Shopping For Growth
Swanton Corp. (#41) is building a position in the coal industry by acquiring financial service companies.
* Sea Galley Stores Inc. (#71) let the competition finance the East Coast expansion of its restaurant chain.
* Heritage Communications Inc. (#37) buys tax shelters to help fund its cable television growth.
* Two corporate mice, Healthdyne Inc. (#24) and Chemical Investors Inc. (#18), are riding corporate elephants they recently bought.
Acquisitions have accelerated the revenue and, in some cases, the earnings growth of dozens of INC. 100 companies, but don't look for a common style in their acquisition strategies. They range from high-risk to no-risk. They are the product of careful planning and of serendipity. Most of them have worked, but at least one hasn't. And they add up to this: Any well-heeled corporate manager can buy size, but buying growth demands at least as much entrepreneurial imagination as capital.
Anyone with $2.5 million, for example, could have bought the ailing Family Fish House chain of 31 restaurants on the East Coast. But it took $2.5 million and some imagination for Sea Galley Stores to buy the chain, keep the six locations it wanted, and sell off the remainder in twos and threes -- at a profit. Sea Galley, headquartered in Mountlake Terrace, Wash., grossed $3.2 million on the separate sales, more than it paid for the chain, and thus financed its 1981 East Coast debut with other people's capital.
This same low-risk, low-cost acquisition strategy has powered the expansion of Crime Control Inc. (#19) into new markets since 1978. Crime Control designs, installs, and services centrally monitored electronic alarm systems for business premises. It targets its acquisitions in high-growth, high-crime areas. "We knew," says treasurer James Clark Jr., "that Miami would be a good market, but when the riots broke out we didn't know whether we would survive to enjoy it."
Crime Control, headquartered in Indianapolis, enters a market by acquiring one or more local alarm businesses. The ongoing revenue flow services the bank debt that financed the purchase while Crime Control sets about converting the acquired companies' existing customers to lessees of more sophisticated, and costly, alarm systems.
Heritage Communications, in Des Moines, has spent about $62 million on nearly 20 acquisitions, primarily in the cable television industry, since 1978. It has also expanded through construction of new cable systems awarded by municipal franchise. Federal tax laws make the dual growth strategies complementary. "Rapid expansion in the cable television business results in losses. As a result," says Heritage vice-president Dave Lundquist, "we have unused tax benefits. So we acquire companies that are profitable. Now we can use our tax breaks against their earnings. It's sort of an internal tax shelter."
Heritage's acquisitions include some non-cable properties, which are nonetheless in the communications field. The same relationship is hard to divine among Swanton's three subsidiary groups: coal mining, financial and investment services, and retail garden and appliance outlets. Chairman Norraan F. Swanton, however, insists that the link is there.
Swanton's coal subsidiary operates and develops low-sulphur mines in eastern Kentucky. The financial subsidiaries, which Swanton built through acquisition, perform financial services for Wall Street firms, provide insurance premium financing, and, most significantly, package and market limited partnership investment programs for the coal subsidiary, which itself is several years away from full-scale production, according to Swanton.
"Coal," he says, "is capital-intensive. It takes a great deal of funding and patience, and its time has not yet arrived. So what I did was to use our financial expertise to create an investment vehicle to give us earnings and capital during the time of the mine development phase. When we get into the operating phase on that mine, it'll be much easier for us to be profitable."
But what about that other subsidiary, the garden center and appliance retailer? "Friendly Frost Inc.," Swanton says, "was an opportunity buy." The 39-year-old company generated $40 million in annual revenues, mostly from its retail outlets in metropolitan New York. It hadn't been profitable since 1976. Swanton paid $5 million for 56% of the company's stock last May and immediately peddled its subsidiary radio station for $8.5 million. With the proceeds, he paid off Friendly Frost's balance-sheet debt and had $4 million in working capital left over.
"The management in there was rotten," says Swanton, "a corporate corpse. We replaced the entire group." This year, Swanton says from his office on Manhattan's lower Broadway, the Friendly Frost subsidiary will turn a profit, another contribution to Swanton's financial staying power while it builds a future in the coal industry.
Fort Worth's Pengo Industries Inc. (#75), like Swanton, used acquisitions to build a revenue base while it was developing its main line of business, wire-line services for the then-booming oil and gas exploration industry. But Pengo's timing was off, and its acquisitions, instead of buoying revenues when hard times came, have been like stones in the parent company's pocket.
Pengo was spun off to stockholders of Gearhart-Owen Industries Inc. in June 1978. Part of the spinoff was an agreement that Pengo would not compete with its former parent for three years in providing wire-line services to oil and gas well drillers or in manufacturing wire-line equipment.
So, during those three years, Pengo used stock, earnings from its other oil-field equipment manufacturing and servicing lines, and bank credit to snap up more than two dozen businesses in the same or related fields. The newly independent company did well. In 1980, the year before its noncompetition clause expired, Pengo generated earnings of $4.7 million on $59 million in revenues with a healthy debt-to-equity ratio of less than 1 to 1. When the noncompetition clause expired in June 1981, says Pengo vice-president for corporate planning Richard Frank, the company had geared up, hired people, and was expanding its capacity. "We went from having no wire-line business to a $36 million annual rate in just a few months."
