Feature: GPs Bolster Platforms, Keep Eyes on Future –

From information technology (IT) services roll-ups to home security buy-and-builds, there has been no dearth of efforts over the past year by buyout groups to consolidate whatever fragmented industries they can get their hands on.

G.P. sources say that while buyout firms are clearly pursuing platforms in the emerging sectors of the new economy, such as technology consulting and telecommunications services, they haven’t turned their backs on traditional industries like manufacturing and general service.

Over the past year, buyout firms continued to bolster existing platforms with a plethora of add-on acquisitions, all the while seeking out those industries as yet untouched by consolidation.

Based on a review of the 173 deals reported in BUYOUTS last year, 1999 might as well be tagged the year of the add-on acquisition. While the establishment of platforms remained as strong as ever last year, accounting for 51% of deals, G.P.s focused more on building up existing platforms.

The purchase of platform companies accounted for just over half, or 51%, of all the 1999 deals, compared with 46% in 1998. More interestingly, last year’s investments in add-on acquisitions weighed in at a whopping 31%, compared with a meager 19% in 1998. That means G.P.s invested in stand-alone companies 18% of the time when doing buyouts last year-a noticeable difference from 1998’s 35%. A review of past years further highlights the current appetite for add-ons (see chart below).

Fragmentation Remains

Seeing that consolidation strategies have been in place for several years now, some industry observers might think the number of available fragmented industries is dwindling. But G.P.s interviewed for this article dispel that notion, arguing there are still plenty of industries ripe for consolidation-not just in the technology space but also in the low- or no-tech sectors.

Buyout firms such as GTCR Golder Rauner and Mason Wells are keeping up with the times, investing in platforms that have a technology or telecommunications spin, while other platform-building gurus, including Trivest and Harvest Partners, are keeping a finger on the pulse of more traditional industries like manufacturing and staffing.

GTCR, the Chicago-based buyout firm known for its platform investing and build-up strategies, represents a firm applying traditional buy-and-build strategies to cutting-edge industries.

The firm placed its bets on IT services, among other things, in 1999, managing to keep its portfolio diverse at the same time. GTCR started out the year adding two more IT service platforms to its already-established 12, closing out 1999 with a return to the golf industry.

Bruce Rauner, a managing principal at GTCR, says his firm became a consolidator of the IT businesses for the same reasons GTCR would get into any other business: rapid growth, a high degree of fragmentation, reasonable purchase prices, reasonable purchase multiples compared with the value that can be created once the companies are brought together and integrated, and the multiple that can be realized upon exit or initial public offering, he said.

GTCR generally puts $20 million to $100 million in equity behind management teams with experience in a certain industry. In 1998, the firm made a $100 million commitment to start AppNet Systems, a company that provides Internet and electronic commerce consulting to mid- and large-size businesses. GTCR made 12 add-on acquisitions and took the company public last June. AppNet now has a market capitalization of $1.51 billion.

Since then GTCR kicked off 1999 by launching two more buy-and-build IT platforms, with a $50 million commitment to build Park City Solutions, an IT company that consults with health-care providers, and a $75 million commitment to FutureNext Consulting, a company that installs computer systems that track the outflow of products used by distributors (BUYOUTS Feb. 22, 1999, p. 18).

Other firms showing interest in IT include Caxton-Iseman Capital, which invests in companies that supply IT services to the federal government, and CM Equity Partners, which made a $70.6 million recapitalization of ICF Consulting Group last year. ICF Consulting provides IT consulting services on environmental issues.

Meanwhile, several buyout firms are attempting to implement a platform strategy in the booming telecommunications sector.

Mason Wells in December bought Troncom Corp., a maker of products that support broadband telecommunications delivery, for an undisclosed amount, putting between $10 million and $20 million down in equity for the acquisition.

John Riley, a managing director at the firm, says Troncom will be used as a platform to build a broadband access equipment company, and sites as an asset the company’s convenient location near Chicago’s telecom hub, where it can be near major telecom players like Motorola and Bell Labs.

Also, Willis Stein & Partners in December made a move to win market share in the fiber optics infrastructure market with the $750 million acquisition of Orius Corp. from HIG Capital. Willis Stein has plans to merge Orius with its existing telecom services company LISN Inc.

