Don’t Lose Your Shirt on an Acquisition

The best way to profit from U.S. deals is to buy American companies. But it can be a disaster if you don't consider these 4 key issues

John Lorinc

Despite a fondness for cheap, made-in-Asia, goods, Americans still like to buy American-made goods. Ivan Rebello, vice-president of Zenan Glass, a $19-million-a-year firm that makes customized beer and spirits glasses, bottles and other sorts of specialized stemware, came to this realization about four years ago; his epiphany was to become the driving force behind the company's expansion strategy into the U.S.

At the same time, Zenan Glass was filling smaller orders for U.S. customers, but the shipping and customs costs were proving to be onerous. Their margins were so narrow that Zenan (ranked No. 260 on the PROFIT 500) walked away from an order from a huge customer—Diageo, one of the world's largest liquor companies, according to Rebello. The company wanted Zenan to supply glassware to 20 locations across the U.S. But when Rebello and his colleagues ran the numbers, they realized they'd lose money on the order. "We couldn't fulfill this profitably."

It was a head-slapping moment.

The acquisitions
Throughout 2011 and 2012, Zenan worked their way out of this problem by purchasing a pair of financially strapped glass and dinnerware factories in the U.S., one in Rochester, New York, and the other, in Ohio, outside Pittsburgh. Together, the acquisitions cost almost $2 million.

Rebello said Zenan's bankers told him not to make the investment. He didn't listen, saying, "Entrepreneurs like myself get a kick out of taking risks."

Since completing the acquisitions, Rebello has spent hundreds of hours traveling between Zenan's Toronto headquarters and the two factories as he pushed ahead with restructuring the facilities so they could begin to deliver on the promise of improved access to large U.S. customers.

Rebello soon found himself focusing on several key issues that arose in the wake of the acquisitions:

• Do due diligence on the due diligence. "We almost lost our shirts" with the first acquisition in Rochester, says Rebello. Before the deal closed, Zenan relied on a local lawyer to supply financial information about the target firm. But once Rebello's team took possession, they discovered that the information they'd been given included a lot of falsified payables and receivables, and double-bookkeeping. Zenan paid $250,000 for the plant, yet ended up spending $1.2 million to sort out the problems. It's taken almost two years, Rebello says, to stem the losses.

• Demographics and the workforce. At the Ohio facility, most of the employees were nearing retirement. Zenan embarked on an aggressive recruiting process to bring in younger workers who would be able to use new technologies and deliver increased productivity. Today, about half the employees are new hires.

• Hire trustworthy managers who understand your vision. When Zenan completed the purchase of the Rochester factory, the company decided to keep the former owner on as the operations manager. After a year, Rebello says, it became clear that this manager was "a major problem." The former owner was replaced with his second-in-command. The new manager had a military background, which pleased Rebello, a former lieutenant in the Indian navy. "He had the necessary discipline with the operation. Knowing my background and this man's background, I would give him instructions and they would be followed to the letter."

• Invest in the right technology. Zenan picked facilities that had ovens capable of reaching the temperatures needed to make glass and dinnerware. However, much of the rest of the equipment in the plants was outdated, so Zenan replaced the aging machines with modern ones identical to the ones used in the company's Toronto facility.

These days, Zenan's revenues include almost $4 million in sales in the U.S. Heading into fiscal 2014, Rebello feels confident that he's worked out the kinks that came with Zenan's new U.S. holdings. Thanks to the technology and management changes, Zenan managed to win back some of the previous customers of the two U.S. plants, and is now better positioned to bid on large deals that have to be shipped to American destinations.

"This year we'll show profit on the two factories," he says. "Next year, I'm looking at substantial growth."

Numbers Don't Lie; Interpretations Might

By: Gary Patterson

"A full 17% of respondents admitted that their CEO's had pressured them to misrepresent results at least once" per a 2002 Electronic Business article. How comfortable are you with the financial results used to manage your business?

 

This article will cover five major areas you might look at or have someone look for you to increase your ability to better know where you really are financially, to be able to sleep better at night. The more of these areas that may be a concern at your company, the more urgent a corporate physical may be.
1. Most companies do not accurately know their top ten customers.
2. Many companies have capitalized some item in the past, whose realizable value will become questionable.
3. Most companies do not know how they will be affected by profitability changes at their top ten customers.
4. Many companies have an asset that strategically they would be better off selling at a loss to pursue some new opportunity.
5. Many companies have painted an overly optimistic picture to a customer, vendor or financing source. 



Top ten customer profitability "I am starting to visit our top ten customers. If you find out who they are, please let me know." said the CEO. I have been asked different versions of that question by more than one corporate leader. A little talked about secret is that most companies do not accurately know their top ten customers. If you are willing to define that as the largest customers by revenue, maybe you know this top ten list. If you want to accurately know the ten most profitable customers, good luck. Changes in business, product changes and system incompatibilities often make this difficult to do without getting the right eight people in a room for a day. 

A past capitalized item will be questioned.Cisco wrote off two billion dollars of inventory several years ago. Many companies have capitalized some item in the past that will be questioned. Goodwill will be reviewed annually. All of us have read the horror stories of write-offs that in hindsight raise questions that often were not valid or even a factor when those assets originated. 

One of my favorites was a company that accidentally set up a sophisticated process that accidentally capitalized part of the write off to that asset in the current year additions to the capitalized asset. If you have reserves, allowances or estimates for loss, why not take a critical look at them at least once a year for downside risk. In more conservative days, the CFO would cover things like this when a year came in better than expected. 

Profitability change at the top ten customers.Those fortunate companies that accurately know the profitability of their top ten customers normally fail to cross the next hurdle of knowing with conviction how the fortunate company's top customers will be affected by profitability changes to those customers. There is a timeframe when top ten customers drop off the A list.
 
Having discussed how this affects the best performing companies, guess what that means for the companies who do not accurately know profitability of their top ten customers.

 
One very interesting exercise I helped on was to estimate the benefit our customer received from our service to see which customers were benefiting or losing money on being our customer. That produced some very interesting and unfortunately accurate estimates of customer retention.

Sell that asset and re deploy the money Has your financial department ever told you that the company has to keep losing money on branch or product because we can not admit to the financial loss the company would have to take if it disposed of the asset? I suggest a lesser version of this situation is failure to look at return on equity related to assets or departments. Many companies have one or more assets they would be better off selling at a loss and re investing in another opportunity. This can be particularly true when the executive bonuses are mainly a function of the dollar level of profitability, with limited influence on return on equity or similar measurements. For those of you who say their company has a mechanism that investment proposals meet threshold rates, how often does someone report back convincingly with what return the investment actually received? 


Painting an overly optimistic picture to outsiders Last but not least. How many companies have painted an overly optimistic picture to a customer, vendor, or financing source? If "forty four percent of Americans lie about their work history" per ADP Screening and Selection Services, might they stretch the truth a little while representing your company. The effects of this are really hard to quantify. When does puffery become misrepresentation? 

I have told CEO's and groups that Murphy's Law suggests your not knowing your company's real equity and risk areas will be a problem at the worst opportune time. Just take a look at all the items someone like me will ask for using a due diligence checklist, and follow up to see how well your company's rough spots would stay hidden. If you do not have such a list, contact me for an example of a standard list. What will you do next week to understand the soft areas and risk factors that all companies have to some degree? 

Author Bio
Gary Patterson is the author of "Numbers Don't Lie; Interpretations Might." He has helped numerous high growth companies enhance growth and profitability. Visit his site to see how you can get a free consultation www.FiscalDoctor.com or mail to Gary@FiscalDoctor.com