to consider is the recurring revenue coming from the customer base of the company to be acquired. Of total revenue, what percentage is recurring? This portion of total revenue is valued more highly than so-called "one-time revenue." Will the combination of revenues from the acquiring company and the acquired company create an opportunity for a higher recurring revenue percentage of the total when the deal is completed? Finally, is there an opportunity to change the business model of the acquired company to result in stronger recurring revenue?

Value Driver #3: Product Integration
A major reason for making an acquisition is to acquire a new and complementary product line(s) so that the acquiring company can leverage its current distribution system and therefore increase gross margins. Great attention must be paid to technical platforms of different products. Even more attention and analysis needs to be completed on whether products are complementary or competitive. Product/market segment research often must be completed before a product integration advantage can be substantiated.

Value Driver #4: Gross Margin
At Focus Enterprises, we believe this is most important line item on the P&L. In-depth analysis on paper needs to be completed to determine whether acquiring the target company will ultimately improve or degrade gross margins. Manufacturing processes need to be analyzed to accommodate more--and presumably complementary--product sets as well as items such as customer installation/training and service/warranty commitments.

Value Driver #5: Intellectual Property
"Intellectual property" is a catchall term meaning one thing to one person and something entirely different to another. Generally, at Focus Enterprises, we use the term in its broadest sense when assisting a client with a transaction. Intellectual property certainly means trademarks, patents and copyrights but it also can mean a "developed process" such as a unique way to generate sales leads and then close sales using only the Internet. Accordingly, proprietary processes should be closely examined when evaluating a company for acquisition.

Value Driver #6: Human Capital
Today, this area is being looked at and evaluated to a much greater extent than ever before. During the late 1990s, a common approach was to acquire a company, assume that management and other key employees would stay for a while and then, the acquiring company would expect to augment or replace management as employment agreements expired. Today, buyers look for situations where management wants to stay for the long term. Post-sale integration failures of the past are largely the result of management departing after the deal is closed.

Value Drivers #7 through #12 Coming in May
Next month, to complete the series, Value Drivers seven through 12 will be explained in detail.

Currently Active Deals
Although our firm has over 20 years experience across many verticals, Focus currently has active transaction engagements in the following business sectors:

• Application Software, CRM and lims Applications
• Digital Media Replication and Logistics
• Fire Protection
• Government IT Contracting
• Healthcare
• HVAC Products
• IT Networking and Service
• Manufacturing
• Medical Devices and Equipment
• Pharmacy / Distribution
• Physical Security Integration and Access Control
• Warehouse, Distribution and Logistics

Our transaction process provides us with up-to-the-minute market knowledge in these sectors which may be of interest to you.

Address your inquires to Focus via e-mail to info@focusbankers.com, by telephone to 202-785-9404, x 341 or by fax to 202-785-9413.

Tim Johnson Joins Focus Enterprises

In March, Tim Johnson joined the firm as a Principal. With experience at CIBC World Markets and Salomon Smith Barney in New York City and at Friedman, Billings, Ramsey in the Washington, D.C. area, Tim is a valuable asset to our clients, adding solid financial credentials and transactional expertise to the firm.

Strategic Partnering: How Focus Enterprises Can Help

Strategic partnering services assist Focus clients in finding and developing relationships with other companies that have products and/or technologies that can benefit from additional sales channels, marketing skills, engineering expertise, manufacturing capacity or investment.

Strategic partnering arrangements can take the form of a license agreement, a joint venture, a sale and service agreement, a contract manufacturing agreement or an equity/debt investment.

Focus Partners are action-oriented in their assignments as quite often these partnership arrangements require a lot of time and effort to complete. A typical scenario usually involves an emerging growth company that has a technology or product line which is under-leveraged and can benefit from a relationship with a larger organization. The larger company can provide a distribution channel, manufacturing capacity, development funding to customize the technology or product to its market segment, and investment capital. The smaller company offers the larger company a focused "quick time-to-market" and customizing capability that often does not exist in a larger company.

While the above scenario makes clear sense, which may be apparent to both organizations, often each organization lacks the available staff to concentrate on the potential of such a partnering arrangement. Focus principals are, therefore, ideally suited to facilitate the transaction to the benefit of both organizations.

About Focus Enterprises, Inc.

For 21 years, Focus has successfully assisted clients with corporate development consulting assignments; merger, acquisition, and divestiture engagements plus capital raising and capital formation assignments. In a mixture of services uniquely beneficial to clients, Focus integrates consulting and transactional expertise with superb research capabilities and precise, proven methodologies.

Unlike larger investment banks, Focus processes are optimized and proven effective in our target marketplace -- private companies or operating units with revenues in the $5 million to $100 million range.

Six full-time Focus Partners provide over a century of C-level operating experience in a variety of industries. Operating nationally and internationally, Focus works with buy- and sell-side corporate clients, private equity groups, holding companies and early stage venture capital firms in the following areas:

• Technology (hardware, software and services)
• Media and Communications
• Telecommunications
• Government Contracting
• Aerospace
• Manufacturing and Distribution
• Retail
• Healthcare