This Is Why Companies Make Acquisitions

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Primeline productsCOURTESY PRIMELINE

In my firm’s mergers and acquisitions business, we spend all our time helping sellers to sell and buyers to buy. The question is: why? What is it about buying other companies that’s appealing to managers? Of course being in control of more assets appeals to people’s egos but as a business proposition, why does that make sense? A transaction we completed this month is a classic case.

Our firm focuses on consumer-related businesses. Our client, Prime Line, is in the business of making products that have other companies’ logos on them and selling through a North American network of distributors. You may have a coffee cup or a pen or pad with a company logo on them or a fidget spinner as in the picture above. That’s exactly the kind of product they make. It’s a family business, now in its second generation. The acquirer, a company called alphabroder, was in the same promotional products industry but the products alphabroder sold through their network of distributors were typically apparel products like shirts, sweaters, jackets and  hats that are suitable for having logos put on them.

alphabroder is many times the size of Prime Line. More important, alphabroder is a mature business. It is one of a very small number of competitors, all of whom are pretty large, in a market that is growing but  not very rapidly.

Here’s a very important chart to know about when you’re thinking about strategy and acquisitions. It’s a life cycle chart. Most companies follow this cycle.

Life Cycle ChartCOURTESY TRIANGLE CAPITAL LLC

Very often, acquisitions arise because companies are in the mature phase of their life cycle. As good as they may be at what they do, there’s no way for them to grow substantially once the business is mature. The only way to grow at all is to take market share from a competitor. That’s a lot harder than it is during the growth phase where all the market participants can grow. In the growth phase, a business can grow even if it’s losing market share. It’s that good a time for companies.

That’s the situation I believe alphabroder found itself in. It is a very well run, successful company but it was not in a growing market. Its competitors were likewise stymied and would defend their client relationships tooth and nail making it even harder for alphabroder to grow. If alphabroder ever intended to have a liquidity event, that is to say if it ever wanted to sell or go public so that its owners could cash out, it needed to find a way to extend its growth in spite of being in the mature phase of its lifecycle. In addition, the two companies together would be able to increase efficiency in the way they served customers; there would be one source for a range of products that was broader than either one of them could offer on their own. The increase in scale and efficiency would enable the next owner of alphabroder to justify paying a high price when alphabroder was sold.

Thus begat alphabroder’s acquisition strategy. Prime Line was in the same business but in a different segment. Hard goods is a different market than soft goods. More important, hard goods had many more fragmented competitors than soft goods. By acquiring Prime Line, alphabroder could extend its time in the growth phase, making its lifecycle chart look more like the dotted line in the chart below, putting off its own maturity and decline.

Life Cycle Chart ExtendedCOURTESY TRIANGLE CAPITAL LLC

With the acquisition of Prime Line, alphabroder could extend its growth phase way beyond what it could do on its own. In so doing, alphabroder changes from being a mature company with a low valuation into a growth company that’s much more valuable. Buyers of companies will pay more for higher-growth companies and bigger companies. What’s more, the hard goods business is fragmented. Although Prime Line is a leading player in the business, there’s a wide variety of other companies who are small and could be acquired attractively by alphabroder and add to its growth. Finally, there are ways the two companies can help each other directly, increasing revenues and reducing in expenses in ways that neither could do on their own.

Here’s a video of the Prime Line and alphabroder CEOs talking about the deal.

There’s a lot of risk in putting two companies together. You have to meld two cultures and that doesn’t always work out. Management of either company could become disenchanted and leave, creating a significant risk of failure. But when acquisitions work out, changing mature, low-value businesses into much higher-value, growth businesses, all the shareholders are winners.

Transaction AnnouncementCOURTESY TRIANGLE CAPITAL LLC

How can you tell if a company is a likely acquirer? Ask the following questions:

  • Is their business mature?
  • Are they in a low growth phase?
  • Do they generate a lot of cash?
  • Do they have a strong balance sheet?
  • Do they have fragmented competitors or are they adjacent to an industry segment with fragmented competitors?
  • Will they be able to help a smaller company to grow faster?

If the answer to all these questions is yes, the company is a likely acquirer.

Will the acquisition of Prime Line by alphabroder be successful? I think so but no one can ever be sure. There are variables that can’t be controlled like how the people in the two companies interact with each other and work together. One thing that alphabroder has going for it is experience. Both alphabroder and Prime Line have each made acquisitions in the past. Both companies are knowledgeable about the risks they’re taking when they do a transaction like this. That’s no guarantee of anything but they’re less likely to be surprised by the problems they encounter than companies who’ve never done it before.

You might not care that the company that made the corporate logo item you’re using was involved in an acquisition. But mergers and acquisitions can happen in any industry.  When they do, the value of the businesses to owners and shareholders can change dramatically in a short time. As buyers use transactions to enhance their growth, a mature business can become a growth company in a day.

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