Scott Mulcahy, Managing Director
XMS Capital Partners
Stock Prices High, Confidence High
Acquisitions are optimistic undertakings. They involve risk. Business leaders feel more confidence when their companies are performing well. Strong operating performance is often coupled with high stock prices and attractive valuation metrics. It is no surprise that, in general, Mergers and Acquisition (M&A) activity tends to rise and fall with the economy and equity markets.
Public Company Table Stakes: Growth
One of the motivators for acquisitions is growth, particularly for public companies. A successful and growing public company with attractive margins, happy customers and hard-working employees can become a victim of its own success. Public company investors observe the accomplishments of successful companies and bid up their valuation metrics. They expect the companies will continue to grow at attractive levels of profitability. While astute investors will reward organic growth more highly than purely acquired growth, corporate CEOs, particularly in the current environment, are regularly using acquisitions to achieve growth targets as well as other strategic objectives.
Scale and Distribution Benefits: Synergies for Battery Companies
In addition to providing a source of growth, acquisitions can also create benefits for the combined companies in the form of cost savings and incremental revenue opportunities. These so-called synergies provide the greatest motivations for M&A activity. The battery power industry, in our observations at XMS Capital Partners, offers substantial synergy opportunities to acquirers.
Cost savings are regarded as among the lower risk sources of synergy. Costs of the combined companies can be reduced by eliminating duplicate administrative and other fixed costs. Typical examples include closing or substantially downsizing one of the corporate headquarters facilities and consolidating certain manufacturing and distribution facilities as applicable. Another cost synergy that is particularly relevant in the battery industry is scale purchasing. Suppliers offer better pricing for buyers of larger quantities of particular inputs. As purchasing activities are consolidated, the combined company should typically be able to achieve improved pricing for its key component materials and sub-assemblies. Expanded purchasing and sourcing requirements can achieve other strategic benefits, such as more global suppliers and dual-sourcing to reduce supply chain risks. An additional source of cost synergies will be the combined R&D activities as advanced power products such as solar inverters require substantial R&D resources.
The current expansionary economic environment is particularly attractive for the second category of synergies, which is the opportunity to increase revenues of the combined companies. As companies are focused on growth, being able to offer additional products to existing customers because of a particularly strategic acquisition can create significant value. Additional paths to market in the form of distribution channels can allow an acquirer to sell their existing products to new, previously unaddressed customers, which provides a second source of revenue synergies in an acquisition. Finally, technology and research and development (R&D) activities can often bring together complimentary capabilities leading to innovative new products for current and previously under-addressed markets for the combined companies.
One aspect of the acquisition (via merger) that ABB and Power-One, Inc. announced in April 2013 is the expanded market access that ABB’s global service and sales team will deliver for Power-One’s comprehensive offering of solar inverter products.
Our team at XMS Capital was involved in another battery power transaction that was strategic and offered cost as well as revenue synergies. Electrochem, an industry leader of total power solutions for critical applications, customized battery power and management systems, acquired privately-held MicroPower, a battery power and charging systems supplier that is a leader in the medical device and other markets. Based in Raynham, Mass., Electrochem was looking to expand on the West Coast and wanted to grow its medical device market share. Portland, OR based MicroPower was an excellent fit. The combined companies have been successful in achieving both cost and revenue synergies. As Tom Hook, president and CEO of Greatbatch, Inc., the parent company of Electrochem, said earlier this year, “Electrochem, revenue continues to exceed our expectations and double during 2013 as a result of the acquisition of Micro Power in December of 2011. This acquisition significantly enhanced our position in the Portable Medical market, which is benefiting from an aging population and the shifting of patient care from clinical settings to the home. These favorable market dynamics, along with our pipeline of new products, provides us a significant lever to drive organic growth.”
Advancing the Strategy: Other Criteria for Successful Acquisitions
While growth and synergy are among the primary motivators for acquisitions, the best acquisitions, in our observations, are transactions that advance previously articulated strategic objectives.
Palladium Energy’s announcement of its acquisition of MicroSun Technologies in November 2012 provides an example of a combination with many strategic elements, including end market and product expansion, significant intellectual property, manufacturing expertise and growth opportunities.
The acquisition significantly expands Palladium’s position in certain key markets particularly military including intellectual property unique to MicroSun in the area of ruggedized power solutions for mission critical applications. Interestingly, the CEO of MicroSun, John Gatti, became president and CEO of the larger Palladium. His background provides some indication of the importance of the military markets to the combined company going forward as he brings, “…more than 25 years of aerospace and defense, engineering and technology, program management and enterprise integration experience from companies like BAE Systems and Raytheon” as indicated in the Company’s press release by Bob Leggett, operating partner at the private equity firm that controls the combined companies, Marlin Equity Partners.
