Gill South: Tough times create chances for managers to become owners

Rod Duke, managing director of the Briscoe Group, gladdened the hearts of consultants around the country last Friday when he talked about being on the lookout for some acquisitions. The company has no debt, he reasoned, and is optimistic about the next six months.

Ambitious managers who feel confident about their firm's financial position should be thinking along the same lines; this is a time of opportunity, if you have the finance.

And evidently some people are thinking this way, says KPMG corporate finance partner Tony McNaught. The number of inquiries to the company's corporate finance website page has gone up 400 per cent in the past couple of months, he says. Parties are asking about acquisitions, management buyouts and divestments.

McNaught is seeing New Zealand management teams looking to buy their business from a multinational parent which suddenly perceives the NZ operation as "non-core".

It can be frustrating working for a multinational at the moment, says McNaught. He remembers a management team pushing to buy an expensive piece of machinery because they believed it would give them excellent competitive advantage. But they got a flat no from the multinational parent because there was a complete freeze on any capital expenditure.

"Ultimately it's soul-destroying for the management; you've got plans and can't implement them. That's why managers start looking around and saying, 'How can we run things better?"'

McNaught is also helping managers negotiate buyouts of smaller family-run companies from retiring business owners.

"Since March a number of owners have said to me, 'How much do I need? Maybe I'll look at selling to management,"' says McNaught.

These company owners no longer find private equity companies waiting to buy, so are having to look to other parties. Typically from the business owner's point of view, the management team is able to see a lot more of the value in the company than private equity.

KPMG is working on two MBOs at the moment and a third where the management already owns a chunk of the business.

The key in this climate is for management teams to accumulate enough money to make a strong offer. Banks have a lower debt tolerance, but values have dropped as well, says McNaught: "It's not as bad as it seems."

Usually a rule of thumb is that each manager of the team contributes a year's remuneration of around $150,000 or higher. Some are putting in their savings or mortgaging the house, while others might be using their superannuation fund.

"Banks are cautious, albeit willing," says McNaught. They want to see that the management are willing to put their own equity on the line.

"Management buyouts are more about management than before." Normally the people the banks want to see are a general manager, sales manager and finance manager.

If the MBO is difficult to finance, the most obvious solution is that the owner remains a shareholder. They might sell 70 per cent, to provide enough money for retirement.

Alternatively, with the help of a company such as KPMG, the management team sources wealthy people who are willing to put up the bridging mezzanine finance or take an equity stake.

It's worth the effort, says McNaught. "We've done about 15 MBOs in the last few years and every one has been successful. In every one the company did better than it did before."

Two MBOs done with KPMG in healthier financial times have been big successes for their former managers. Nigel Merrett led a management buyout of appliances retailer Hill & Stewart seven years ago from Fisher & Paykel Appliances. Merrett had worked with Hill & Stewart for two years and for Noel Leeming and Bond & Bond before he made the MBO offer, so knew the industry well. He took the job at the company because he knew it was coming up for sale.

There was no guarantee that it was his: the deal went through a merchant bank in a competitive process. After he took over as the owner, his staff and suppliers were more willing to go the extra mile, he says.

"In the end people want to deal with the owner - if you say you will do something you will do it. As an owner operator you just have to make it work, you have no choice to making it work. Within 18 months we had achieved our five-year goal; it happened pretty quickly."

Merrett sold a substantially improved business to JB Hi Fi at the end of 2006.

John Anderson, managing director of milking machine manufacturer Waikato Milking Systems, had a very healthy company when he bought it in 2001. He had spent 12 years there and was general manager. But when he was called in to help with some overseas divisions of the parent company, he could see there were going to be problems.

"I could have either waited it out and seen what happened or given it a whirl and make some things happen," he recalls.

Finance wasn't a problem in 2001. He was used to working with banks and raising money. Anderson took a 25 per cent stake and brought in two partners.

Since then he has paid off debt, made some acquisitions and started up some new business units, including an engineering company. The business has expanded fourfold and doubled its staff thanks to a soaring dairy market in the past few years.

"My advice is to buy a company that you've already worked with," says Anderson. "You know the inner workings and then you can value it and understand in your mind what the upside is."

The best thing management teams can do at the moment is lay the groundwork for a potential MBO, says Ocean Partners director Tim Howe. He is not convinced that company owners' price expectations have changed or that banks are feeling particularly adventurous.

"We are talking about the environment of 2008-09. Those MBOs done in previous years have been supported by higher levels of debt. The rules have changed. People are a lot more conservative."

Traditionally in an MBO, you need private equity but "this group has gone home", says Howe.

However, he says, "things will get better. The important thing is to be prepared for when that comes - there's going to be higher level of equity, so you have that lined up, and a higher level of bank security. Baby boomers will still get older and will want out. It's a big issue for New Zealand business."