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BUYING A SMALL BUSINESS

The Anatomy of a Sale--Ours, Part 2

Magazines know how to go after a story, but this one came to us. Inc. was recently the focus of a business drama with valuable lessons about what a company is worth--in the marketplace and to the people who work for it.
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Part 1 | Part 2 | Part 3

Rising Star

Joe Mansueto
Joe Mansueto
Founder,
Morningstar

Joe Mansueto, founder and CEO of Morningstar Inc., the Chicago-based investment research firm well known for its rankings of mutual funds, first learned of the planned sale of Fast Company and Inc. from an e-mail message on the morning of Wednesday, May 25. The message was from Paul Sturm, a writer for SmartMoney magazine and a member of Morningstar's board. Sturm had attended a dinner the night before honoring BusinessWeek's outgoing editor in chief, Stephen Shepard. There, Sturm had run into John Byrne, who'd spent 18 years at BusinessWeek before joining Fast Company, and they had talked about G+J's announcement that morning. In his e-mail, Sturm suggested there might be an opportunity here for Mansueto, who was looking for investments and was interested in magazines. If he wanted to pursue the matter, Sturm said, he should get in touch with Byrne.

At about the same time, Mansueto also received a voice mail message from Mark Edmiston, an investment banker who had brokered a deal the previous year that made Mansueto a 50% owner of TimeOut Chicago, an entertainment listings magazine. Edmiston said that his firm, AdMedia Partners, was representing G+J in the sale of Inc. and Fast Company and wondered if Mansueto was interested. Mansueto called back and asked Edmiston to send him the deal book as soon as it was available.

The book arrived at Mansueto's vacation home in Michigan on the Saturday morning of Memorial Day weekend, and he could see at a glance that it was rather skimpy—a reflection, he assumed, of the haste with which it had been assembled. Of the 28 pages of information, 20 concerned Inc. alone, three covered both publications, and just five were devoted to Fast Company. The entire discussion of Fast Company's potential consisted of five sentences, four of which reflected negatively on the magazine's value. Nevertheless, Mansueto was intrigued. He'd read both magazines since they'd first appeared. Indeed, Morningstar was a five-time Inc. 500 company, and Mansueto himself had been featured on the magazine's cover. "I thought that these were two very powerful brands, icons in their respective areas," he says. "And I'm a big believer in the power of brands and the power of high-quality editorial content."

"When I heard about it, I thought it was perfect for Joe," says Don Phillips, managing director of Morningstar, who has worked with Mansueto for almost 20 years. "Here you had great products in an industry that had fallen from grace. It was a classic value opportunity, and Joe is very good at making decisions. He doesn't waffle."

When John Byrne got ahold of the deal book, his initial reaction was shock, which quickly gave way to rage. He showed it to an investment banker friend who said, "John, I've just read your death warrant."

Byrne, meanwhile, was also looking through the deal book for the first time that morning. Koten had urged him to get a copy as quickly as possible, adding: "You're not going to believe how much it undersells our magazines." Byrne's initial reaction was shock, which quickly gave way to rage. The book did a poor job presenting Inc.'s prospects, he felt, but its discussion of Fast Company was appalling. He later showed the book to an investment banker friend who said, after reading it, "John, I've just read your death warrant." Byrne and Mansueto had scheduled their first telephone call for that afternoon, but Byrne wasn't going to wait. He sat down and in an hour and a half pounded out a 13-page, single-spaced memorandum making the case for Fast Company and fired it off to Mansueto by e-mail.

Byrne and Mansueto finally connected by phone at about 2 p.m. and talked for an hour or so. Byrne explained the history of Fast Company and discussed his vision for the magazine—what he was trying to do with it. Mansueto was impressed. "I have a full-time job at Morningstar," he says. "For me to get involved, I have to be sure that there's a highly motivated, enthusiastic team of talented people who are going to pull this off. And I got the sense from talking to John Byrne that that was the case."