But as rapidly as Pengo geared up, the oil and gas exploration business wound down. Oversupply and price uncertainty in the oil market reduced the number of working drilling rigs by nearly half from December 1981 to a year later. "Our market," Frank says, "went into a big black hole." So did Pengo revenues and profits.
The company, Frank says, had borrowed heavily to finance its wire-line business, raising its debt-to-equity ratio to 4.3 to 1 during the year ended September 30, 1982. As diversified as Pengo had become in the industry, virtually all its business depended on continued exploration in the oil patch. Last year it reported a net loss of $83 million on revenues of $151 million, and while holding its lenders at bay, Pengo is trying to divest itself of its manufacturing subsidiaries. There aren't many takers.
A collapse of the world oil market was the last thing Pengo had planned on. Says Frank, "We kinda got caught. . . ."
Xonics Inc. (#99) was also caught overextended, but that was in 1978 when the company fell into default to its senior lenders. Xonics, founded in 1970 to design and manufacture medical imaging equipment, had collected eight acquisitions by 1977 in fields not necessarily related to medical imaging. It had to divest and refinance to survive. (One of the companies it sold was Hadron Inc. [#81]).
Recently, a healthier, and presumably wiser, Xonics has been on another acquisition binge, this time staying with what it knows -- medical imaging. Its acquisitions have been designed to broaden its technology base and improve its distribution facilities. Would the Des Plaines, Ill., company consider diversifying again? "Our inclination," responds chief financial officer Arthur L. Goldberg, "would be negative."
If diversity was unhealthy for Xonics, it has been a tonic to Gary Zintgraff, founder and chairman of Chemical Investors Inc. (#18). Zintgraff relied on internal growth and a couple of modest acquisitions to move his company from its 1976 start-up as a supplier of high-cost, low-volume chemical specialties into veterinary drugs and instruments, chemical distribution, and the manufacture of liquid crystal wall thermometers. Revenues in 1979 were a bit more than $5 million, but the company's balance sheet was debt-free.
Zintgraff may be deliberate and cautious, but he isn't timid. He wanted growth, and in 1980, he got it. Chemical Investors used borrowed money to buy the Mystik Tape Division, which had $30 million in sales, from Borden Inc. Zintgraff thus leveraged his suddenly not-so-small company into the No. 2 slot in the $1 billion-plus pressure-sensitive tape industry.
In September, Chemical Investors put up $1.1 million in cash, gave Borden a 10% note for $4.7 million, and borrowed the balance of the $16 million purchase price from General Electric Credit at a healthy premium over the prime rate, which immediately began to climb, taking Chemical's floating rate eventually to 25%. Digesting the new division, says Zintgraff, was easy. It was servicing the debt that gave him indigestion and ate up all his cash reserves until rates moderated.
Fifteen months after the Mystik acquisition, Chemical Investors rounded out its tape line by buying the assets of Arno Adhesive Tape Co., which had been closed for a year by its parent because of unprofitability and labor problems. The seller financed $4.3 million of the $7.8 million price tag with an 11%, 10-year note. Chemical Investors put $1.5 million down and paid the balance by buying Arno's raw materials inventory as it was consumed over the next 10 months.
Zintgraff still seems surprised by what he has done. "We're nationally known," he says, the pride coming clearly through. "There's Scotch, then Mystik, and after that there's nothing. . . . It's an unbelievable feeling."
Healthdyne, another onetime corporate mouse, with $18 million in sales, recently swallowed an elephant, $80 million Narco Scientific Inc. "It wasn't such a ridiculous stretch," says Healthdyne chairman Parker H. Petit. In 1982, Petit points out, Narco Scientific may have done $80 million in business, compared with Healthdyne's $30 million, but Healthdyne's net worth was greater, $33 million, compared with $27 million; its aftertax profit margin was higher, 12% versus Narco's 3%; and Healthdyne's market value was roughly three times Narco's.
Last year, before the acquisition, Healthdyne, a 13-year-old Marietta, Ga., company, earned $3.3 million on sales of its home health-care equipment -- oxygen concentrators for respiratory sufferers and monitors for children susceptible to sudden infant death syndrome -- and its line of hospital life-support and monitoring devices. With less than $1 million in long-term debt, Healthdyne was looking for someplace to put its money. Narco, an independent maker of hospital equipment, was not the obvious choice.
Healthdyne had been steadily acquiring retail dealers to ensure a market for its own home-health equipment, but these buyouts were small and required only stock. In itself, the hospital equipment market didn't offer nearly the growth potential that the home market did. So why did the Narco deal make sense?
"Doctors," says Petit, "prescribe the equipment the patient is to use at home. But doctors work in hospitals, and they aren't going to prescribe anything that they haven't already used there. If you want to sell home-care products, you better get into the hospital first."