Strategic Transactions Not Just for the Fortune 500

June 14, 2004

BY FRANK MORSE

Comcast's failed hostile bid to acquire Disney was the latest chapter in a 20-year Eisner saga that could easily be lampooned in a full-length animated film.

While it's difficult to ignore the theater in the boardroom, the executive intrigue and outsized compensation packages surrounding Disney's cast of characters, there was a compelling strategic rationale for the integration of these two companies. Essentially, Disney was the diverse media and content partner while Comcast was one of the most powerful distribution networks in the world.

The valuations and strategic directions of privately held companies are generally not as well articulated as their public counterparts, and certainly not as transparent. But that doesn't mean that enlightened management teams of privately held companies aren't constantly assessing their competitive advantages, planning for long-term profitability and contemplating strategic acquisitions.

There are many strategic reasons why companies, whether public or private, come together. Examples are overlapping or complementary products that reduces competition, increases market share and strengthens pricing, such as Hewlett Packard and Compaq; expanded products or services that can be marketed into the sales and distribution structure of an acquirer that eliminates the cost of a sales and marketing team, such as Oracle and PeopleSoft; and to widen distribution that open new markets, such as Bank of America and Fleet.

Strategic Reasons
These examples and most of the highly visible public transactions have several elements of strategic rationale working together. Aside from the transparency of these deals, the strategic reasons are the same for private companies as for public companies.

A synergistic strategic acquisition was the sale of DeMaria ElectroOptics (DEOS), a laser manufacturer of high-powered CO2 lasers in Bloomfield.

In 1995, five engineers from the Optical Systems Division of United Technologies decided to start a new company - with UTC's blessing - to commercialize certain laser-based technologies.

Six years later, the DEOS management had created value by developing a proprietary family of laser products with applications such as marking, coding, engraving and electronics. Strategic acquirers were then knocking on their door, so they engaged CMC to organize the sale and maximize shareholder value. A controlled "auction" resulted in the sale to Coherent Photonics, a worldwide producer of photo-optic solutions.

Valuation aside, it is instructive to examine why Coherent bought DEOS and why DEOS went with Coherent.

First, DEOS' product lines complemented those of Coherent and, in some instances, were technologically superior to Coherent's products.

Second, DEOS' products could be sold through Coherent's sales and distribution network.

By far the most important reason for selecting Coherent was DEOS' comfort level with the "people issues" such as management style, integration plan, compensation and incentive schemes and corporate culture. These issues can often overshadow issues of valuation and deal structure.

Coherent acquired DEOS in a premium cash transaction that was not only satisfactory for the shareholders but resulted, 18 months later, in a Connecticut-based subsidiary employing three times the number of employees than before the transaction; a modern facility requiring an investment of several million dollars, and all management remaining gainfully employed. A win-win for all.

Leveling The Field
On the "buy-side," private companies should always consider acquisitions to be part of their growth strategies. However, private companies are at a distinct disadvantage when seeking to grow by acquisition. The main reason is availability of capital.

Publicly held acquirers often do not have to look outside their own balance sheets for cash, their own credit or their shares to pay for an acquisition. Only the strongest private companies can finance a transaction without going to outside sources such as banks or private equity sources. And these sources can be scarce, expensive or both.

The second hurdle is that the process of acquiring and integrating another company is expensive, disruptive and all consuming. While managements of public companies execute acquisitions every day, often within dedicated departments, private companies are rarely organized for acquisitions and often minimize the disruption of ongoing operations.

The principles driving strategic transactions are equally applicable for companies that are large, small, public or private. Size does matter on both sides of an acquisition. Generally speaking, the larger the entity the easier it is to effect a transaction. That said, mergers and acquisitions along the entire spectrum happen with regularity. They are always complex transactions and private companies are well advised to surround themselves with sophisticated advisors (legal, accounting and financial) in order to level the playing field with parties on the other side.

Frank Morse is a managing director of Carter Morse & Mathias, an investment banking firm based in Southport, Conn., specializing in raising capital, mergers and acquisitions, and valuations.