The case
The global economy demands operating efficiency. The result is consolidation in one fragmented industry after another. But often the roll-ups of small companies into large concerns fail because they amount to little more than financial plays -- acquisitions designed mainly to strip out cost, not to strengthen operations and foster growth.

Enter Michael G. Rothman, 44, who thinks he has a better way. Through a series of acquisitions that have emphasized strategic rather than purely financial goals, Rothman has built Kenny Industrial Services LLC into one of the largest players in its industry. In theory, when Rothman consolidates companies, he adds rather than subtracts. Would you be happy to see this man at your company's door?

Taking prisoners
Mike Rothman has always been a man on the move. By the time he was 27 he had acquired his first industrial-services company, which he subsequently grew to $3 million in sales before selling it, in 1989. He then started another company, which he sold in 1992. That company in turn was sold to a division of Waste Management, where Rothman eventually rose to vice-president of marketing. In 1995 he left to start yet another company, Kenny Industrial Services.

Along the way, Rothman jousted with John Manta. Manta's grandfather had arrived in this country from Greece in 1908 and began working as a day laborer, painting steel mills in Gary, Ind. His hard work grew into the J.L. Manta Co., one of the largest industrial-coating companies in the country. Manta, the grandson, started wielding a paintbrush at 13 and eventually joined a sister division of J.L. Manta, HMS Services Inc. Since Rothman and Manta both worked with large manufacturers in the Chicago area, they would often end up bidding ferociously on the same jobs. "We used to kill each other," says Rothman. Echoes Manta: "We were cutthroat competitors. We took every opportunity to take advantage of the other guy."

After one grueling battle, Rothman landed the contract, but, as he recalls, "dropped a lot of money off the table. We had to adjust for that." He placed a call to Manta, who, not surprisingly, did not call him back. When Rothman finally got through, he told Manta he wanted to buy J.L. Manta and HMS Services. Together they could expand their business by offering more services to more customers. Standing alone, they'd just keep fighting over scraps.

Rothman knew his market was changing fast. His customers, Fortune 500 manufacturing companies, were looking to outsource more work to fewer, more capable vendors. Manta could see that, and he could also see that he and Rothman, his fellow survivor, had more in common than he cared to admit. "We were the two companies in the market that were growing the quickest and taking the most prisoners," says Manta. He quickly saw the logic in merging. To seal the deal, he and Rothman went to a White Sox game with their kids. At one point, Rothman turned to his son and, pointing to Manta, said, "See that man? He's the man who used to take food out of your mouth."

Eat or be eaten
In 1998 Kenny Industrial recorded $20 million in sales, which grew to $80 million in 1999. Last year its revenues reached $210 million. The bulk of that growth came from the eight acquisitions Kenny had made of companies like J.L. Manta. In fact, Rothman's acquisition strategy was central to Kenny's growth.

Kenny does not lack for targets, as the two markets in which it operates -- industrial services and coatings -- are as fragmented as they are large. The former, for example, is a $6-billion market divided among 6,500 companies, most of them family owned and grossing less than $20 million a year. Their founders are often looking for an exit strategy, as many lack a next generation that can keep abreast of a dynamic market.

The global economy places a premium on economies of scale. Consolidation has swept through the industrial-services market, just as it has been doing in virtually every other industry. The theory behind doing a roll-up of an industry is that it raises volume and strips out costs, thereby creating value and efficiency. But roll-ups, for all their implied logic, have often done better on paper than in practice. The CEOs who mastermind such consolidation often overreach by paying too much, acquiring too quickly, or simply buying the wrong company. If an acquiring company is public, it often pays the seller with stock, which in today's volatile markets can fluctuate wildly in value. And, finally, roll-ups often don't take into account the clashes of culture that can arise between buyer and seller.

In sum, roll-ups are fraught with hazards. Just ask Paul Kocourek, a senior partner at the consulting firm of Booz Allen & Hamilton Inc., who has studied roll-ups and advised numerous company owners over the past decade. Kocourek says that roll-ups enjoyed "extreme popularity" in the mid-1990s, handsomely outperforming the S&P 500. "Then in early 1998 they tanked," he notes.

Booz Allen followed 81 roll-ups from January 1993 to December 2000. "If every time one of those went public you put a dollar into it, and you put another dollar into the S&P 500, today you would have $92 in those companies versus $264 in the S&P," says Kocourek. Of the 81 companies that the firm studied, only 11 have outperformed the S&P 500, while 20 are either in or near bankruptcy.

What makes it so hard to pull off a successful roll-up? "The first thing is, you need to have a clear idea of how you intend to create value," says Kocourek. A successful roll-up must be more than the sum of many disparate parts. Kocourek cites such value-adding earmarks as the ability to create national or regional accounts, to harness aggregate purchasing power, and to spread best practices throughout the enterprise.

