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The Rules of the M&A Road

Posted: 02/1999

The Bottom Line

The Rules of the M&A Road
By Duane W. Richardson

It has been an explosive time for mergers and acquisitions (M&As) in the telecom
industry. MCI Communications Co. and WorldCom Inc. have joined forces. AT&T Corp. is
negotiating with Tele-Communications Inc., focusing its sights on combining voice, data
and video services over a single pipe to their customers. A $72.4 billion merger is
pending between SBC Communications Inc. and Ameritech Corp. Bell Atlantic Corp. and GTE
Corp. announced their monolithic intentions in July. These transactions account for four
of the top 10 largest mergers of all time.

The consolidation effect is far-reaching, encompassing both small and medium-sized
players. For example, St. Louis-based Advanced Communications Group Inc. recently burst
onto the telecommunications landscape with a $120 million initial public offering (IPO),
purchasing several operating companies in a consolidated POOF (see below, "POOFs,
IPOs and the Language of M&A"). With rapidly expanding technology and the
increasingly relaxed regulatory environment, more and more deals will continue to make
headlines.

POOFs, IPOs and the Language of M&A

As if
telecommunications terminology wasn’t complicated enough, add to it the language of
mergers, acquisitions and high finance, and you may find yourself swimming in acronyms.

  • Consolidated POOF–The purchase of several companies paid for through a
    public offering and combined into one entity. Typically, the POOF is contingent upon the
    success of the initial public offering (IPO).
  • IPO–When taking a private company to a public market, a percentage of the
    company (typically around 30 percent) is offered for sale to the public. Money raised in
    an IPO goes to promote operations and pay for acquisitions and fees.
  • Merger & Acquisition (M&A)–A merger is simply two
    operating companies that decide combining their efforts under one board of directors and
    one management team can further the companies’ profitability more efficiently for the
    shareholders than they could separately. In contrast, an acquisition places one company in
    the buyer’s mode. It can acquire certain parts of the company in an asset purchase or all
    of the company in a stock purchase. It then takes over that company from a managerial and
    financial standpoint.
  • Roll-up–When several companies merge, or "roll up," to create
    one entity as in a consolidated POOF or "buy-and-build" scenario.
  • Reverse Merger–Typically this is when the stock of a private company is
    merged into a public shell. The shell company usually is an entity that is listed and
    traded on the public market, but it may not have any operating revenues. The attraction of
    a reverse merger is that it is faster to get to the public market and, in many cases, the
    shell has a net operating loss (NOL) that can equate to significant tax advantages. In
    addition, there already is someone familiar with the stock, such as the analysts,
    underwriters and market makers.
Source: Richardson Barto Inc., Houston

Some critics contend that the Telecommunications Act of 1996 is creating an oligopoly,
rather than spawning competition as it was intended to do. While this may appear to be
true by the spate of billion-dollar megamergers, consolidation is a natural byproduct of
competition. It often is faster and more efficient to buy than build.

Regardless of volume, many companies’ goals include growing their business
exponentially; ex-panding their customer base and/or network; diversifying their product
line; keeping up with today’s technology; or simply exiting with a respectable multiple.
While these are the drivers for M&A activity, it’s important for growing players to be
taken seriously by understanding the rules of the road. Careful consideration must be
made, however, for a smooth transition of back-office operations, billing systems, revenue
streams and technologies, not to mention the overlap of employees (and egos).

The Seller

Let’s discuss the specifics of a merger or acquisition then, from the perspective of
buyer and seller. The seller’s goal should be to position the company’s strengths and
avoid making some of the more common mistakes, including:

  • Overestimating the company’s worth. Proper and professional valuation is critical to
    moving forward with negotiations. Sellers need to reach a finite number that is realistic.
  • Overcoming emotional attachment. Naturally, the company couldn’t have come this far
    without its principles, but it is imperative it look at the big picture. Buyers want to
    see revenue, distribution-channel efficiency, bottom-line profitability and the strength
    of the management team.
  • Underestimating the amount of necessary due diligence. Buyers need to see audited
    financials. Who is the client base? What is the attrition rate? What is the bad-debt
    exposure? Was the customer base acquired through telemarketing or direct sales?

One of the most important things a seller can do is to facilitate sales through proper
documentation. Most companies are unsuccessful not because of lack of revenue, but because
they cannot facilitate the revenue they have due to inefficient provisioning, billing,
credit and collections, etc.

The Buyer

The buyer should:

  • Reread items 1 and 2 above and double them for the emotional quotient.
  • Establish the seller’s true motivation. Is it cash? Is it cash-plus-stock to have
    monthly recurring revenue? How much debt does it want in the company, understanding that
    with debt comes equity? How much equity is it willing to give up?
  • Consider human-resources issues–one of the most critical components of any merger. What
    should the seller tell its employees and when? Which employees will stay and work as a
    cohesive team? What will the restructured management team look like? There probably will
    be presidents and vice presidents who will become directors and managers. This must be
    addressed tactfully for a win-win outcome.
  • Carefully determine the new company’s board of directors early. This will dictate how
    the underwriters and analysts view the company.

Only senior management can say ‘yes’ to deals. However, when in the serious due
diligence phase, the seller should talk to second-tier lieutenants who truly understand
the nuts and bolts of the company–sometimes even more than the owners.

Experience shows that most projections, most deals, most closing dates and most due
diligence processes take much longer than anticipated. Buyers and sellers should accept
this from the beginning to avoid missing the budgets and timelines that are critical.


Graph: Volume & Value of Telecommunications Mergers

Obviously, there is more to mergers and acquisition than the "1,000 words or
less" printed here, but the basic business principles still apply. Do the homework,
rework the business plan and remain flexible. Whatever is saved in time and money will be
paid for in frustration.

Duane Richardson is chairman and CEO of Richardson Barto Inc., a merchant banking
and telecom consulting firm based in Houston. Richardson also owns Advanced Convergence
Technologies (ACT), a prepaid 1+ company. He can be contacted at dwrichardson@randb.net.


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