In association with

middle marketm&a OutlOOk

3

Foreword What is the state of play in middle market M&A? Partnering with Forbes Insights, we’ve just concluded

a survey, supported by an array of qualitative interviews. The result is a critical, and we believe,

illuminating look at today’s opportunities as well as attitudes, strategies, and practices.

Among competing avenues toward growth, why should a company pursue M&A? Perhaps a

publicly held technology company has a stock price that is higher than its peer group’s, which

becomes a strong currency for acquiring market share or other competitive advantages. Or

maybe a manufacturer sees M&A as a means of leveraging its core strengths, acquiring similar

businesses, then stripping out excess costs to achieve still stronger margins. Perhaps a health-

care provider or pharmaceutical maker sees acquisition as a means of obtaining more products or

assembling a broader footprint for distribution.

The underlying drivers are many. And in truth, no two deals — even within the same industry

— are ever identical. Nonetheless, the underlying best practices within any ongoing corporate devel-

opment program are becoming clearer. And those who approach the M&A arena from a strategically

sound and procedurally disciplined perspective are able to extract commensurately greater value from

their transactions.

So is your business making optimum use of its opportunities in M&A? Are you aware of the most

effective approaches in strategy formation, target identification, valuation, operational integration, as

well as continuous review and refinement?

As providers of financing to the M&A markets, we have a vested interest in helping you succeed.

Our capital employed in your transaction becomes our skin in your game. This places us in a unique

role as a dedicated partner with goals in close alignment to your own. It is from this standpoint that

we offer the following report, which we hope you will find useful as you approach your next — or

perhaps even your first — transaction.

Robert D. MatthewsRBS CitizensVice Chairman, Commercial Banking

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Table of Contents

Foreword 3

Table of Contents 4

Key Findings 5

Methodology 7

Introduction 8

Q&A: Sydney Finkelstein 9

Attitudes and practices 10

Leading indicators 12

Q&A: John Zimmer 13

Q&A: Barry Greene 14

To sell or not to sell 17

Q&A: Jeff Hawn 18

A look at best practice 19

Q&A: Larry McAfee 20

Q&A: Jeff Bailly 21

Q&A: Michael Shea 24

Q&A: Peter Cittadini 25

Conclusion: Not just any deal 26

5

• Key signals indicate that markets could be ripe for M&A. Two out of three middle market executives view

conditions today as a buyer’s market. Meanwhile, two-thirds of the survey respondents also said that balance

sheet cash was plentiful—with over a third indicating that they could acquire assets of $2 million or more

without incurring debt or injecting equity.

• But other signals are mixed. Deal volume is often driven by market participants’ view of future asset values.

Only about a third of executives said they believed prices would be higher one year hence. However, among the

most active acquirers in the survey sample, that expectation rose to one-half.

• For now, organic growth is the preferred path. More of today’s mid-size companies are focusing on

achieving growth through wholly internal means than by any of the corporate development approaches involving

mergers, acquisitions, partnerships, or other close collaboration with external counterparties.

• But companies are very much open to M&A. M&A is recognized as a source of potentially significant

growth. Half of all executives described themselves as active in M&A, with one out of eight describing

themselves as very active. It is these active executives who will likely seek to take advantage of today’s relatively

low current asset prices.

• There will be deals. One in three executives said they were likely or very likely to acquire one or more

significant assets over the course of the next year. Among the most active in the study, the figure rose to three

out of four executives.

• Most express a merely opportunistic approach. About one in four executives described their current

orientation toward transaction markets as proactive. Their companies are poring over balance sheets and income

statements, looking for viable external targets or even potential internal divestitures. And though a fifth of

respondents felt indifferent about transactions, the majority, well over half, said they were merely opportunistic:

though not actively seeking a transaction, these executives would be willing to act should a compelling

proposition arise.

Key Findings

6

• Synergy, though challenging to achieve, still drives valuations. Synergy, the idea that one plus one can

equal an amount greater than two, is often invoked within a deal premise. Synergies come in two basic forms:

cost and revenue. While both can be difficult to achieve, and both are often overestimated, it is the latter

category that sophisticated acquirers say should be treated with particular skepticism. In any case, two out of

three in the general sample, and four out of five among the most active executives, said that synergies were a

vital component of valuation.

• Executives perceive a range of integration challenges. One reason that executives tend to prefer organic

growth is that bringing an acquisition online—or for that matter, severing ties with divested assets—requires

considerable focus and resources. Survey participants noted that a number of areas are, at best, difficult to

integrate. The areas of greatest concern include IT, sales and marketing, product development, and

manufacturing. Nonetheless, over half maintained that they were fully confident in their integration approach—a

figure reaching three out of four for the most active in the survey.

• Deal practitioners are using a wide range of tools. In performing valuations, executives use multiple lenses.

Tools include everything from discounted cash flow models (DCF) to comparisons of comparable transactions,

public company valuations, payback periods, and even real option and multi-variable simulations.

• Consultants matter. Faced with the challenges of assessing opportunities, performing valuation, or financing a

deal, executives recognized the need for a mix of both in-house and external resources. For the most active,

valuation, financing, and due diligence are the areas where specialists are most often tapped. However, those

interviewed for the report said external legal expertise was absolutely essential.

• We’re not for sale. Three out of five executives bluntly stated: their companies were not for sale. This is not to

say they have no discrete assets to part with, just that an outright sale is not in the cards. Still, the remaining two

out of five said they were willing to entertain the idea of being acquired. Only a tiny fraction of survey

participants described themselves as anxious. And a note to any would-be sellers: the vast majority of executives

viewed carve-out financial statements as at least somewhat or very important. Or put another way, the

preparation of reliable carve-out statements can help to ensure a quicker transaction.