Kocourek says that simple acquisitions -- when one company buys another -- fail some 60% of the time. Roll-ups, by definition, involve dozens, if not hundreds, of acquisitions. Kocourek says that consolidators are faced with hard choices. "They need to move quickly to integrate newly acquired companies," he says, but then they also need a deep understanding of what he calls the "loose-tight" nature of roll-up management.

Most target companies are small and have local customers. (That's a major reason why their markets are fragmented to begin with.) A successful roll-up must maintain that local feeling while adopting the operating practices of a much larger corporation. And yet such small local companies are entrepreneurial in nature. So they often chafe at the prospect of being managed from afar. "You can't just leave them alone and tell them to create value," says Kocourek. "On the other hand, you can't discourage their entrepreneurial impulses. That's a very fine line to walk."

You have to go into a roll-up with your eyes open and with few illusions, warns Ken Hendricks, chairman of ABC Supply Co., in Beloit, Wis., who has done his share of consolidating. Over the past six years, ABC, which sells roofing and siding to the wholesale market, has made about 60 acquisitions, giving it annual sales of $1.4 billion.

Hendricks has found that keeping the acquired company's original owner in place usually doesn't work. "In most cases the business is better off without the owner because he's out golfing half the time and then comes in to clean out the till," says Hendricks. "When we buy the business, the owner usually retires."

Hidden problems within companies and greed on the buyer's part can also be pitfalls. Many consolidators have visions of a rich public offering waiting in the wings. What Hendricks looks for is far more mundane than that: hardworking middle managers who can flourish (once the owner is gone) and take the business to the next level -- with Hendricks's help. "We give them buying power and organization," says Hendricks. "We are their salvation."

Rothman, clear-eyed and plain-spoken, agrees with much of what Hendricks says, save for one obvious difference. He doesn't buy broken companies, and he insists that the owners of his rolled-up companies stay on. Based on his experience at Waste Management, he understands the pitfalls of buying a company just because it looks like a bargain. "I left there because I didn't agree with their acquisition philosophy," he says.

To him, the Waste Management experience was mainly about finding operating efficiency, while the customers' needs and sense of urgency were given short shrift. "You have to have a high level of pride and intensity to do business with the companies we work with," says Rothman, referring to his roster of large companies that expect blue-chip service. "There's a difference between consolidating companies to take out costs and consolidating them strategically for the customers' benefit."

When Rothman started Kenny, he first focused his buyout strategy on building what he calls a national platform. The idea was to buy companies in regions of the country and in service niches that Kenny had yet to cover. That would allow the company to land national contracts that could be serviced uniformly yet would still have regional or local oversight. "We will say to an oil company, 'We can negotiate one set of prices and work rules to paint your tanks all over the country," says Manta.

Hardly a day goes by in which somebody at Kenny doesn't receive a call from an entrepreneur wanting to sell his or her company. So what exactly is Kenny looking for?

The answer is healthy companies run by seasoned managers. "We look for sound companies that are not distressed or on the block," says Darryl Schimeck, Kenny's executive vice-president of business development. Beyond that, the target company must have a culture committed to safety. Applying those criteria eliminates three-quarters of the companies Kenny looks at.

"We want operators who will stay on," says Manta. "That's key." Kenny is not so much buying companies as it is investing in entrepreneurs who share its values. The company's goal is not to cut costs but "to add capacity," as Rothman puts it.

What Kenny is offering its newly merged partners is, in effect, a quid pro quo. Kenny brings to the table management support and money. In return, the acquired companies step up growth. Rothman says he typically sets a target of 12% growth for the first year after acquisition, ramping up to 20% in the third year. "You buy a company because it's a great company. You support it," he says. "Other consolidators will buy a multiple of earnings and cut G&A. That destroys that company's ability to operate."

With an eye to rapid growth, Kenny now employs 25 salespeople, up from 3 two years ago. That takes the pressure off the small acquired companies, which often land jobs and then get so consumed by them that they don't have time to prospect for the next one. "We want to give our operators a chance to sip from the fire hose," says Rothman.

Kenny's bias for buying well-operated companies is reflected at the corporate level, where the average manager has 15 years' experience in the industry. But even more notable, middle managers at Kenny subsidiaries average 25 years' experience. It is there, at the project-manager level, that Rothman believes the battle is won or lost.