ICCNexergy saw a particularly strategic opportunity in its recent acquisition of Brighton, MI-based Applied Power, Inc. The acquisition of Applied Power gives ICCNexergy an immediate presence in the medical computer cart market and adds capabilities particularly in medium format Li-phosphate batteries. The strategic acquisition, per ICCNexergy’s press release, complements ICCNexergy’s position as the industry’s leading developer and manufacturer of custom rechargeable power systems.
Red Flags: Risks for Acquirers and Factors that Lower Valuation
While these recent transactions demonstrate some attractive attributes of combination partners, XMS Capital has observed some characteristics that can limit the prospects of the successful sale of a company. These characteristics often include business risks that potential acquirers or merger partners need to assess and may ultimately deter a transaction or lead to a relatively unattractive valuation for the target. Among the more common risks that we have observed are:
• Concentrated business risk (customer, supplier, end-market, etc.)
• Immature or vulnerable technology – not fully developed/proven commercially
• Limited track record of profitability/visibility
• Average or inferior solution in competitive marketplace
• Minimal cash flow and assets – financial risk which limits ability to win business
In the battery power sector, business concentration can include the risk of being highly dependent on a particular chemical formulation (e.g., lithium, or lead) or end-market (e.g., hybrid electric vehicles). In our experience, better valuation is ascribed to growing and profitable companies with exposure to multiple end markets that are not overly reliant on a small number of customers or suppliers.
Capital Structure: When the War Chest Becomes A Bullseye
Having available capital for acquisitions can be an attractive asset. An acquirer can demonstrate to potential targets the certainty of having funds available to consummate a transaction. However, too much cash on a company’s balance sheet can be double-edged. Having an excess amount of cash on a company’s balance sheet provides any would-be buyer with a bit of a coupon in the form of cash to fund a portion of the purchase price. While a public company’s stock price should reflect the value of having surplus capital, there are instances where this readily available asset is enticing to would-be acquirers.
While highly synergistic, ABB’s afore mentioned merger with Power-One may reflect some element of this dynamic. Power-One had $266 million of net cash on its balance sheet, which was reflected in ABB’s purchase price of roughly $1 billion for the equity of Power-One. The implied enterprise value of roughly $760 million is 6.4 times Power-One’s trailing earnings before interest, taxes and depreciation.
While Power-One’s solar inverter products will be a nice fit with ABB’s portfolio of leading power products and global distribution channels, the valuation available to ABB was somewhat opportunistic based upon the cash held on Power-One’s balance sheet. As Power-One’s management consistently articulated to investors, having some significant amount of cash on its balance sheet served to give customers comfort that Power-One will be able to honor its long-term commitments such as product warranties. After the transaction closes and Power-One becomes part of the much larger ABB organization, this cash may be more accessible.
Given the relative strength of the US economy and the cost-cutting initiatives put in place during the economic down-turn, corporate balance sheets are relatively strong with little leverage and growing cash coffers. This dynamic should provide incremental capital for acquisitions.
Private Equity Owners: Major Participants in the M&A Market
Private equity investors have been active participants in the battery power industry and are increasingly important participants to the overall M&A market. In the first quarter of 2013, financial sponsors accounted for 36 percent of total activity as either a buyer or seller (or both), up substantially from 2012, which was 24 percent. Notably, this participation by financial sponsors in the M&A market had not exceeded 20 percent of overall activity since 2007, which was the peak year for US financial buyer activity both in number and value of transactions.
Interestingly, financial sponsors substantially increased their participation as sellers of assets during 2010 when nearly 15 percent of transactions involved a private equity seller. In 2012 and for the first quarter of 2013, financial buyers have significantly increased their acquisition activity, which includes add-on acquisitions for companies owned by the sponsors. ICCNexergy provides an interesting example of a successful battery power systems platform company built by its financial sponsor owners. Nexergy was acquired by Inverness Graham in 2007. The business was combined with ElectriTek AVT in 2008, and merged with International Components Corp. (ICC) in 2010 creating ICCNexergy, which continues to make acquisitions including the previously mentioned Applied Power.
Many of the leading battery power companies have private equity ownership currently or in their corporate history. In addition to the previously mentioned combination of Palladium Energy with MicroSun which has been led by Marlin Equity Partners, the now publicly traded EnerSys was originally a private equity leverage buy-out (LBO) of the US assets of GS-Yuasa facilitated by Morgan Stanley’s private equity group that has since left the firm and is now known as MetalMark Capital.
The current market conditions are such that XMS Capital Partners expects that capital will continue to be available for acquisitions and growth will be a priority particularly for public companies. The market has been rewarding strategic activity and there are a number of strategic acquirers, including businesses owned by financial sponsors that are highly interested in adding to their platforms. If interest rates stay low, equity values maintain their strong levels and the economic outlook remains reasonably stable, we expect M&A activity will continue to be robust.
For more information, please contact XMS Capital at www.xmscapital.com.