7

Methodology

The insights and commentary found in this report are derived from both a survey instrument and personal interviews:

the survey, conducted by Forbes Insights in September 2011, was completed by 432 senior executives. Key demographics include:

Executive title: SVP/VP/Director (54%), CFO (15%), Owner (11%), CEO (8%)

Company size: $100 million -$500 million (25%), $25 million – $100 million (30%), $5 million –$25 million (45%)

The survey features a wide spectrum of industries with no notable concentrations beyond manufacturing (18%), professional services (10%), and

financial services (7%). Eighty-three percent of respondents hail from privately owned companies, versus 17% publicly owned. Respondents are also evenly

distributed throughout the U.S.: South (30%), Northeast (26%), Midwest (22%) and West (22%).

Interviews were conducted with 11 senior executives, eight of whom were willing to speak on an attributed basis, including:

•BarryGreene,PresidentandCOO,AlnylamPharmaceutical

•JeffBailly,President,UFPTechnologies(UFPT)

•PeterCittadini,CEO,Actuate

•SydneyFinkelstein,StevenRothProfessorofManagementattheTuckSchoolatDartmouth

•JeffHawn,ChairmanandCEO,Attachmate

•LarryMcAfee,CFO,U.S.PhysicalTherapy(USPH)

•MichaelShea,EVP/CFO,Mac-Gray

•JohnZimmer,CFO,Transcat,Inc.

Forbes Insights extends its gratitude to these named executives.

8

Organic growth—investment in internal staff, processes, or R&D—is the “traditionally preferred path” says Sydney Finkelstein, Steven Roth Professor of Management at the Tuck School at Dartmouth College. “Managers like organic growth because the territory is more familiar, with fewer unknowns.”

By comparison, says Finkelstein, “M&A can be a much more challenging path—and very often fails to deliver on its promise.” Nonetheless, given the right circumstances, mergers and acquisitions can be an invaluable tool for fuel-ing corporate growth. Consider examples among:

SpecIalty ManufacturIng Industries featuring multiple players battling for lim-ited customers on a local or regional basis are often strong candidates for M&A-driven consolidation. As Jeff Bailly, president of Georgetown, Massachusetts–based UFP Technologies (UFPT), explains, “We look first to organic growth—that’s where we have the most control of our own destiny.” Still, M&A figures prominently in the compa-ny’s growth strategy. “We find that if you go about this the right way, with a clear strategy, with a good understanding of the processes and patience, you can create tremendous value from acquisitions.”

dIStrIbutIon M&A can help companies broaden their reach and attain critical mass in terms of efficiency. According to John Zimmer, CFO of Rochester, New York–based Transcat, a leading distributor of hand-held calibration, measur-ing, and testing devices, his company has completed four

Introduction

transactions in the past year. Each deal, Zimmer contin-ues, is helping to “expand our services footprint and achieve economies of scale.”

healthcare provISIon Larry McAfee, CFO of Houston-based U.S. Physical Therapy (USPH), views M&A as a means of “leveraging our business model.” To date, organic growth accounts for about three-quarters of the company’s presence—with the remaining quarter achieved through acquisition. But going forward, says McAfee, “we’re looking to M&A for about half of our future growth.”

M&A can be a highly effective means of generating growth. But not every business organization is equally willing to consider M&A. Indeed, middle market deals are getting done. But broader market trends do not drive any individ-ual deal’s prospects for success. As Finkelstein notes, “When the economy is churning, you generally see a lot more deals.” But in fact, the best time to execute a transaction is often when deal volumes are at a relative trickle. “As a buyer, you don’t want a lot of bidders and higher asset prices,” says Finkelstein. “So executing an acquisition in a [down cycle] can present an advantage.”

More important than overall market volume or direc-tion is the appropriateness of any specific transaction. Each deal is unique, and each must be based on its own merit. No matter the broader market conditions, it is those transactions that are based on a sound strategic premise, priced appropri-ately, financed efficiently, and then competently integrated that feature the best chances for creating value.

There is no telling what the future holds. Nonetheless, conditions are right for a surge in middle

market M&A. In a September 2011 Forbes Insights survey, in association with RBS Citizens,

most mid-size companies said they had ample cash, while two-thirds viewed today’s con-

ditions as a “buyer’s market.” To this, add the fact that asset prices are at or near historical lows.

Accordingly, one-half of middle market executives now describe themselves as active or very

active in M&A.

9

Steven roth profeSSor of ManageMent at the tuck School at dartMouth

“Learn; improve.”

SyDNey FINkeLSTeIN, THe AuTHOr OF 15 bOOkS INCLuD-INg A NuMber ONe beST-SeLLer (WHy SMArT exeCuTIveS FAIL), IS A FrequeNTLy CONSuLTeD reSOurCe ON AvOID-INg MISTAkeS AND IMprOvINg THe perFOrMANCe OF M&A prOgrAMS.

What are the best ways to identify good candidates for acquisition?

I think a mistake companies make is leaving this 100% to the president or CEO. The people running operating divi-sions, the ones closest to customers and competitors—it’s those people who often have the best insights. But at the same time, you cannot leave this entirely in the hands of the operating managers because they’ll just come up with a list of companies they want to buy. So you need adult supervision, and that leads, ideally, to where you have par-ticipation and synergy between the people at the top and on the front lines.

What capabilities are needed in-house?

The most successful acquirers spend time and energy to develop this into a capability. But you will still need out-side assistance, to what extent driven by how important M&A is to your core strategy. If you are doing one or two or three small deals a year, you may need to outsource a significant amount of capability. But if your plan is to turn M&A into a competence, if you’re going to do a number of significant transactions, then it may be worth investing in some expertise. Surprisingly, the easiest thing to outsource is valu-ation. That’s the area where your own finance people probably have some insight, but at the same time it’s the most mechanical of the processes. Where you tend to need

to develop your internal resources is in areas such as deter-mining strategic fit or managing the challenges relating to integration. What should be outsourced?

Relatively inexperienced acquirers might want to hire a con-sultant to help with developing the strategic piece. It starts with whether the target fits into your overall strategy. And the key question you should ask: will making this acquisi-tion enhance, expand, renew, or create a new competitive advantage? There’s no other reason to make an acquisition unless it does something to create value within your strategy.