"The difference between Rothman and the typical CEO is that he comes from the operations side. He talks at that level," says Ted Mansfield, former CEO of Canisco, which was bought out by Kenny. Mansfield started Canisco and has devoted his career to it, and to him Rothman's down-to-earth style counts for a lot. "He's down there in the trenches," says Mansfield. "Most CEOs are financial guys. These managers at Kenny are young, aggressive guys who are not afraid of change." Mike Chakos, Kenny's chief financial officer, says the company's mission is simple: deal with change. "We want to show them where the market is going and how we are going to be a part of it," he says.

And with that simple message, making the next acquisition gets easier. "The companies we buy know the other good companies because they've competed against them," says Chakos. "The word gets out that we treat operators well. And they all realize it's a survival issue. We give them autonomy. We also give them a huge dose of expectations. We tell them that what we did was great but not enough. They're excited and scared at the same time.

"When we walk in the door, we are not the enemy."

Edward O. Welles is a senior feature writer at Inc.

The Company

Kenny Industrial Services LLC, based in Chicago

Business: Provides a range of industrial services, including cleaning, painting, and maintenance, mostly to Fortune 500 customers, from 30 locations nationwide

Financial summary: Sales of $210 million in 2000, up from $20 million in 1998. That growth has been fueled by eight strategic acquisitions the company has made in the past two years.

Management: CEO Michael Rothman; chief financial officer Michael Chakos; and John Manta, president of Kenny-Manta, a major subsidiary of the company.

Capitalization: Kenny is privately held. In 1999 it raised $6 million through Bluestem Capital using the Shattan Group LLC, a New York City investment-banking firm. That gave it the legitimacy to attract a major investor -- Saunders, Karp, & Megrew, also of New York -- which put $31 million into the business, enabling Kenny to step up the pace and size of its acquisitions.

Strategy: Acquire thriving, well-managed companies that will allow Kenny to expand the industrial services it offers to existing customers and to extend its reach into new geographic markets.

Philosophy: Rothman believes in buying sound companies at a fair price, not broken ones for a bargain. He invests in his acquisitions so that they grow faster than they would if they had remained independent.

The Founder

Michael Rothman has always prided himself on being an operations man, having worked in the field from the moment he left college. "I'm not a financial buyer who can't add anything," he says. "I'm a strategic buyer." By dint of his experience, he knows what makes an industrial-services company tick, so he knows what to look for when he goes to buy one.

Rothman says the first thing to overcome in the acquisition process is prejudice and distrust. His industry is so cutthroat that every competitor is seen as suspect. "When you do an acquisition, you have to filter out all the negatives you hear about a guy," says Rothman. Then there's price. But that part of the deal has become easier for Rothman as Kenny has done more acquisitions, establishing price benchmarks along the way. He typically pays between three to five times trailing cash flow for a company. He says he offers sellers two things of value. The first is cash -- a way for them to diversify beyond owning what is often a small, privately held, illiquid business painstakingly grown over a lifetime of hard work. "I give people a chance to redeploy their capital," he says. The second is a chance for sellers to grow their business -- and its value -- beyond the limits it may well have bumped up against in a market that favors large companies and economies of scale. In sum, Rothman often gives ambitious entrepreneurs a second wind.

Rothman, similarly, profits in two ways. First, he gets more diversified, too. "My risk profile is reduced because I'm spreading out the seller's business over my existing capacity," he explains. Second, he gets a chance to challenge himself by targeting a higher return on his invested capital. He uses the example of paying $5 million for a business with cash flow of $1 million a year -- a 20% return. "Well, if I can increase your cash flow to $2 million, then I am making 40% -- and, in effect, I've paid a lower multiple for your company," he says. "That's why I am prepared to take the risk of buying you."

Best Practices

Rothman always pays for his company's acquisitions using some combination of cash and a seller's note. Although Kenny does have private stock, Rothman says it's too hard to value and too illiquid. Buying a company with stock "is gambling, and I prefer not to gamble.

"The secret is to buy companies you have a high degree of confidence in," says Rothman, who is definitely not in the turnaround business. Whatever business he buys, he wants to grow -- with a clear target. That figure typically is a 12% increase in revenues in the first year, rising to more than 20% by the third year.

Kenny invests in corporate management along the way but adopts the best practices of the acquired companies. One of the benefits of consolidation is that Kenny can now afford to hire top-notch administrative talent, such as managers in information technology and human resources. At the same time it aims to spread the best practices of the acquired businesses companywide. After Kenny bought Canisco, it adopted the newcomer's program for projecting and tracking costs on jobs, because that system was more sophisticated than anything Kenny's managers had seen.

Rothman doesn't pit former adversaries against one another. Kenny often ends up buying companies that previously fought tooth and nail over contracts. Ensuring who gets what job is a responsibility of management. If there is any doubt, Kenny will pay bonuses, if warranted, to both branches, rather than risk residual resentment.

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