Strong growth options beckon savvy entrepreneurs and middle-market companies, and broadcast radio is poised for action.

The intense bear market has caused many firms-investment banks, law firms and strategy advisory firms alike-to downsize or reallocate their merger and acquisition advisory teams. Bull market blues, low interest rates, and under performing assets in the current economic environment, including the financial plight of larger national companies, makes the landscape ripe for savvy entrepreneurs, middle market companies and M&A advisors to middle market firms in search of strong growth options.

A recent article appearing in The Deal.com raised a biting question: Is the M&A banker going extinct? The current market environment would certainly lead any market watcher to ponder the question. The intense bear market has caused many firms-investment banks, law firms and strategy advisory firms alike-to downsize or reallocate their merger and acquisition advisory teams.

Such articles comport with other similar pieces appearing in both local and national business press. Recently, The Wall Street Journal reported that M&A groups have lost 50 percent of their team power over the last 18 months, and can expect to lose more in the months to come. Goldman Sachs has eliminated its mergers and acquisition team altogether.

For the larger bulge brackets firms such radical moves might be appropriate. Clients represented by firms such as Goldman, JP Morgan and Morgan Stanley tend to be larger publicly traded companies that frequently look to their stock as currency in merger and acquisition transactions. With the equity markets in the doldrums, and corporate profits at depressing levels among the Fortune 500, the M&A advisor serving this group might find free time these days.

The current economic environment, including the financial plight of larger national companies makes the landscape ripe for savvy entrepreneurs, middle market companies and M&A advisors to middle market firms in search of strong growth options. Why?

--Bull-market blues: A significant number of larger national public companies pursued a tremendous number of acquisitions through the 90s that are proving to be ill-conceived purchases. Many of these companies are now feeling the pain of poor strategies, not to mention the overwhelming prices at which the acquired companies were gained, further depressing profitability in an already down-market. Middle market companies and investor groups can actually help these firms by making offers that are significantly cash-based, while also helping their own growth strategies.

--Low-interest rates: The current funding environment is tremendous. For well-conceived M&A growth options that look to strong cash-flow based businesses and market sectors, the current funding situation could not be better. The prime rate is currently less than four percent.

--Underperforming assets: In tough economic times, companies take a hard look at underperforming assets. Even though a business unit or division might have been less than successful under its current owner does not necessarily mean it will be unsuccessful under another. With some focused attention and more synergistic skill-sets brought to the table, someone elses underperforming asset can be another companys star.

The convergence of these three factors create a narrow window of opportunity that might last only for the next eight months or so as the economy is likely to begin breathing at that point and national corporate chieftains are likely to feel less distressed. Any serious growth-oriented middle market company or investor group has to give strong consideration to exploiting the window. Broadcast radio and television, as well as other non-media related market segments and industries, including the confectionery industry (e.g., chocolates and candy) and makes the point.

Broadcast radio -- poised for action

Prior to The Telecommunications Act of 1996, a radio company was permitted to own a maximum number of eight radio stations in each market, and no more than five of each kind-AM or FM. Merger and acquisition activity took off with abandon following the `96 Act as well-positioned radio companies sought to strengthen their market stance. During this period the four largest US radio holding companies-Clear Channel, Infinity, Cumulus and Citadel-grew to represent 14 percent of the total radio assets in the country.

In 2001 alone, according to Securities and Exchange Commission documents, Clear Channel acquired 183 radio stations in 63 markets. In 2000 Clear Channel acquired AMFM, a radio broadcasting company holding approximately 450 radio stations, for a grand total of $19.4B.

Albeit on a different scale, other radio holding companies paid top dollar for stations during the period. Cox Radio, for example, acquired 6 radio stations in 2001 for $58M. In 1999 Cox acquired 13 radio stations for $222M.

In a number of cases, the debt ratio of these companies was not much affected. However, operating income-a key profitability measure-took a nose dive. Prior to its acquisition by Viacom in 2001, Infinity demonstrated negative growth between 1999 and 2000, according to its SEC disclosure statements. Operating margin
declined from 30 percent in 1999 to 21 percent in 2000 and then again to eight percent in the year of the Viacom purchase.    
                  
Of course, 2001 was a disaster for the radio industry because of the advertising slump. On the other hand, other radio holding companies also show the long-term slump in profitability alongside their acquisition binge. Clear Channels operating margin declined from 24 percent in 1997 to 18 percent in 1998 to nine percent in 1999 to six percent in 2000. In 2001 Clear Channels operating margin was negative eight percent.

The thinking behind some of these acquisitions, the synergies that they were thought to bring, the goodwill amortization expenses and the impact on profitability, is a story in and of itself. Perhaps the most interesting dimension, however, is the potential growth opportunities it creates in the current market environment for middle market companies and investor groups.

Back to basics

As companies consider M&A growth options in this environment, particularly in broadcast radio, remembering the basics is incredibly important:

Every acquisition should have a clear comparative advantage-with 13,000 radio stations in the country, investor groups should pursue strategies that reflect a market niche or a dimension that is not currently pursued by other radio companies. In radio, for example, few companies have given deep thought to avenues for exploiting converging technologies on the radio market, including cable and internet.

Market selection should be carefully considered and support the strategy being explored-radio is driven by advertising dollars. The strategy team should determine whether the target market can support the strategy. A market with three other sports/talk radio stations might not have sufficient dollars to support a fourth station. In this case, perhaps an effort to acquire one of the three existing radio stations is a better option.

A strong team is invaluable to the deal-a successful acquisition is accomplished by bringing several different and complementary skill-sets together. At least one member of the team should have experience in raising capital. Alternatively, an outside advisor that is an ad hoc member of the team will be key in guiding the capital raising dimensions of the deal.

Capital raising capacity-a couple of radio stations in Top Fifteen radio markets can require between $40M-$60M simply to acquire the assets, not counting the working capital needed to cover potential losses in the early years. Even in the current market, these funds can be raised (e.g., through private placements). However, the investor group will need to demonstrate a capacity to raise money early on through a seed" financing round for pre-acquisition related activity, including for the lawyers accountants and other external advisors. Seed money can come from the acquisition team directly or through their friends and family." In either case, for large scale acquisitions where the time-table cannot always be predicted and the acquisition may require up to a year to close, $500k-$700k in pre-acquisition financing is not unreasonable.

The value of M&A as a growth option is high in most situations. It can be especially valuable now for some companies and investor groups. Neither the M&A banker nor M&A activity is dead. It is alive and kicking and relevant for those that poised to seize the opportunities it can present.

About The Garrison Company

Derrelle M. Janey is a partner in The Garrison Company, a boutique strategy advisory firm headquartered in downtown Baltimore and with an office in San Francisco. The firm is currently advising on several M&A and private equity transactions based on the East Coast. Martin Flachsland is an Associate. The Garrison Company can be contacted at dj@thegarrisoncompany.com.

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