Valuations & Acquisitions: What Acquisition Due Diligence Reviews Can Teach You

As competition among acquirers of catalog companies has increased and multiples have grown, these buyers have become more sophisticated in their acquisition due diligence reviews (DDRs).

“Multiple” refers to the multiplying amount applied to the latest 12 months of EBITDA (earnings before interest, taxes, depreciation and amortization), to equal the final valuation. And this especially is true for equity house investors, all of whom have extensive fiduciary responsibilities to their sources of capital, which often are insurance companies, pension plans, banks and other institutions. In fact, even most large direct marketers don’t acquire catalogers without similar intensive DDRs.

DDRs help as you do your circ plan, determine paid and natural search budgets, establish an annual P&L forecast and attempt a three-year strategic plan.

A DDR occurs between the signing of the joint letter of intent and the acquisition’s closing. Typically a 90- to 120-day period, DDRs for deals of any significant size include at least two primary reviews: from the buyer providing equity and from the financing source.

Since there can be more than one type of debt (e.g., short, mezzanine, long-term), there may be a third DDR. A fourth can occur if the working capital line is provided by an additional outside bank.

DDR Methodology and Intensity

The extent of each DDR varies with the investor. The intensity of the review in descending order usually is the equity investor, followed by the short- and long-term debt sources, followed by the working capital line source. Each has certain metrics it tends to focus on, so each analysis and DDR normally is custom made.

If you’re an old-line cataloger, you may wonder why you should study this and how you can learn anything from a bunch of “Johnnies-come-lately” professional investors. It’s simple: Most DDRs are conducted by long-time experts drawn directly from some of the best career catalog and Web site people in our industry.

Yet in each case, virtually all are concerned with sustained and growing cash flow. Many simply reference EBITDA. That said, growth is the most important characteristic assuring the equity investors receive their required ROI, and the debt sources receive their payback with interest. Both often are shareholders; without receiving their due, failure is in the cards.

Future growth is the same primary objective that catalogers have to focus on. When catalogers exercise the DDR approach, its disciplines and interpretations, they not only help their own EBITDA generation, but they also best position themselves to do their own deals — whether it’s to buy, sell or raise growth financing.

The first industry “expert” within a DDR analysis program is the so-called executive-in-residence. Equity investors normally are aligned today with career direct marketers, who invest alongside them, and who eventually hold senior management, operating positions.

Some examples: Jon Medved at Chef’s Catalog, Rich Hebert at BlueSky Brands, Jack Rosenfeld at Potpourri Group and Gary Giesler at AmeriMark. These all are heavy-duty career catalogers, who know what metrics and performance standards lead to future growth, how to measure historic rates, how to improve performance and which investments to avoid.

When they acquire an initial platform business, or complete a later add-on acquisition (of size), they assemble a team of catalog industry experts, by operating area, to conduct the DDR analysis. It’s not unusual to see a consultant (or consulting firm) investigating and analyzing, through meetings and performance data requests with company management, each discipline in the company to be acquired. These include merchandising, inventory control/forecasting, marketing, Web and search, operations, accounting/financial statements, and legal.

Such investigations typically take 75 to 100 days, and can cost more than $100,000. If there are multiple brand/catalog titles, this figure can increase greatly. Additional costs for the legal due diligence and closing documents can represent an incremental $100,000 to $250,000 or more. Finally, add expenses for intermediaries, such as myself, as we often can work on a deal for up to a year on the sell side, and six to nine months on buy-side representation.

DDRs use the best available analysis methodologies, and the findings almost always become part of:
4 the operating improvements instituted by the management team after (and often before) closing;
4 the marketing plan (circulation, space ads and search); and
4 the P&L forecast.

DDR Personnel and Mechanics

While current senior marketing execs may head up the DDR, they typically recruit and organize three to five consultants to conduct the core meetings and data analysis with managers of the business to be bought.

They are given upwards of three-dozen due diligence questions and add their own key performance questions. With the answers, the consultant submits a report with the executive. Follow-up questions are prepared, and a meeting normally takes place to discuss conclusions and options for implementation.

The buyer normally will have its own senior people, from marketing and merchandising, fulfillment and finance, in the DDRs. This increases the intensiveness of the process. And that’s true whether the buyer is an equity house, retailer or fellow cataloger. «

Larry West is president of West Cos., a New York-based valuations and acquisitions consulting firm. Contact: dmgrowth@yahoo.com.