Legal, meanwhile, is a given. This is not just writing a contract, but it is also knowing a slew of intricacies that it would be really unusual to already retain in-house, so legal fees become part of the price you have to pay. any other advice?

Once you’ve done a few transactions, I’d recommend that companies take a look at evaluating past performance and then capturing the knowledge gained to build capabilities going forward. You can make a lot of mistakes in a transac-tion, and you don’t want to repeat them. But you can also do a lot right, and you need to be able to repeat or improve upon those things. So if M&A is going to be part of your business strategy, you need to start a program of codifying practices and leveraging experiences

Q&A: Sydney Finkelstein

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Corporate development is the set of all strategic actions intended to shape the growth and sustainability of a busi-ness organization. In terms of the numbers of companies focusing on a range of corporate development tasks over the next year, the survey shows that M&A weighs in at num-ber three, behind organic growth and cost-cutting. In other words, more companies today are focusing on achieving growth through wholly internal means than by any of the corporate development approaches involving close collabo-ration with or acquisition of external counterparties.

But even if these competing approaches to corporate growth are more often cited as a focus, this by no means diminishes the potential value of M&A. In fact, when it comes to the pursuit of transactions-based corporate development such as acquisition, merger, joint venture, or divestiture, precisely half of the businesses in the survey described themselves as being either active (37%) or very active (13%).

Another means of gauging attitudes toward M&A and related activities is determining whether executives lean more toward being proactive, opportunistic, or indiffer-ent. Here, nearly one in four executives in the survey (24%), described their approach to corporate development–focused transaction markets as proactive. That is, these executives agreed that their company proactively assesses its own port-folio in relationship to the external marketplace in search of opportunities to create value through acquisition, divesti-ture, joint venture, partnership, or alliance.

As for the rest of the sample, 57% of executives viewed their transactions strategy as opportunistic. That is, though the company may not routinely conduct rigorous valua-tions of both internal and external assets in a sort of ongoing

fIgure 1: Which initiatives will your company’s management be focusing on over the next year?

0% 50% 100%

Note: Executives could select multiple responses.

Organic growth

Mergers & acquisitions

Partnerships,JVs,alliances

Revamping business model

Obtaining financing

Other

Cost-cutting

60

53

29

25

24

22

7

Note that throughout the survey, there were no significant differences based on locationofrespondent.Inotherwords,M&Aactivityandattitudesareindependentof geography.

fIgure 2: How actively do you pursue M&A, JV, divestiture or similar corporate development actions?

16% 13%

• Very actively • Actively • Not actively• Not at all 37%

35%

Attitudes and practices

11

arbitrage, it is willing to act when an attractive deal presents itself. Finally, one in five executives, 19%, described their companies as indifferent to transaction markets.

Thus a significant number of executives are taking a pro-active approach to M&A in today’s market. Indeed, says healthcare provider USPH’s McAfee, “we’re looking to add locations—and from here, that will be driven about one-half organically, and the other will come from acquisitions.”

For the remainder of this report, this group will be referred to as “most active.”

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Leading indicators Though the drivers behind any individual deal may be unique, there are certain indicators that tend to improve deal conditions and drive deal volumes. Here, the survey tested a range of circumstances and sentiments that tend to have a critical impact on the deal environment overall.

how much cash? Reports that companies today are flush with cash—often referred to as “dry powder” in M&A cir-cles—are confirmed by the results of this survey. More than two-thirds of respondents say they have significant cash on their balance sheets. The figures are even higher among publicly traded companies (89%) and the largest companies in our survey, those with annual revenues of $100 million to $500 million (79%). So much dry powder in the form of strong cash reserves translates into ample buying power. The mere existence of liquidity, says Finkelstein, can drive corporations to pur-sue deals simply “because they have cash burning a hole in their pockets.” So executives, says Finkelstein, “should be careful” not to get so excited about a transaction that they exaggerate its pluses and understate its risks. Over a third of companies, the survey demonstrates, have enough cash and/or equity on hand to execute a pur-chase of $2 million or more with no debt financing. And to show that size is not the sole driving factor behind acqui-sition capacity, the figure rises to 42% among the smaller companies within this study, those with annual sales of $25 million to $100 million. Still, debt continues to play a role in the lion’s share of transactions. Executives were asked the likely composition of their bids should they enter the market for a significant transaction today: the deal structure, on average, would consist of 45% cash, 37% equity, and 33% debt. Among the most active companies, expected cash levels climbed to 54% (versus 32% equity and 29% debt).

Is it a buyer’s or seller’s market? Two-thirds (66%) of sur-vey participants viewed today’s general M&A climate as a buyer’s market. A mere 8% described today’s conditions as a seller’s market, while 26% don’t know or have no opin-ion. Over the next year, the numbers expecting a buyer’s

fIgure 3: Do you have significant cash on your balance sheet?

Yes

No

69

89

89

31

11

11

• Total Responses • Most Active • Publicly traded

0% 50% 100%

market to persist dropped to 53%, with virtually all of the decrease shifting to those who don’t know or who are uncertain, which rose to 37%. The belief that conditions a year from now will signal a seller’s market remained virtu-ally unchanged at 9%.

Active corporate development participants were both ever so slightly more willing to describe today’s conditions as a buyer’s market (70%) and significantly more likely to call this a seller’s market (20%). Looking ahead a year, exec-utives at these active companies were still more likely to describe conditions as more favorable to a buyer (63% ver-sus 53% for the general sample) than a seller (17% versus 9%).

What’s the bid/ask spread? One of the key determinants of deal volume is the degree to which buyer and seller expec-tations are in alignment. The closer the bid/ask spread for businesses, the easier it becomes for one party or another to close the gap. As Bailly of UFPT explains, “Owners often have a lot of sweat equity and pride in their businesses,” which can result in an inflated perception of their value.. Even so, there are many cases in which the value of the combined assets creates a compelling business case. In such instances, a buyer like UFPT “will sometimes be willing to ‘overpay’ relative to comparable assets in the marketplace,” says Bailly. But in general, the wider the gap in expecta-tions, the lower the deal volume.