Unlike some of the other bidders, Mansueto wouldn't have to achieve a specific rate of return to satisfy investors, and he had no board to go to or shareholders to worry about. The money he'd be spending would be his own.

Mansueto thought he might have an advantage because G+J was in such a hurry. Unlike some of the other likely bidders, moreover, he wouldn't have to achieve a specific rate of return in a certain time frame in order to satisfy investors, and he had no board to go to or shareholders to worry about. The money he'd be spending would be his own, not Morningstar's. Mansueto had taken Morningstar public in May, and his holdings in the company were worth more than $800 million. So he could move fast. Given G+J's obvious sense of urgency, he thought he might even be able to put in a preemptive bid and stop the auction.

First, of course, he had to settle on a number, which he says wasn't all that hard, despite the sketchiness of the financials in the deal book. "Remember, I was a stock analyst, and I have a background in analyzing financial statements. I can look at Inc. and put a value on it, look at Fast Company and put a value on it, look at the websites and put a value on that. I wind up with a number that gets me to what I should bid, leaving some margin of safety in case I want to increase it."

On Tuesday, May 31, Mansueto e-mailed Edmiston an offer: He was willing to pay $28 million for the magazines and websites if G+J halted the auction. A few days later, Edmiston reported back that the amount wasn't enough to shut down the auction. Preliminary bids were due that Monday, June 6. "I decided to let my offer stand as a preliminary bid," Mansueto says. "After the other bids came in on Monday, I was told I was in the middle but toward the front of the pack. When I heard that, I thought maybe my financial analysis was not too far off."

The Suitors

By the time Mansueto put in his bid, it was clear to everyone involved that there was more interest in Inc., if not Fast Company, than Axel Ganz and the G+J crew had anticipated—which made me think that Inc.'s German owners had never really understood the value, and potential, of what they had. Fast Company was a harder sell, partly because of its association with the 1990s economic bubble. Of course, Inc.'s managers were partially responsible for the interest in their magazine. They were reaching out to everybody they could think of—or at least everybody who might let them keep their jobs. Lee Jones was calling friends at CMP Media, a publisher of trade magazines, and at Wasserstein & Co., which owns The American Lawyer magazine and New York magazine. Koten was trying to contact Pat McGovern, founder of International Data Group. Ed Sussman was in touch with Reuters and talking to a friend at ACON Investments, a Washington, D.C.-based private equity firm. ACON, in turn, was exploring the possibility of partnering with media and real estate mogul Mort Zuckerman—the person who'd sold Fast Company to G+J for $350 million in 2001. Russell Denson was calling someone he knew at Abry Partners, a Boston private equity firm that specializes in media deals. And Byrne, for his part, was trying to stir up interest in Fast Company. He made a pitch to people at McGraw-Hill, owner of his previous employer, BusinessWeek. They weren't interested in the magazine, but BusinessWeek was interested in Byrne. Shortly after the initial announcement of the sale, it had inquired about whether he might want to return. He had said he couldn't do anything until Fast Company's fate was resolved.

Aside from the potential bidders being contacted by the managers, there were some heavy hitters who needed no prodding from anyone. Foremost among them was The Economist Group, which had long coveted Inc. The London-based company, publisher of The Economist, had sent out numerous feelers over the years about the magazine's availability. As soon as the auction was announced, the group's head of U.S. operations, Martin Giles, was on the phone, laying the groundwork for a serious bid. As he told one person close to the magazine, "How often does a really good magazine come on the market—in your niche, with a solid brand?"

Ray Shaw
Ray Shaw
Founder, American City
Business Journals

Advance Publications was another contender. In addition to Condé Nast, publisher of The New Yorker, Vanity Fair, and other consumer magazines, Advance owns American City Business Journals, based in Charlotte, N.C., which has a network of 41 business newspapers serving on a local level an audience that is similar to the one Inc. addresses on a national level. ACBJ's founder, Ray Shaw, a former president of Dow Jones, still runs the operation and recognized instantly how well Inc. might fit into it. He lost no time making his interest known.

