The Strategic Acquirer’s View
Scott Parker, Owner, Parker Lumber
We spend a lot of time reviewing deals like this all over the country, as we are always in the market to acquire small, one-unit operations, all the way up to a medium-sized chain of stores. If we are lucky enough to find a business like this, I can tell you first and foremost, we care about the quality of the people inside the organization. We’re not afraid to pay for a group of stellar performers, and in this case we feel we have that.
Next, we want to further understand the value we are receiving for the price: How is the location — are we buying an old, outdated operation that needs a lot of work? Or is this business turnkey? What is the competitive environment like, and will this market provide significant upside in the future? Since the location here is above average, there is moderate competition, and we see significant upside in Southern California’s future — we have sufficient to favorable outlooks on all of these points. Albeit not perfect, these dynamics won’t bring down our valuation, but aside from the latter, they also aren’t reasons for us to go completely crazy on the valuation, either.
No deal is complete without addressing the numbers, of course. Initially, we want to see whether or not the business is profitable. This particular business is cash-flow positive, which is good because if a business isn’t cash-flowing, our valuation is significantly different because of the risk involved, and depending on how bad the losses are, we might not even look at it.
If we were to come across a deal like this, we are looking at a net book value deal, plus a slight bit of good will in the form of a non-compete for the selling owner. We feel this valuation is market, it’s fair, and we feel Parker can make a sufficient return on investment at a reasonable level of risk.
We will purchase cash, inventory and fixed assets. We will also come to an agreement on assuming the current liabilities, less debt. We typically don’t buy accounts receivable but will help the selling owner collect for a certain period of time.
We will also need to discuss the real estate. We approach real estate on a case-by-case basis, as it is the hardest thing to put a price on in today’s market. In this case, since the owner owns the property in a separate company and doesn’t want to sell today, we would look to sign a market-rate lease with them and negotiate a purchase option at an agreed-upon price.
Ultimately, we feel we are the best group out there to sell to. We feel so strongly about this, we even encourage sellers to speak with those who have sold to us in the past. We have a track record of treating people in a fair and equitable manner, and will look out for your employees once they become part of the Parker Lumber family. That’s worth a lot among the many horror stories out there.
Parker Lumber is an 18-unit chain of home centers headquartered in Beaumont, Texas. The Do it Best dealer has locations in the southeastern region of Texas and in Southern California.
The Adviser’s View
Jason Fraler, Founder, Anchor Peabody
We find ourselves giving out the same advice over and over again these days: Don’t sell today unless you have to. This advice applies here.
During the boom times, this business probably traded at 3.5 times to 4.5 times adjusted EBITDA, or approximately $3.5 million to $4.5 million. Even if we never see those lofty EBITDA multiples in the future, if the business can improve and achieve around $2 million in EBITDA in several years, it will be worth almost $7 million at the low range (3.5 times)! Clearly, if the client can stick it out, we are going to recommend doing so. This always isn’t the case, of course.
The current market valuation for a profitable business this size is net book value plus some amount of good will. This business has a lot of things going for it: Management team, a diversified customer base (low customer concentrations), high-margin products for sale, a great position in a market with a lot of upside, and they’re right there with the business metrics.
What is working against this business is its historic performance. Even with the management adjustments, adding back in some one-time events that affected performance from 2004 to 2008, we feel this business has underperformed from a profitability standpoint. We like to see businesses that operate in this segment around 8.0%+ adjusted EBITDA, as we can make the case to potential buyers they are paying for a top performer.
We would push for a net book value deal plus another $1 million in good will paid via earn-out (additional cash paid over time, based on performance). Our argument would be (i) the client doesn’t have to sell, (ii) you can only sell your business once, and our client is selling at the bottom of the market, (iii) we ran a discounted cash flow (DCF) analysis on the business, and expect a buyer to make 5.0 times their money on the business at our valuation. For a variety of reasons — which we would share with the potential buyer — we feel a strategic buyer can afford to increase the purchase price to entice the current owner to sell and still make a sufficient return on investment.
We would also try and structure the deal a little differently. If the accounts receivable is not purchased, it adds risk to the client, as customers are less likely to pay you because they don’t need you anymore. Regarding the real estate, the hardest thing to come to an agreement on today is the value of real estate. We suggest including some language in the purchase option, which values the real estate via a third-party appraisal at time of purchase.
Without a doubt, the seller should run a competitive process to maximize this valuation. We agree with Scott: Parker Lumber may be one of the best groups out there to sell to. However, this does not mean they are the only game in town — especially in Southern California.
Anchor Peabody is a private equity investment and M&A/debt advisory firm that focuses exclusively on the building products and construction industry.
Improving your company’s value
By Jason Fraler, managing principal, Anchor Peabody, LLC
We are recovering, but things are still slow. Many of you are starting to replenish your teams — holes created from the deep cuts you needed to make to survive, while waiting for the market to come back. Lots of you are talking up market share gains, gross profit increases and efficiency gains. A few of you are even getting back to expanding your business by opening a new location or via the selective acquisition target.
All very commendable activities, but how about: Beginning with the end in mind.
Many business owners in our industry are up in age and missed the opportunity to sell during the boom times. Then the bottom dropped out. Six years later, business is not great and it may be awhile until the market recovers to a point where owners will consider selling their business again.
As we put the pieces back together, in our opinion, one of the best things an executive or owner can be doing now to enhance shareholder value is to work on areas that can improve the value of the business later. As business gets better, it will become harder and harder to work on this, as all of our waking moments and energy are focused on executing within the operation. Why not now?
Here’s a partial list of areas where you can focus your efforts to improve valuation:
• A business with significantly positive EBITDA: Businesses with cash flow beyond “razor-thin” positive are valuable, as acquirers know that there will always be hiccups. Additionally, businesses with large cash flow increase the amount of debt a buyer can use to purchase the business — increasing their potential ROI and, in turn, your valuation.
• Size matters: Deals that require more than $10 million in equity will get the attention of financial buyers, increasing the competition for your transaction (higher demand). Also, larger businesses command a greater multiple of EBITDA because there are fewer of them (less supply) and, right or wrong, buyers consider larger companies to be less risky.
• Timing: Remember, bears and bulls do fine, and pigs get slaughtered. As the market recovers, those of you holding on only to sell later need assure history doesn’t repeat itself. Leave buyers with some potential “runway” in the market by selling before the market gets overheated again. Doing so will create more competition for the deal and ensure buyers won’t pull out for fear the market will contract. Also, keep in mind it can take six months or more to sell a business. Leave yourself some time.
Potential deal killers and areas that hurt valuation
• A business with negative EBITDA: There aren’t many, outside of the turnaround firms, that want to acquire a problem. We’re amidst the fifth or sixth year of a downturn, and the housing market is bouncing along the bottom. At this point, the consensus view is that barring some extraordinary circumstance (i.e. legacy lease expense), operators should have right-sized their business. Many hold the view that turnarounds rarely turn around; do what you need to do to stop the bleeding or you’ll pay for it.
• Poor management team or an owner who “is the business:” A business is its people, first and foremost. Examples of poor situations: Untrustworthy people, a team with a poor track record or the whole management team is leaving post-transaction — and taking the customer relationships with them out the door. Transition those customer relationships early and think about building the management team “bench” depth.
• Large customer concentrations: The most typical example here is a business that sells to the national builders. Some dealers have built their business around these customers only to walk into the annual vendor meeting one year and lose the account. Buyers like to sleep at night. Any customer representing more than 20% of sales is a potential deal-killer; diversify away from them if possible.