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cfo, tranScat, Inc.

“you get a lot of great people”

CLOSINg ON FOur ACquISITIONS IN THe pAST yeAr, THe LATeST IN SepTeMber 2011, JOHN ZIMMer AND HIS TrANS-ACTIONS TeAM Are ACquIrINg experIeNCe FAST.

What drives a typical acquisition for transcat?

Primarily, we provide calibration, testing, and measure-ment equipment. To maintain quality, manufacturers or other businesses often need to achieve certain specifica-tions in pressure, temperature, electrical flow, dimension, or other attributes. We offer instruments, technicians, and labs that can measure how well they are meeting those standards by calibrating and/or repairing their measure-ment equipment. Today this market is fragmented—a lot of indepen-dently owned calibration labs. And once these get to a certain size, it takes a lot of capital to make it to the next level: expensive equipment, a sales team, and support staff. So consolidation is a big driver. Another driver, our industry features a lot of owners who came out of the military in the 1970’s and 80’s, grew their businesses, and now they want to scale back—they’re looking for an exit strategy.

What is your track record in integration?

It’s too early to tell regarding our most recent acquisition—September 8—but we’re generally very pleased, and we’re confident going forward. There are a lot of things that have an impact. But we believe one of the most critical criteria is that you have an owner who is willing to stay with us long enough to complete the integration.

how do you gain a former owner’s willing participation?

One way is to offer an earnout, or an arrangement where the (former) owner can increase the amount of the purchase price by providing us with additional revenue. They may have a customer conducting $50,000 in business today but whose spending would likely rise to $100,000 if the location could provide a broader array of labs and other services. If the owner can be instrumental in making that happen, we would increase his compensation. And this is one of the hidden benefits of an acquisition. If done correctly, if you treat everyone fairly, what you end up with is a lot of very good people. You expand your human resource pool and your technical capabilities into a much wider range of services.

do you have any advice for others?

Make sure you have a very clear set of criteria. Know what you’re looking for and stick to it. If the transaction doesn’t have most of what you need, it’s probably best to move on. We have, in fact, gotten down the road pretty far on a number of transactions and then turned back. For exam-ple, we’re a high-quality shop, and maybe our due diligence determined that in too many instances, the [target] had cut too many corners—and fixing things would be too expen-sive. Or other instances, it could be that we find the seller is not interested in a “win-win” deal, but is only in it for him-self. We want a fair deal for all concerned. But sometimes, you get into a discussion and all this person wants is a one-way negotiation. If that’s the way you’re going to start out, if there’s no give and take, it’s only going to get worse. And a last piece of advice: do your homework in due diligence. Our processes and our checklist are by no means a finished product—they’re being constantly refined as we gain more experience. But this is an area where you cannot afford to cut corners.

Q&A: John Zimmer

14

preSIdent and coo, alnylaM pharMaceutIcalS

“There are alternatives to acquisition”

CAMbrIDge, MASSACHuSeTTS-bASeD ALNyLAM pHArMA-CeuTICALS FOCuSeS ON breAkTHrOugH THerApIeS THAT ATTACk DISeASe-CAuSINg geNeS – eSSeNTIALLy STOppINg DISeASeS beFOre THey CAN STArT.

What’s your growth strategy?

Our goal is to build an innovative pharmaceutical company around our research and advances in RNA interference. So far, that’s organic growth, much of which is being achieved through strategic partnerships. Partnerships, we find, are vital to our growth. Our key strategy is to develop RNAi therapeutics.

Why do you favor partnership over acquisition?

We have a history of doing very valuable partnerships that have helped fund our business and enabled others to develop RNAi therapeutics. A good example is Takeda, one of Japan’s largest pharmaceutical companies. The Takeda deal is game-changing. They recognized we had a transformative modality. So in May 2008, we entered into an agreement where they will make drugs using our RNAi technology. They’ve essentially licensed our platform for oncology and metabolic disease.

What are the benefits?

Up front, we received a $150 million payment. As they develop therapeutic products, we receive royalties and milestone payments. We in turn will get access to up to four products they develop which we can market in the U.S. for 50% of the profit. So it’s a great deal all around.

Would you ever be open to M&a?

If there were a technology available that could further our aims, that would be something of interest. But for now, we’re moving ahead with a key product focus in the area of genetic orphan diseases, where our goal is to have five such programs in advanced clinical development by 2015. We’re doing this by focusing on programs that target defined dis-eases, have clear development paths, have clear attributes for obtaining approval and that show strong biomarkers—that is they show that they’re having the desired gene silencing effect—in Phase I trials. We currently have two programs from this effort in clinical trials, and we also have two other products in clinical trials from our partner-based programs. We’re open to opportunities, but the core business is where we are placing our focus.

Q&A: Barry Greene

15

A mere 16% of the overall sample said they believed buyer’s and seller’s pricing expectations are currently in broad align-ment. Worth noting, however, is that among the most active in the survey, the figure increased to 31%. Meanwhile, 38% of the general sample believed current pricing expectations between buyers and sellers were out of alignment, compared with just 33% of the most active segment.

Where are assets prices headed? Another driver of deal vol-ume is the extent to which market participants believe asset prices today are poised to increase—or decrease—tomor-row. Here, about a third of executives (37%) said asset prices would indeed increase over the next year. And again, this view, which would tend to stimulate transactions, rose to 50% among executives at the most active companies in the survey. Still, a significant minority, one in five executives (20%), predicted prices over the next year would decrease, while 44% said prices would remain stable—and in both instances these figures were broadly consistent across all major segments of the data.

are buyers feeling aggressive or cautious? Describing their associated attitudes toward M&A over the past year, 28% described themselves as active/aggressive compared with 72% who said passive/cautious. Note that there were signifi-cantly higher numbers of those in the aggressive category among the most active (83%), and among the largest com-panies, those reporting annual sales of $100 million to $500 million (45%).