The ultimate heavy hitter was Time Inc., but its intentions were a huge question mark. As Koten had learned from John Huey, Time had been talking secretly with G+J for months about buying the business magazines, apparently with the intention of shutting them down and putting Inc.'s name on either Business 2.0 or Fortune Small Business. According to one executive at Time Inc., G+J had originally approached it with an offer to sell them for $75 million. That was far more than Time Inc. was willing to pay, but it had continued to discuss a possible deal right up until the auction process began. So would Time Inc. now submit a bid? Nobody seemed to know.

And those were just the players we were aware of. In the end, AdMedia sent out between 25 and 30 copies of the deal book over Memorial Day weekend. The following Tuesday, just one week after the announcement of the sale, the due diligence process got under way. One after another, potential buyers began doing their interviews, and we began to see the many ways people were thinking about taking advantage of the opportunity presented by G+J's decision to sell Inc. As for Fast Company, John Byrne canceled a business trip so that he'd be available to answer any questions the bidders might have about the magazine. Other than Mansueto, none of them called.

Round One

Martin Giles
Martin Giles
Managing Directtor,
North America, The
Economist Group

While Koten, Sussman, and Jones were busy meeting with prospective buyers, the Inc. editorial staff spent the next two weeks trying to focus on putting out a magazine. Koten gave us periodic updates, but that didn't keep us from speculating. Rumors swirled. Although we all had contingency plans in case things didn't go our way, we really didn't want to have to use them. Indeed, no member of the editorial or Inc.com staff left during this period, though several people received job offers. (The business side wasn't so fortunate. It lost three of its marketing people.)

On June 6, 10 first-round bids were submitted to AdMedia Partners, which winnowed out those it knew would not make the final cut. Some bids were simply too low. Others were high enough but the bidders lacked sufficient financial muscle to assure G+J that they could deliver if they won the second round. That left five finalists: The Economist Group, Advance Publications, Abry Partners, another private equity firm called Alta Communications, and Joe Mansueto. Time Inc. chose not to participate in the first round but stayed ready to pounce.

By then, Koten, Jones, and Sussman thought they knew, or could guess, the intentions of all the bidders except Alta, about which they had almost no information. They'd met or been in touch with the people from The Economist Group, Advance's Ray Shaw, and Joe Mansueto, while Russell Denson had been talking to Abry. Based on those contacts, the managers had some sense of whom they should be rooting for—and whom they might want to root against.

The people from The Economist Group, for example, gave every indication that they liked the magazine as it was and wouldn't make major changes, at least not in the editorial and Internet operations. Martin Giles had a due diligence meeting with Jones and Sussman and later told Koten that he hadn't been included because the editorial content of the magazine wasn't a concern. Both Koten and Sussman had numerous other discussions with Giles and his colleagues, who seemed to feel that any problems Inc. had were on the business side, and that The Economist Group could fix them by applying its own publishing expertise, bringing in new resources, and making Inc. a platform for a host of profitable ventures, just as it had done with its other magazines.

Mansueto also professed to be a fan of the magazine, as Koten discovered when they finally connected. On June 6, the day first-round bids were due, Byrne had told Koten about Mansueto and said, "You're going to love this guy. You should call him." Koten was already familiar with Morningstar from his days as the editor of Worth magazine and could imagine why Mansueto would be attracted to Inc. and Fast Company: They were subscription-based information services companies, not unlike Morningstar. As an Inc. 500 CEO, moreover, Mansueto certainly understood Inc.'s market, and it was clear that he ran the kind of values-driven company that Inc. liked to hold up as a model. Granted, there was a possibility that Mansueto would move the magazine to Chicago. That would be hard on the staff, but Koten could live with it: He'd grown up there.

