Jig May Be Up on Fantastic Stock Multiples from Roll-up Acquisitions
BY Hal Plotkin
New SEC Staff Accounting Bulletin may spell the end to the roll-up gravy train.
"I wanted work to be optional by age 44," says Steve Wilson, founder of Mid-States Technical Staffing Services, based in Davenport, Iowa. He achieved his goal in 1993 when Mid-States was acquired as part of a successful "roll-up" pulled together by staffing giant AccuStaff. Since the roll-up, Wilson has seen the paper value of his AccuStaff stock more than quadruple.
"If this had been a straight cash transaction, my company would have gone for 3 to 5 times earnings, but since it's part of a roll-up, Wall Street places the value at 10 to 12 times earnings," says Wilson, who left AccuStaff last month, when his three-year contract ended. (Like Wilson, most roll-up entrepreneurs remain at the helm of their companies for some period of time after they've been acquired, often as a matter of contractual obligation.)
Also called consolidations, roll-ups have enabled scores of entrepreneurs to cash in their chips at very high multiples. Roll-up specialists have applied Securities and Exchange Commission rules that allow the assets of different companies to be pooled before an initial public offering without first deducting the cost of goodwill--the difference between a company's hard assets, like real estate and machinery, and the valuation of the company. Normally, goodwill would be written off the merged company's balance sheet. The result, say some critics: high reported earnings in the consolidated companies and high stock prices. Since the spate of cash-outs began in earnest, in 1992, the amount of equity issued by industry consolidators mushroomed more than 20-fold, exceeding $1.6 trillion in 1995, according to Securities Data Corp.
But the fast-moving roll-up gravy train may be heading for a ditch. In a bit of arcana called Staff Accounting Bulletin No. 97, issued on August 1, 1996, the SEC reinterpreted the rules to require, in most cases, that goodwill be written off against earnings for a period of up to 40 years. "This is a disaster for entrepreneurs," says roll-up specialist and Notre Capital president Steven Harter, whose firm promoted many of the most successful recent roll-ups, including U.S. Delivery Systems, Physicians Resource Group, and Coach USA. Harter contends that the accounting change discriminates against entrepreneurs--and, of course, by association, roll-up specialists like him.
There certainly have been concerns about roll-ups. For starters, some, including smart investors, worry that the high reported earnings that push stock prices up will evaporate once traditional measures of business performance, such as comparisons of same-store sales, are applied. Others argue that like hungry sharks, the roll-ups must keep moving forward, acquiring new companies in order to keep the numbers up. "That's nonsense," says Harter. The SEC would "be destroying the only opportunity many entrepreneurs have to get to the equity markets."
Meanwhile, at least some entrepreneurs have adopted a wait-and-see attitude. "I'm not a Wall Streettype person," says Ed Katz, owner of New York Citybased Choice Courier, the nation's largest privately owned ground courier. Katz rejected invitations to join roll-ups in recent months, mostly, he says, out of concern over what might happen to his longtime employees, who would have been required to take salary cuts in exchange for stock options whose value might not hold. "If you make a dollar today and Wall Street says it's worth $100, well, is it really worth $100? I don't know about that. Yes, the deal would have made me wealthy," Katz confirms, "but we have a happy little company here, and I run it. I'd like to keep it that way."
Resources: CHOICE COURIER, Ed Katz, 733 Third Ave., 5th Floor, New York, NY 10017; 212-370-1999