For the coming year, prospects for M&A as measured by the survey increased only slightly. For the overall sample, the figure rose to 34%. It meanwhile climbed to 89% among the most active companies and 53% among the largest.

fIgure 4: Is it a buyer’s or seller’s market?

Seller’s market

Uncertain/don’t know

Buyer’smarket

Seller’s market

Uncertain/don’t know

Buyer’smarket

66

70

8

20

26

9

53

63

9

17

37

20

0% 50% 100%

today

In one year

• All • Most Active

What will your company do? In terms of specific transactions, about one-third of businesses in the survey (34%) described themselves as either likely (23%) or very likely (11%) to acquire one or more significant assets over the course of the next year. Note that among the most active in corporate development, the figure rose to 76%, comprising 46% who said a deal or deals was very likely.

16

Other forms of corporate development were also sig-nificantly more likely among the most active group in the survey. Eighteen percent of the general sample said that they were either likely (13%) or very likely (5%) to form a sig-nificant joint venture in the coming year. Meanwhile, more than twice as many in the most active group, 44%, described the chances as equally likely (22%) or very likely (22%). The same is true of potential mergers. Whereas fewer than one in ten of the general sample said such an event was either likely (6%) or very likely (2%), the figure rose to nearly one in four among those companies most active in corporate development (17% likely and 7% very likely). The most active group is also vastly more likely to enter into a significant new partnership over the next year. Twenty-three percent of the general sample said such an event was either likely (17%) or very likely (5%). But among the move active in the survey, the figure reached 61%, with 26% describing the possibility as very likely, and 35% likely.

1717

to Sell or not to Sell?

Amere3%ofexecutives surveyed said theywereanxious to

sell and actively seeking a buyer. Over a third, 39%, said they were

open to the idea and would be open to being acquired under the

right circumstances. The most common assertion, however, is that

the company is not for sale. Nearly three in five, 59%, said they

had no interest in or willingness to be acquired. (The figures were

broadly consistent for all key sub-samples.)

This “not for sale” orientation does not mean these companies

would be opposed to the sale of discrete assets—merely that they

arenotlookingtobeacquiredoutright.AsMichaelShea,EVP/CFO

oflaundryequipmentandmanagement-focusedMac-Grayexplains,

“if something you own would be more valuable in the hands of

someoneelse,that’sanopportunityforbothcompanies.”Hiscom-

pany divested a non-core asset, MicroFridge, in 2010. (See sidebar,

page 24.)

In an important note to any would-be sellers of discrete assets:

the vast majority of executives view carve-out financial statements

as at least somewhat or very important. Or put another way, the

preparation of reliable carve-out statements can help to ensure a

quicker transaction.

fIgure 6: How important is the development of carve-out financial statements within any divestiture?

Very important

Somewhat important

36

51

44

43

0% 50% 100%

• All • Most Active

Not at all important

13

13

fIgure 5: Attitudes toward being the target of an acquisition

Anxious

Open

Not for sale

3

39

59

0% 50% 100%

18

chaIrMan and ceo, attachMate

“Deals can be transformational”

IN 2010, A $400 MILLION eNTerprISe SOFTWAre prOvIDer, THe ATTACHMATe grOup, ACquIreD NeTWOrk- FOCuSeD NOveLL IN A TrANSACTION THAT prOpeLLeD reveNueS TO $1.2 bILLION.

What motivates — what enables — a $400 million company like the attachmate group to acquire a larger business like novell?

One of the most important things to realize is that it takes one set of skills to be able to put together a good deal. But it’s quite another thing to be a good operator. What we are at The Attachmate Group is a group of people who know how to make good strategic choices and then follow through with a sound approach to operations.

So you’re a private equity firm?

Not really. What we are is an enterprise software firm in the hands of private investors. And so the story actually begins long before the Novell transaction. In 2004, after completing a number of transactions for BMC, I became loosely affiliated with a number of firms that were looking for good investment opportunities. So in 2004 we bought WRQ, a company that many would say was in an out-of-favor segment of enterprise software — what some would call the last decade’s news. But to us, this was a company that had great fundamentals: a solid base, good product and service, and great customers. That took us to $80 million. Then in May 2005 we acquired Attachmate, essentially merging the number two and number three players in a mature segment. And after playing it fast but fair as it relates to restructuring, we now had streamlined operations leading to even stronger fundamentals — now we’re at $200 million. So with our strong balance sheet and P&L, in 2006 we’re able to acquire NetIQ. They’re in a different segment of

IT, but by now we feel we have an acquisition capability and enterprise approach that would be a great fit [with NetIQ]. Through 2008 and 2009, like everyone else, we hunkered down, but continued doing the right things investment-wise and by our customers so that by 2010 we’re at $400 million.

So how does novell fit into your growth strategy?

With Novell, we’ve nearly tripled our revenues (to $1.2 bil-lion), but more importantly, we’ve taken on a business that, when combined with our ability to manage operations, is going to be a very strong competitor. And we’ve already taken steps to improve the business focus. For example, Novell had acquired an Identity Management business, but that was actually a much better fit within our NetIQ busi-ness. Novell also acquired SUSE in the Linux/open source area. And what we’ve done there is turn that into a stand-alone business unit to improve its focus, leaving Novell to focus on restoring the strength of GroupWise, NetWare, and ZENworks. So with The Attachmate Group as the parent and four business units underneath, we’re a company with strong fundamentals and leadership positions across a range of products and services. And from here, our strategy and our operations can now focus on meeting the needs of our installed base of 65,000 customers around the world.

any advice for today’s $10 million or $20 million companies just getting started in M&a?

Let’s start with congratulations. Hundreds of businesses never make it to $10 million, and even fewer get to $20 mil-lion or $50 million or $100 million. And from here, growth becomes even harder to achieve—it’s a steep curve. As for advice, first, don’t be afraid to walk away from a bad investment. If the timing isn’t right, if it’s not the right price, it’s not a good deal. But even more importantly, you have to go in eyes wide open about what it takes to drive success. Success comes from working for your customers and your employees. If you work for those two, by extension, you’ll do well by your investors. So any deal that you do, make sure you know how you’re going to run it and that it fits into your overall strategy.