Ray Shaw was a little harder to read. When he and his son, Whitney, arrived at AdMedia's New York office for their due diligence meeting, Shaw greeted Koten warmly. "The last time I saw you, you were a cub reporter at The Wall Street Journal," he said. He and Whitney spoke for an hour or so with Koten, Jones, and Sussman, who all came away convinced that Shaw could turn Inc. into an extraordinarily profitable enterprise. He seemed to do that with everything he touched, and the opportunities for synergy between Inc. and American City Business Journals were too numerous to count. Moreover, these were opportunities, Koten noted, that he would want to explore even if Advance didn't win the auction.

But what a sale to ACBJ would mean for Inc.'s current staff was unclear. Shaw mentioned that he already had more than 500 business journalists who would love to write for Inc. When asked if he would keep the magazine in New York, he said he wasn't sure it was possible to be connected to the American entrepreneurial heartland if you were based in New York. (I happen to agree with him about that. So does Koten, but he argues that there's a bigger danger in being perceived as irrelevant by the New York publishing and advertising worlds.)

Shaw was obviously familiar with the magazine and inquired at one point about Norm Brodsky. After the meeting, Koten called Brodsky and suggested that he give Shaw a call. They eventually had what Brodsky later described as "the worst telephone conversation in my entire life," in which Shaw showed no interest in him or anything he had to say. (Shaw says he remembers it as "a pleasant chat.") All that led us to believe, perhaps mistakenly, that—as much as Shaw might value the Inc. brand—he considered at least some of us expendable. That's true, of course: We are all expendable. But we naturally prefer to work with people who think we aren't.

The distinction between the Inc. brand and Inc. magazine as we know it also became apparent when we finally figured out what the Alta group had in mind. It turned out that Alta was backing a trio of magazine industry veterans, none particularly well known. What interested them was the potential return on investment, not the opportunity to build an enduring brand—or so we thought. One member of the group, Ron Kops, insists that they saw Inc. as a "sleeping giant" and that they had long-term plans for it. If so, it wasn't apparent at the time. They set up a meeting with Koten and then canceled it. A friend of Byrne's met with one of them and reported back that they planned to "gut the magazine." When they met with Ed Sussman, they asked if there was a good young (and presumably inexpensive) editor on staff who could handle a big assignment. From their questions, Sussman deduced that they saw Inc. as an undervalued asset they could quickly streamline and flip for a nice profit.

That, of course, is a legitimate strategy, as well as a reasonable way to take advantage of the business opportunity presented by G+J's decision to unload Inc. at what was arguably the bottom of the market. It was no doubt inevitable that somebody would come up with such a plan. In effect, the Alta group seemed to be betting that the Inc. brand was strong enough to survive for a few years even if Inc. magazine became a pale reflection of the publication that had created the brand in the first place. We hadn't realized that the brand and the magazine could be separated in that manner, so it was an interesting lesson for us—one we hoped we'd never see played out in real life.

In any case, both Alta and Abry Partners were long shots. They were what are known as financial bidders, meaning they had to base their bids strictly on the financial return they expected to get from their investment. Financial bidders almost always operate at a disadvantage to so-called strategic bidders—in this case, The Economist Group and Advance's American City Business Journals—which usually have more resources to draw on and can justify paying a higher price based on how the acquisition will increase the value of their existing businesses.

That said, strategic bidders don't necessarily enjoy competing against financial bidders. With Alta, for example, there was the possibility that, by building massive cost-cutting into its plan, it could project enough future cash flow to justify a much higher bid than the strategic bidders would offer. As for Abry Partners, it had actually been the high bidder in the first round—a fact that led at least one of the other bidders to cry foul.

In Part 3, controversy, a bidding war and the proud new owner.

Part 1 | Part 2 | Part 3

Last updated: Sep 1, 2005

BO BURLINGHAM: Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business.
@boburlingham




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