By Dan Joseph
One year ago, Dave Guttman and I came to the ATSI show with the hope of finding an answering service to buy. Although it was our first time at ATSI, we liked what we saw: good people offering an important service to customers in need. We also identified growth potential and felt that the requirements for success fit well with our backgrounds.
Having made several acquisitions, we are satisfied that the industry does indeed have strong growth prospects, and that we can achieve our goals by continuing to acquire good companies. Our plan is to create a publicly held, diversified “Tele Solutions” company.
Our strategy remains consistent: we want to buy good companies that will thrive in the 2lst century. We want to provide the people who run these companies with the tools they need to excel, liberating them from back office functions. And we want to generate additional value in each company by investing in sales, marketing, and new technology.
In the process of making our first few acquisitions, and evaluating many more, we developed a business model that guides our decision-making. Although we use it as a barometer and not a rule, it allows us to quickly assess the feasibility of a given situation. In that way, we don’t waste anyone’s time pursuing a transaction in which common ground is unattainable. The model’s key attributes are two fold:
- Classify each business generically.
- Value each business uniquely based upon a variety of characteristics.
Definition, These companies have broken the $5 million revenue barrier and are generating in excess of $1 million in EBITDA (Earnings Before Interest. Taxes, Depreciation, and Amortization). They typically have multiple locations, draw value from good equipment, and have built an infrastructure to handle growth. The companies have good management, employ well-trained operators, and have customer churn at or below 30%. Finally, these companies have diversified their revenue base by pursuing new opportunities, such as custom call processing and order entry.
Initial Valuation Perspective, Although this figure will vary, we typically value these companies at 3.5 4.5X EBITDA, depending on the amount of post-acquisition investment we need to make. Typically, these deals will be structured with a combination of cash, notes, and an incentive earn-out if the owner wishes to remain. We will also offer stock if the owner wishes to join us as a partner. These platform companies can command an overall premium when compared to industry norms.
Definition, These companies generate $1.5 – 5 million in revenue, with cash flow in the 2O-35% range. They invest in their businesses, look for ways to provide better service, and are leaders in their market. Typically, these companies have no more than three offices. The owners of these companies are focused on profitability, and do not actively seek acquisitions outside their home markets. Upon acquisition, these companies will require little investment or operations attention, allowing us to focus on growth.
Initial Valuation Perspective, We value these companies between 3.0-4.25X EBITDA, taking into account any post-acquisition investment. Again, these deals will be structured with a combination of cash and notes, plus an incentive if the owner wishes to remain. Under certain circumstances, we will agree to pay a percentage of the price in stock.
Solid Cash Flow Generators With Opportunities For Improvement
Definition, These companies have revenue between $1 million and $5 million, but they have not optimized profitability. Their cash flow, as a percentage of revenue, is below 20%, and they typically require an investment in technology, a cutback in infrastructure, or other operational adjustments that take time and money. The weaknesses detract from value and require management intervention in order to achieve targeted profitability.
Valuation Perspective, These companies will typically be valued based on a combination of a monthly revenue multiple (8-10X) and an EBITDA multiple (2.5-4X).
Under $1 Million in Revenue/10% plus Profitability
Definition ,These companies are typically well-run from a bottom-line perspective, but have not grown effectively, and are therefore at a competitive disadvantage. Typically, they have inadequate infrastructure and an over-dependence on the owner, although a solid customer base, good employees and above-market pricing allow for profitability.
Valuation Perspective, Typically, these companies will be valued at 2.0-3.5X EBITDA, depending on level of profitability above 10% and on deal structure. A desire for more cash will typically require a significant price concession.
Under $1 Million in Revenue/Less Than 10% Profitability
Definition, These companies have not taken the steps necessary to attain profitability standards, either because of mis-pricing and/or providing service that needs to be improved. As a result, we will need to devote resources and capital to the task of repairing certain operational elements of the business.
Valuation Perspective, Typically, these companies will be valued as a function of monthly revenue. Depending on deal structure, and the level of profitability below 10%, the multiple of monthly revenue will vary from 4-7X monthly billing.
Definition, These are unprofitable or minimally profitable companies, and require a great deal of work to achieve an acceptable level of profitability. Their customer base might be mis-priced, they may have excess infrastructure to support their revenue base, or they may simply be operating inefficiently. Invariably, there are steps that we need to take over a six-month period that will bring the company in line with profitability standards.
Valuation Perspective, These companies will be valued as a function of monthly revenue. Depending on revenue size and deal structure, the multiple of monthly revenue will vary from 4-8X. In certain situations, we will allow the owner to reap additional benefit that results from his/her working with us through a transition period.
Specific Characteristics That Enable Unique Valuation
The second element of our business model looks at a variety off actors to assess where a company stands within a range of value. These factors help us to refine our valuation and arrive at a price and structure that satisfies the requirements of both parties.
Equipment That Must Be Upgraded, Poor equipment demands additional investment. Good technology is a critical element in this industry, and therefore, an important component in our valuation. We only pay full price (i.e. the high end of the range), when equipment is up-to-date and well maintained.
Limited Excess Capacity, If a company lacks excess capacity, we will need to invest in new equipment in order to grow. If we are to be successful, growth at a reasonable cost is very important. We always look for opportunities to better utilize our asset base.
Limited Infrastructure, Many companies are over-dependent on the owner. Great companies prepare for succession by creating a structure in which no individual determines success or failure. These companies require the owner’s time only for strategic direction. When we buy a company, we are buying its people; their attitude, skill, and desire create value.
Hardwired Accounts, Hardwired accounts provide an additional risk that lowers our valuation of the business.
Large Base of Unprofitable Accounts, Under-pricing, or flat-pricing, creates unprofitable accounts that diminish service quality. In most cases, we will have to raise prices to improve service and customer profitability, inevitably resulting in lost customers. We will not pay for customers with no real value.
Need to Invest to Bring Service Levels Up to Standard, Some companies, by virtue of poor equipment, training, or management, provide substandard service. Because our long-term success will be based on providing great service, we will need to commit time and capital to bring service levels up to or above standard.
One-Dimensional Revenue Base, This is a big negative. Given that the traditional TAS customer base is eroding, a company that offers diversified services has expanded its universe of potential customers.
As a final note, no two situations are alike. Although we use our business model as an advisor, we will always consider the owner’s perspective and allow ourselves to look at each transaction as its own entity. We believe strongly that in every case, a creative and mutually appealing transaction can be created.
Dan Joseph is the CEO of XACT Tele Solutions, a multi-site telemessaging service provider. Prior to forming XACT, Dan was the president of Brand Builders International, a marketing consulting firm. His background also includes management positions with Procter & Gamble and Bankers Trust Company. He can be reached at 201-462-0071.
[From Connection Magazine – July 1998]