Q&A: Jeff Hawn

19

M&A is a very challenging endeavor: the most successful acquirers invest the time and energy to develop and con-tinuously improve their capabilities. This survey took a closer look at two of the most critical challenges, valua-tion and integration. On the most fundamental level, both are relatively straightforward: valuation is the challenge of accurately pricing the assets; integration is the set of oper-ational challenges involved in realizing that value. But in practice, success in either undertaking tends to require con-siderable experience, as the surrounding processes demand immense focus and skill.

focuS: valuatIon Another driver of deal volume is the extent to which mar-ket participants believe asset prices today are poised to increase—or decrease—tomorrow. Here, about a third of executives (37%) said asset prices would indeed increase over the next year. And again, this view, which would tend to stimulate transactions, rose to 50% among executives at the most active companies in the survey. Still, a significant minority, one in five executives (20%), predicted prices over the next year would decrease, while 44% said prices would remain stable—and in both instances these figures were broadly consistent across all major segments of the data.

payback period A basic technique, a look at the amount of time needed to recover the capital invested in a transaction, it was the most frequently cited in the survey. Half of users said they looked at payback period either often (28%) or very often (22%).

discounted cash flow modeling More than a third of exec-utives, 39%, said they used net present value (NPV) or internal rate of return (IRR) analysis as part of their valu-ation. Twenty-six percent of the most active in the survey said they used such techniques very often, compared with only 14% of the main sample.

economic value-added (EVA) Forty percent of respondents said they used tools such as EVA within their decision-making, though only 12% said they did so very often.

comparable transactions Again, about a third of respondents, 36%, said they looked at comparable transactions when con-ducting a valuation. In this instance, the most active in the survey were more than twice as likely to say that they used such techniques very often (28% versus 11%). Slightly fewer executives examined the valuations of publicly traded com-panies within their decision-making frameworks.

options/simulations Twenty-four percent said their transac-tions benefited from real options analysis. Another 17% of executives said they used multi-variable simulations such as Monte Carlo analysis. While such techniques are undoubt-edly deployed, the question is one of how rigorously they are implemented, as both forms of analysis require consider-able expertise.

A look at best practice

• Not at all often • Not often • Sometimes • Often • Very often

16 14 31 25 14

19 11 34 25 11

23 15 34 22 8

20 10 30 28 12

15 7 28 28 22

35 20 28 13 8

27 16 33 18 6

72 9 13 3 3

62 8 24 3 4

fIgure 7: When evaluating an acquisition or divestiture, how often do you use the following tools?

Discounted cash flow

Comparable transactions analysis

Comparable public company valuation

Economic value added

Payback period

Scenario analysis (e.g., tornado or Monte Carlo)

Real options analysis

Other (please specify)

I don’t know

0% 50% 100%

20

cfo, u.S. phySIcal therapy (uSph)

“Skin in the game”

THOugH AppreCIATINg THe vALue OF OrgANIC grOWTH, LArry MCAFee, CFO OF uSpH, vIeWS M&A AS A MeANS OF ACCeLerATION.

What is your approach to growth?

We’re a national provider of pre- and post-surgery treat-ment of minor to major aches, strains, joint pains, and other injuries. As of now, we’re in 42 states with 300 clinics we developed on our own and 120 that we’ve acquired. From here, we’re using a mix of organic growth and acquisitions to build our presence. Over the past few years, each year, our growth has come from about 20 of our own and 20 we’ve acquired—and that’s the pace we’re trying to keep going forward.

What is your approach to M&a?

We look for owners/founders who want to continue to grow their business but who, perhaps, have outgrown their financial resources. Or maybe they didn’t have the right infrastructure, systems, or other support that can deliver the cash flow they need to grow their business. We have systems, we have capital, we have marketing—and we have that all in a business model that’s ready to go. So when we form a partnership, they can continue to grow, and we all benefit. The key thing is that we are not seeking 100% owner-ship. What works best for us is if we can form a partnership with local therapists in a given marketplace. So we’ll take a majority share, we’ll provide them with our resources so they can run their businesses more effectively, but we want them to keep some skin in the game.

how do you find your targets?

We approach that from a variety of sources. Mainly, we know the marketplace and know where to look for acqui-sitions. On the de novo start-up side, we have a number of full-time partner recruiters, people whose job it is to go out and identify good candidates. And we have a website that does a good job of presenting our business proposition. Where might I find my local u.S. physical therapy?

You can look, but you won’t find one under the name U.S. Physical Therapy. We always brand our clinics locally. Whether it’s our own clinic or one that we’ve acquired, it’s name it something that’s relevant to the town or the practice focus. We choose a name that conveys what we have to offer to the doctor and the patient. So what we’re leveraging is our business model, not a national brand.

Why do you continue to pursue M&a?

A typical startup, from scratch, it can take two to three years to reach profitability. But the way we build our partnerships, they’re typically profitable within the first year. So M&A, for us, is a growth accelerator.

Q&A: Larry McAfee

21

preSIdent, ufp technologIeS (ufpt)

“The patient pursuit of scale”

JeFF bAILLy, preSIDeNT OF uFpT, IS A veTerAN OF “eIgHT Or SO” ACquISITIONS. THe COMpANy He LeADS IS A DISCIpLINeD ACquIrer, ALWAyS IN purSuIT OF NeW OppOrTuNITIeS “buT Never IN A Hurry.”

What is your fundamental growth strategy?

Our basic philosophy is to focus on markets where our skills and the market needs are the best fit—targeting those segments where we add the most value and therefore can achieve the best margins. We also try to be materials neu-tral. That is, we aren’t trying to push any particular product, but rather, we want to provide what’s best for our custom-ers. So if our customers are asking about a new material, one we cannot readily provide, we’ll go out and talk with four or five fabricators with experience in the material. If the numbers can work, we would consider acquiring one or more of them. Through consolidation we can build economies of scale and can become a dominant player in a material we didn’t sell before.