Orius specializes in infrastructure services for telecom and cable TV companies.

In addition, an investor group led by Banc One Equity Capital and Saunders Karp & Megrue last month announced plans to start a telecom infrastructure platform called Linc.net and immediately closed on three acquisitions.

The investment group plans to grow Linc.net into a full-service provider of telecom infrastructure services.

Increasingly, G.P.s are adding Internet initiatives to their platform strategies.

Charterhouse Group International continues to capitalize on instability in the health-care industry, closing a deal in early December to buy home respiratory care company MP TotalCare Inc., which it will use as a platform. Charterhouse also hopes to build the company though internal growth by boosting sales to retail pharmacies and making alliances with companies in the chronic disease market (BUYOUTS Dec. 20, 1999, p. 12).

Sounds traditional, right? Well, looking more closely, the company also has plans to use e-commerce as a distribution channel by the end of this year.

Thomas Dircks, a managing director at Charterhouse, says his group’s experience with two recent health-care investments with successful online components will give Charterhouse the general Internet knowledge to help roll out Web-based commerce for MP TotalCare.

Even though it may seem that technology and telecommunications somehow touch every aspect of modern business, plenty of buyout groups are staying out of these industries and focusing on those they know best-and continue to make successful investments, despite a belief held by some in the industry that consolidation opportunities are growing scarce.

Old-School Platforms

New York-based Harvest Partners currently manages four different platforms, none of which rely on the Internet or sophisticated telecommunications.

Ira Kleinman, a general partner at Harvest Partners, says his firm is constantly searching for new platform opportunities.

Searches go on throughout the year, but the entire Harvest Partners staff meets quarterly to bring together the different ideas and narrow the pool down to five or six, Kleinman says.

When in search of new industries in which to begin a consolidation effort, Harvest uses several strategies that include placing advertisements in the Wall Street Journal, retaining headhunters, and using contacts from previous investments. Sometimes new deals come with a bit of luck, Kleinman says, like when a call from an investment banker comes at just the right time.

Harvest traditionally starts with a management team before acquiring a platform company, but has been known to invest first in a company as well, depending on its management.

“As most private equity groups will say, the key to anything is management,” Kleinman says.

Harvest has exited only one of its platform strategy companies, Career Horizons, which also happens to be the firm’s first build-up. Harvest acquired this temporary staffing company in 1990, built it through acquisitions, did an IPO and sold it to AccuStaff Inc., now Modis Professional Services, in 1996, garnering an $82 million profit-more than 10 times the original $7.9 million investment.

Since investing in Career Horizons as its first platform deal, the firm has been devoted to the buy-and-build strategy.

“And we’ve never turned back,” he says, pointing to frustration with auction prices as the main reason his firm entered the platform investing arena.

“Prices in the last couple of years have just been crazy,” he says. “Even people who haven’t done build-ups before are trying to find an industry, trying to get in early, trying to buy up smaller companies and build up value that way instead of paying seven to nine times for it when it reaches a certain size.”

The firm most recently put together a management team to venture into the commercial printing industry.

Not surprisingly, though, some industries never look attractive to Harvest Partners, no matter how fragmented.

“It never fails-the newest person at the firm always brings up dry cleaning and thinks it’s the best idea in the world,” he says. “But it’s just one of those industries we’re not going to do.”

Watching Your Back

Platform investing specialist Trivest’s managing director Peter Vandenberg notes there are a number of things that can make platform investing and consolidation strategies tricky.

“Some people make the mistake of thinking you can just automatically add companies together-cut, slash and burn administration costs and accounting systems and immediately benefit from eliminating duplicate functions,” he says. “You have to be cautious of that 80s mentality of slashing employees right off the bat and therefore cutting too close to the bone.”

Harvest’s Kleinman says special care needs to be taken when integrating family-owned and operated companies because they don’t have familiarity with working under a debt situation with interest payments and are not used to reporting financial results to a parent company.

“Sometimes they’re not even completely focused on profitability,” he says.

Small company owners might previously have been focused on cash instead of earnings so the parent company has to turn them toward focusing on profitability, he says.