For those of us born before 1950 this decade was to be a time to enjoy early retirement or tackle the challenge of a career change with the knowledge and experience of 30-plus years under our belt. Unfortunately, as we talk to entrepreneurs about selling their businesses we frequently hear them lament that they may have missed their window of opportunity. The most notable comment we hear is: “I could have sold my company in 1999 or 2000 for significantly more than the market says it's worth now. I'll wait until multiples come back.”
Many owners feel opportunity may have slipped away since the lofty days of the late ‘90s. However, upon closer examination of the facts, now may not be as bleak as it appears.
Given the substantial fall in stock prices and declining interest rates over the past three years, the value of proceeds from a sale at that time would have deteriorated such that an equivalent transaction could be done today at a lower multiple.
Let's run through a simplified example. Suppose there is a mid-size equipment rental company that was doing $30 million in annual revenue (60 percent rental and 40 percent sales, parts and service) a good balance between aerial work platforms and construction equipment with an average age of 3.5 years and earning $8 million in Earnings Before Interest Taxes Depreciation & Amortization (EBITDA) in 1999. Furthermore, the owner passed up an opportunity to sell in early 2000 at five times EBITDA or $40 million. For the sake of our analysis we will assume the proceeds from the sale were 100 percent cash.
Assuming all proceeds were taxed at a capital gains rate of 20 percent in 2000, available proceeds would have been $32 million. Now, what would the owner have done with the money? We will assume that a sound investment mix at the time would have been as follows:
We need to also assume that in order to live comfortably during the following three years the owner would require $300,000 annually. After factoring in all of the above, how much would the owner have left after the first quarter of 2003? See the chart below (in thousands of dollars).
As the chart points out fairly dramatically, the sale proceeds would have been diminished by close to 16 percent during the period.
To simplify our comparison we assume that all earnings since 1999 were either invested in the business and/or used for living expenses. In addition, assuming EBITDA is the same today as it was in 1999 (this could be an optimistic assumption given current rental rates in most of the country) the breakeven multiple would be 4.22 times EBITDA. In other words, if the business was sold for $33.7 million at the end of the first quarter producing $26.7 million in after tax proceeds, the owner would be in the same position as if the business was sold at the higher multiple three years ago. Furthermore, with the new change in capital gains tax to 15 percent, the breakeven value today before tax would be $31.7 million (less than four times EBITDA).
Other factors that may impact the price a buyer is willing to pay for an equipment rental company include the mix of revenue between rental, sales, parts and service, age and condition of the fleet and the number of locations.
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Revenue mix: Many consolidators are (or were) more interested in rental revenue versus sales of new or used equipment because the returns are generally better and it is consistent with their strategic direction. On the other hand, there is something to be said for establishing a broad customer base by consistently distributing solid brands of equipment. The stronger the brand the more valuable the installed base of equipment under warranty and even beyond warranty periods. This will provide a steady stream of maintenance and repair work for the service personnel. The strong brands will also hold up better in the used market when the iron needs to be removed from the rental fleet or is traded in. The key is finding a buyer that has a similar strategy or is interested in moving toward a more balanced approach.
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Age of the fleet: Many of the large equipment rental companies have been aging their fleets and trading off higher maintenance expense. This is nothing new for most private companies that generally have older fleets. However, the key is the strength and discipline of the maintenance program. Common sense tells us that a well maintained older fleet might be more valuable than a poorly maintained, younger fleet.
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Number of and desirability of locations: Filling in an underserved contiguous market is always of interest to a growing equipment rental company. Capturing new markets generally will be more desirable than eliminating a competitor in an existing market.
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Other factors impacting value: There is any number of other factors that could also impact value, but at the end of the day, those companies that consistently produce the highest return on invested capital will command the highest multiples.
We also did not factor into our analysis the risk of holding 100 percent of one's net worth in a privately held equipment rental company vs. the more liquid and diversified stock market. Such an analysis is beyond the scope of this article. However, anyone who has started, inherited or bought an equipment rental company has made the determination, consciously or unconsciously, that building value in a tangible business that is impacted by the owner every time he or she walks in the door is either more valuable or more fun than owning a bunch of stocks they have little or no control over. Although, once a private business has matured to the point where growth is difficult to come by without significant investment and the owner is staring at more taillights than headlights, maybe diversifying personal risk is an option to be explored.
Lastly, the investment mix between equities and debt instruments can significantly impact the results of the analysis. If more proceeds were directed away from the stock market the past three or four years, then obviously the loss of principal would have been substantially less. However, over long periods of time stocks have outperformed the risk free return (Treasuries) by 7.4 percent according to the long-horizon version from Ibbotson Associates' Stocks, Bonds, Bills, and Inflation 2002 Yearbook — Valuation Edition.
Our conclusion (ignoring capital gains tax) is that unless an earnings issue needs to be addressed before the sale, a company should be sold whenever the owner is ready. Good companies are almost always in demand. Trying to game the market is difficult at best, and at the end of the day when multiples are high the re-investment risk is high (i.e. stock prices are more likely to decline than increase) and when multiples are low the re-investment risk is low (i.e. stock prices are more likely to increase than decrease).
Pat Martin is president of Chicago-based CBIZ Century Capital Group. CBIZ Century Capital Group has closed more than 330 middle-market M&A transactions including eight equipment rental companies across the country. Martin can be reached at 312-602-6717, [email protected] or at www.cbiz.com/centurycapital.