What makes for a successful transaction?

First and foremost, you need a solid strategic fit. If you add this company or that capability, how is it going to contribute to your being a strong company? That needs to be clear. Second, and I believe this is often overlooked, you need to look at the cultural fit. In our industry we believe there are some good guys, honest and ethical, those who treat customers and employees well, and some bad guys too. We won’t entertain a transaction unless they have the right culture. Third, you need to pay really careful attention to inte- gration. The people, the equipment, the processes: they all have to be ready for business on day one.

What is your value proposition – or deal premise?

In our business, there tend to be advantages to building scale through more effective raw material purchase and increased factory efficiencies. A lot of small businesses are out there facing stiff competition and operating with only half the business they need to operate efficiently. So what we do is go out and talk to them about the advantages of joining forces. In the combined entity, they can spend more time focusing on what they like to do and what they are good at, and we can take care of the rest. We focus on sharing best practices. If you could walk through 10 or 12 competitor plants and learn their best prac-tices in production, selling, procurement, etc., you would find many ways to improve. Well, we’re already running 10 to 12 locations, many of them acquired, so we’re going to introduce you to a lot of best practices, plus we’ll likely adopt a few more good ideas from you. Then we are also very good at adding focus to a business. Within our due diligence, we take a snapshot of any busi-ness at that given moment. When you look at where they’re making and losing money, it’s typically a bell curve. At one end, the margins are strong. At the other, they’re not. So what it is about those good customers that is making you rich—we look for more of those. And for those at the other end, we ask, can we service that group at a lower cost? And if not, we may want to give up some customers.

What is your outlook over the next year?

We are always optimistic—and always working hard at this. Our deals come together over time—when the sellers are finally ready. We go in, we tell our story, and we let them know, if you’re not ready to sell, that is perfectly fine; we will begin discussions with the next company. We’re pro-active but also very disciplined and very patient.

Q&A: Jeff Bailly

22

Inputs, in turn, will tend to vary depending on the tool in question. Discounted cash flow (DCF) models such as NPV and IRR require rich transaction details—essentially a map of the acquisition’s relevant cash flows. Gathering reliable forecasts for such data—expected costs, market projections, selling prices—is a skill unto itself. At the same time, using DCF models, companies often face a challenge simply in determining an appropriate discount rate. Other tools, such as a Monte Carlo simulation or real options analysis, require users to postulate a range of values for key valuation com-ponents such as input and commodity prices, labor costs, selling prices, and even the potential actions of competitors. Synergies, drivers of value premised on the idea that one plus one may very often equal more than two, are yet another critical element within any valuation. Synergies come in two principal forms: cost/operating and revenue. Here, more than two out of three executives, 69% of the general survey, said that synergies were very important to the val-uation of any acquisition. The number rose to 82% of the largest companies in the survey and 80% of the most active. But in practice, says Finkelstein, “within transactions, synergy is very often another word for losing money.” On the one hand, inexperienced deal teams “have a tendency to overestimate potential revenue synergies,” says Finkelstein. On the other, the actual achievement of any given synergy

“can be very difficult to accomplish.” Cost synergies arise when the combined companies create redundancies in processes, functions, or divisions resulting in lower labor, technical, or related costs. Of the two forms of synergies, cost reductions “are probably the easiest to realize,” says Finkelstein. But even here, companies often underestimate the number of people needed to run the combined business units, or they overlook real costs such as severance, or recruitment costs when turnover accelerates. Revenue synergies arise from opportunities in areas such as bundling products, accessing new customers with exist-ing product lines, and related cross-selling initiatives. But if the achievement of cost synergies is relatively easy, the real-ization of revenue synergies is an entirely different matter.

“The track record in revenue synergies,” says Finkelstein, “is extremely poor, as too many buyers tend to drastically over-value what they can achieve.” Consequently, says Finkelstein,

“the most successful acquirers tend to ignore or discount rev-enue synergies—they hope to get them, but they don’t use them to price their offer.”

focuS: IntegratIon Experienced acquirers know that agreeing to terms and get-ting ready to close are only the beginning. Integration, that set of tasks related to bringing a new acquisition fully online and performing to full potential, represents the real chal-lenge within any acquisition.

The potential for errors, hiccoughs, and calamities is enormous. Consequently, skilled acquirers devote consider-able resources to integration planning long before any deal is inked. As UFPT’s Bailly explains, “You have to be ready to conduct business on the day you close.” Oversights here can lead to a host of problems ranging from customer defection and lost sales to outright business disruption. Avoiding mis-steps, says Bailly, “requires attention to every detail, from order to production, fulfillment, and billing.”

Executives participating in our survey acknowledged that, indeed, a number of areas are, at best, difficult to inte-grate. Leading the list is IT, at 58% for the general sample, 68% for the largest companies, and 65% for those most active in M&A. Other challenges include sales and marketing (cited by 34% of the general sample), product development (27%), and manufacturing (22%).

Just over half (55%), however, still maintained that they were fully confident in their processes for ensuring that any newly acquired businesses would be fully operational on the day any typical acquisition closed. Worth noting, this fig-ure rose to 78% among the most active in the survey. By inference, the most active acquirers recognize the need for greater focus on integration.

the uSe of outSIde reSourceS Another aspect of best practice is knowing when and how to use external resources. Experienced acquirers recognize that they cannot be expert in all areas relating to an acquisi-tion. Nor can they in many cases afford to employ the level of resources needed on a full-time basis. So when respond-ing to the above challenges, companies more often than not turn to a range of external resources for assistance with

23

corporate transactions.

Respondents were also asked about the relative impor-tance of a range of external providers within their M&A programs. Topping the list at 44% (the sum of most valuable and valuable) were commercial banks, followed by account-ing firms (42%), investment banks (31%), and boutique firms (14%). These figures were broadly consistent—even among the most active in the survey.

fIgure 8: For which of the following tasks are you likely to engage an external provider?

