Monday, January 30, 2017

Attractive Acquisition Attributes – Part One, Consistency

“Slow and Steady Wins” – I saw this slogan on a tee-shirt recently and realized how true it was when related to what makes an attractive acquisition target.  Stated another way, we are talking about steady, consistency in any number of business metrics that a potential purchaser might consider.

Since valuation is predominantly driven by earnings, let’s begin by looking at consistency of earnings.  At times, we have clients come to us ready to go to market because they have finally had that gang-buster year they have been waiting for.  Revenues are up 50% and earnings are up 60% and everything looks great for the future.  Unfortunately when we pull back the curtain and look at the long-term trends, earnings have been volatile even when there has been a long-term positive trend.  It is always better to go to market when you are coming off of a good year but buyers look at more than one year and tend to average out the up years with the down years.

Volatility, risk and value are undeniably linked.  I have a favorite saying, “Buyers purchase the future but pay for the past.”  What I mean by this is that Buyers purchase a company for what they expect they can do with the company in the future but they set the price based on past performance, not based on some optimistic forecast, which may be based on one good year.  So where does risk come in?  When we market a business, we present a forecast to prospective buyers.  These forecasts are largely based on past performance but tend to represent some level of straight-line (consistent) growth in to the future.  If this nice consistent, straight-line forecast is based on historical numbers that are volatile rather than smooth and consistent, then the risk for the purchaser of achieving the forecast is higher.  Higher risk equal lower valuation when the buyer tries to determine a purchase price.  So “slow and steady” (consistent) earnings are much more valuable than one great year.

There are other areas where consistency can add to the overall value of a company.  Consistency in management show stability and continuity and lowers the risk to a purchaser.  Consistency in the customer basis (if repeat business is a normal part of your business model) demonstrates stability and lowers risk.  Similarly, consistency in a company’s supplier basis shows stability and can positively impact value.  Even consistency in the presentation of financial information (financial statements) reflects stability and will make a business more attractive to purchasers and therefore more valuable.

“Slow and Steady” is not necessarily sexy or exciting but given the choice of representing a company that has slow and steady earnings vs. one that has volatile earnings; even if the average earnings over a five year period for both are identical, Slow and Steady Wins every time.

Alan D. Austin, CFA

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