Private equity insider

Private equity firms have been making quite a splash in the multichannel marketing industry in recent years. Each month seems to bring news of at least one major private-equity transaction.

So what's the deal on landing a PE deal?

Private-equity investment funds acquire businesses, support management teams with strategic resources, and grow those companies for a later sale in hopes of a big financial return. Private equity has grown substantially in recent years and continues to invest — and divest — at a rapid pace.

Direct marketing has been a recurring favorite industry of the PE community, and 2007 was no exception. In all, 2007 saw 79 multichannel/direct marketing transactions involving PE firms.

Why do PE firms like direct marketers? The industry is highly fragmented, with an estimated 10,000 to 15,000 catalog titles alone, offering a deep pool of potential acquisition targets and consolidation opportunities.

The quantitative nature of direct marketing — particularly the ability to drive sales through a predictable process of measuring variable contributions from specific customer segments — greatly appeals to numbers-oriented PE professionals.

Additionally, direct marketers have not relied exclusively on large investments in stores and have low receivables, resulting in unusually high cash flows. This allows PE firms to realize higher returns on total capital and effectively use their favorite financial engineering tool, debt, to further enhance returns.

Finally, the growth offered by the expansion of Internet shopping and procurement is a structural change facilitating rapid growth.

Many owners of multichannel businesses have partnered with PE funds to finance a substantial liquidity event to secure their personal wealth, while staying involved as both CEO and investor to grow their businesses. Bringing in a quality PE partner can have many benefits for a business owner, including:

• Taking substantial cash out of the business and diversifying one's personal wealth;
• Remaining in place to manage the business, with management succession assistance from the PE fund;
• The opportunity for the owner to reinvest a portion of his proceeds for a “second bite of the apple” when the PE fund exits the investment — usually at a substantial profit;
• A financial partner with industry experience, relationships, and strategic insight; and
• Support and financing for rapid growth through acquisitions of smaller direct marketers to add new products and customers.

THE INVESTMENT CYCLE

Once a PE fund is established, it begins a period of acquiring businesses, with the hope of exiting those investments within a specified period (usually two to five years). It also aims to secure equity returns of 20% to 30% for its investors.

The “exit” may be achieved through a sale of the business to either a larger operating company (a “strategic buyer”) or another PE fund, or by taking the target company public. A high return on investment drives compensation to the PE fund professionals and the PE fund's ability to raise a new fund.

PE funds typically finance their acquisitions through a combination of equity and debt capital. While equity is usually 35% to 40% of the capital structure, the exact ratio of equity to debt will vary depending on the stability of the company's cash flows. PE firms typically strive to use high levels of debt to enhance return on investment.

To ensure that these high levels of debt are serviceable by the company, PE funds focus on businesses that have strong, stable cash flows, low capital expenditure requirements, and substantial growth prospects.

For these reasons, direct marketing businesses with defendable market niches, low overhead requirements, and scalable business models tend to be popular investments and attract substantial enterprise values.

How does the sale process work? The typical time frame for an acquisition by a PE fund is approximately six months, and involves several key steps:

Investment banking representative

Most business owners achieve maximum value by involving a knowledgeable investment bank with relevant experience in the direct marketing and retail industry. An effective investment banker will take the time to understand the needs of the business owner, identify and communicate with buyers, and run a smooth auction for the business. The best process will promote competition among bidders to achieve maximum value and the most favorable terms.

Positioning the company

The investment bank will work with company management to create a detailed overview of the business. It will also create an investment thesis in the form of an offering memorandum that will effectively communicate the company's story and the opportunity to potential buyers.

In addition to the company's financial results, buyers will focus on the health of the 12-month customer list, customer retention, growth opportunities and the economics of prospecting, and trends in merchandising and marketing.