0% 50% 100%

Opportunity assessment

23

17

Valuation

47

56

Due diligence

44

43

Biddingstrategy

17

15

Integration

11

13

Financing

45

50

Overall corporate development strategy

12

7

Other (please specify)

1

4

Not applicable

18

11

• All • Most Active

24

evp/cfo, Mac-gray

“Don’t stray from core focus”

WALTHAM, MASSACHuSeTTS-bASeD MAC-grAy, A LAuN-Dry equIpMeNT AND MANAgeMeNT COMpANy WITH MOre THAN $300 MILLION IN SALeS, ONCe uSeD AN ACquISITION TO expLOre A COMpLeMeNTAry AveNue. THOugH THe DeAL WAS by MOST MeASureS SuCCeSSFuL, THe COMpANy’S evp/CFO MICHAeL SHeA SAyS, “We WILL NOT STrAy AgAIN.”

Why did a laundry equipment and management company acquire a refrigerator maker?

We bought MicroFridge in 1998 as part of a strategy to grow the business beyond our existing focus. We do a lot of our laundry management business with the academic marketplace. We noticed was that colleges were buying a lot of these small, dorm-sized refrigerators. We saw an opportunity to take advantage of our distribution, because in many of the schools, decisions about laundry manage-ment and dorm refrigerators were being made by the same person.

Why did you later divest Microfridge?

We did very well with MicroFridge. We ran that success-fully and in fact, over 12 years, found even more synergies, generated organic growth, and doubled the business. But eventually, the number of cross-selling opportunities ran out of gas. So it was still a great division, but it was out-side of our core focus. In truth, it was no longer projecting the sort of revenue growth in our hands that we like to see. We were approached by Danby Products, one of the larg-est appliance marketing companies in North America, who could do a lot more with the business than we could. So we agreed on price, sold them the company and that gave us more cash to invest back into our laundry facilities man-agement business.

In terms of M&a, where will you go from here?

Our strategy has for some time been a mix of both organic growth and acquisitions-based growth. In our industry, organic growth is typically slow and methodical. You can only implement price increases in small increments, and we’re already very efficient in that respect. And the sin-gle digit growth that generates isn’t an exciting story for a public company. Significant growth and a compelling story come from well-executed M&A, because we can buy assets, run them efficiently and grow our geographic footprint and portfolio. Acquisitions are a complement to organic growth.

any advice for others?

Stick to what you know. While you can succeed buying businesses that aren’t your core focus, we’ve learned that it’s a lot more difficult and it can take a disproportionate amount of management time.

Q&A: Michael Shea

25

ceo, actuate

“Acquire in the ‘sweet spot’”

SAN MATeO, CALIFOrNIA-bASeD ACTuATe, WITH ANNuAL SALeS OF Over $100 MILLION, IS ONe OF THe FIrST buSINeSS INTeLLIgeNCe SOFTWAre prOvIDerS TO be OpeNLy COM-MITTeD TO OpeN SOurCe DeveLOpMeNT.

What is the premise behind your most recent acquisitions?

We bought Performancesoft in 2006. They had this score-card application that we thought would be a tremendous complement for our existing clients. And as it turned out, it worked about as well as expected as a stand-alone prod-uct but then really well as a built-in to our newer offerings. The Xenos acquisition, in 2010, that’s been a home run. That acquisition gives us capabilities in managing unstructured data, which really complements our focus on structured data. So this combination is putting us in front of a lot of CIOs with a really powerful technical stack. The two businesses combined are more valuable than they were on their own.

Why do you pursue M&a?

For us, it’s a means to accelerate your product road map. You can grow through R&D, but often, it can go much faster when you do an acquisition.

Where do you look for opportunities?

Anything we would acquire has to be right in our sweet spot. It has to be something we can leverage in our go to mar-ket. That means it’s sold to the same people our sales people already know, so it can flow straight to our existing custom-ers and prospects. Also, any deal we do has to be accretive — or be danger-ously close. And by that I mean, we have a clear view how we can tweak the market opportunity or the cost structure

to get them cash flow positive in a hurry. We’re blessed with a rock solid base: we’re cash flow positive and profitable. So we don’t want to buy anything dilutive because we have public shareholders. any advice for others?

Don’t assume the cost synergies are going to come easily. Too many management teams get too close to their acqui-sition, and then they don’t take action as quickly as they should. They’re reluctant to cut staff or scale back on R&D. But if you’re going to be successful, you have to follow through and make the moves you need to right away.

Q&A: Peter Cittadini

26

Conclusion: Not just any dealOrganic growth is and likely always will remain the pre-ferred route to growth. And rightly so, given the many known risks—along with the many unknowns—generally recognized as part and parcel of major transactions.

Nonetheless, acquisitions-fueled growth can serve as a powerful adjunct. Transactions can help a business to more rapidly acquire market share, add product/service lines, or expand the regional footprint. In certain cases, M&A can be transformative, propelling a business from being one of many to becoming a market leader.

The most critical element of M&A is that a target must help a buyer improve its core business. Strategic fit is abso-lutely vital.

Given that a deal makes strategic sense, the key challenges within M&A are valuation and integration. Companies must take all needed steps to improve the chances that their valuations are accurate. This includes not only the use of the

right models, but also adequate levels of due diligence to determine the quality of the information used within such models.

As for integration, executives need to make realistic assessments of the challenges ahead and develop specific plans for getting a new business up and running as quickly as possible. And in the face of all such challenges, the most successful acquirers take steps to turn acquisitions into a repeatable and continually improving core competence.

Transaction volume in the broader marketplace will rise or fall independently of any single company’s actions. The only thing that matters is whether or not there is a transaction available today or in the near future of unique interest to a company that could deliver differentiating value. The degree to which a company is active, opportu-nistic, or indifferent to M&A markets will extend or limit its growth potential.

bruce rogerS CHIEFInSIGHTSOFFICER

chrIStIaan rIzy DIRECTOR

brenna SnIderMan RESEARCHDIRECTOR

kaSIa Moreno EDITORIALDIRECTOR

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