Flawless Financials the Financial Forecasting Online Newsletter from Minotaur Financial and David Brode July, 2005 Sent monthly to over 500 subscribers. Please pass on Flawless Financials to those in your network. To leave Flawless Financials, follow instructions at bottom. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * This month: Rollup Models * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * A company that grows by acquiring a series of competitors is sometimes called a “Rollup” because it is rolling up smaller companies into one large(r) entity. Rollups make money for investors in two ways: (1) as my father would say, “buy low, sell high,” i.e., by buying all the components at 6x EBITDA and selling the larger company at 10x EBITDA to a still larger acquirer; or (2) by achieving economies of scale in operating synergies, i.e., combining similar back- office functions to improve the EBITDA over what it would have been if the companies had remained independent. Rollup forecasting models offer challenges beyond the typical set of projections. First, Rollups are discontinuous. A normal business grows organically; even if it evolves quickly, it’s growing at some percentage rate each quarter or year. Not so with Rollups: one day you’re a $10 million company and the next you’re a $15 million company. But the next quarter you don’t make any acquisitions, so you only grow at a 4% rate. So being able to keep track of the scale of the business in the forecasts is the first issue. The second issue relates to the transactions themselves. Since the Rollup is acquiring companies, it has to find some way to reflect those acquisitions on the balance sheet. While I’ve always muddled my way through solutions to this problem before, just last week I hit upon a new structure to represent the financing side to repeated acquisitions—more on that later. Modeling Discontinuous Growth: Few Targets The first solution most people come up with is to have a small model for each acquisition that begins when the company is acquired. Just have a summary section where you can add up all the pages and you’ve got a Rollup model. Not so. The problems you quickly run into here are a) keeping the different pages synchronized, and b) trying to add or remove an acquisition. This second problem is commonplace and non-trivial. For instance, say you’re looking at five acquisitions and have them all baked into the model. Then, during due diligence, you find a potential deal-breaker and you want to revise the model to take it out for one scenario, but leave it in for the main scenario. Also, what if you identify a sixth target company? It’s a major pain to revise all the formulas to add one more sheet’s results. The solution I’ve found for this involves a control page where you can turn the individual acquisitions on or off in different scenarios and easily switch between scenarios. The method behind this involves some heavy Excel functionality (passing an array of data in each cell of a data table), but the results are spectacular. An example of how this works can be found on my website at http://www.brode.net/resources/RollupExample1.xls. Modeling Discontinuous Growth: Many Targets If you’re planning more than a handful of acquisitions, the method above becomes too cumbersome. For this case I’ve created the “standard acquisition” showing the revenues, expenses, capex, etc. of an acquisition for the first five years and then indicate how many acquisitions we’ll be making each quarter. Then, through a bit of math magic we calculate the combined results of the acquisitions for any future period. The beauty of this method is that you can quickly see the results of the various ramps as you change the acquisitions over time. An example of this method is on the website at http://www.brode.net/resources/RollupExample2.xls. Paying For It All At the moment of acquisition, there are many potential balance sheet impacts. First, there’s a purchase price, and the balance sheet needs to reflect assets that add up to purchase price, either in working capital, PP&E, or otherwise in goodwill. And then the company has to pay the sellers. The model I designed last week permitted five forms of payment: excess cash, if any; and then debt owed to the seller (i.e. a seller’s note); external debt raised; shares in the company issued to the seller (i.e. paying for the acquisition with paper); and shares sold to outside investors to raise cash given to the sellers. The innovative part of this was that this model integrated the cap table so that I could change the share price over time, reflecting increasing value in the company, and see exactly how dilution occurs during the various fund raises and show the IRR for any class holder or for an investor who participates in each round. And, of course, changing how the financing worked had a large impact on returns to investors, highlighting areas where management could focus in cutting deals and funding acquisitions. This is cool technology, and I’m glad to demo it via a PC-Anywhere style session, if you’re interested. Best wishes for a fun and fulfilling summer! Until next time, David Brode -- Minotaur Financial Removing Financial Issues as a Deal Roadblock * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * NEWSLETTER ARCHIVE AVAILABLE Make sure to visit the Minotaur Financial website for the Newsletter Archive at http://www.brode.net/resources/ * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * http://www.brode.net mailto:David@Brode.net 1919 14th Street, Suite 510 Boulder, CO 80302 (303) 444-3300 * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * ABOUT DAVID BRODE I’m a financial modeling specialist. Over the last fifteen years I’ve completed dozens of models and certainly thousands of versions to support corporate development, M&A, strategic planning, and debt and equity transactions. These models have raised over $1B in debt and $100M in venture capital and private equity. Over time I’ve consistently revised software tools and work processes to get the job done quickly and well. If you have a financial forecasting issue, I’d love to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * (c) 2004 Minotaur Financial, All rights reserved. You are free to use material from the Flawless Financials newsletter in whole or in part, as long as you include complete attribution, including a live web site link. Please also notify me where the material will appear. The attribution should read: "By David Brode of Minotaur Financial. More articles on financial forecasting can be found at http://www.brode.net " * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * Are you struggling to convince others to do a deal which you think is a no-brainer? To discuss how you can take numbers off the table as a deal roadblock, call (303) 444-3300. I'm very accessible and glad to help. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * DO YOU LIKE THIS NEWSLETTER? You are welcome to share this email with colleagues who would benefit from better numbers. Your feedback is always welcome and appreciated. Write in to mailto:feedback@brode.net. * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * PRIVACY POLICY: I never rent, trade, or sell my email list to anyone for any reason whatsoever. You'll never get an unsolicited email from a stranger as a result of joining this list. To SUBSCRIBE FREE to this newsletter, send an email to mailto:subscribe@brode.net. And you'll get Minotaur's Financial Forecasting White Paper in the deal. To be REMOVED from this list, send an email to mailto:remove@brode.net. (Please note that this message needs to come from the email address that originally subscribed. If you need help determining this, please email mailto:David@Brode.net.)