Private Equity Funding Driving VAR Consolidation12:00 AM EST Mon. Dec. 04, 2006
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The current wave of channel consolidation is increasingly being funded by private equity companies that may not have a lot of experience reselling computer hardware or services, but that do know a good solution provider when they see one.
And the primary beneficiaries of the funding are solution providers that are making aggressive moves to branch out into new skill sets or geographies by acquiring or merging with their peers.
Joe Mertens, executive vice president at Sirius Computer Solutions, one of IBM's largest solution providers with $578 million in annual sales last year and the recent recipient of an undisclosed amount of equity funding from San Francisco-based Thoma Cressey Equity Partners, said that the investment in his company and in many other solution providers comes as the solution provider space is rapidly consolidating.
That consolidation is what is drawing the attention of private equity firms to the channel.
Orlando Bravo, a managing partner at Thoma Cressey, said his company and other investors see solution provider consolidation as a huge growth opportunity for themselves and for the VARs in which they invest.
"We see this as a consolidating space, and feel it will continue to consolidate for the next five years," Bravo said. "It's way too fragmented. But a company like Sirius has a broad breadth of products and geographies."
John Clarey, managing director of Clarey Technology Group, an Irvine, Calif.-based private equity investment company that in July acquired Phoenix Computer Associates, a Phoenix-based mainframe and peripherals solution provider, said the channel has a lot of $4 million to $5 million players, but few $50 million to $100 million players.
"It looks like an area where we can get economy of scale," Clarey said. "This business is not going away. We're seeing new requirements for such regulations as SOX [Sarbanes-Oxley], HIPAA and so on. But not a lot of big companies in it."
The consolidation is really only in the beginning phase, Clarey said. "Many of these companies are undercapitalized," he said. "This is a people business, a relations business. And they need to grow."
And grow they are. Much of the equity investment in solution providers is going toward acquiring other VARs.
NEXT: A look at VAR mergers and acquisitions.
MTI Technology, an Irvine-based EMC solution provider that was No. 76 on CRN's Fast Growth 100 list, used equity funding from Lindon, Utah-based Canopy Ventures and Boston-based Advent International as part of its June acquisition of Collective Technologies.
MTM Technologies, Stamford, Conn., which was No. 19 on CRN's Fast Growth 100 list, used a combination of $10 million in equity funding and a $25 million subordinated term loan late last year as part of its acquisition last November of another solution provider, NEXL.
Incentra Solutions, a Boulder, Colo.-based provider of storage and managed services to enterprise customers that was No. 10 on CRN's Fast Growth 100 list, used a combination of equity and debt funding to acquire several solution providers this year and last year to expand its geographical reach, said Chairman and CEO Thomas Sweeney.
"Our preference is to use debt from private equity funds," Sweeney said. "It lessens the risk, and is less onerous than working with banks."
Sirius already has a nationwide presence, Mertens said. "But there are some geographies where we still need a footprint," he said.
Mertens said that Sirius has grown organically about 15 percent annually for the past couple years, as well as about 10 percent to 15 percent yearly due to acquisitions, and has been profitable since it was founded.
Despite the strength of its business and its IBM relationship, Mertens said it is important to look for ways to continue to grow. "Customers are looking for firms that are larger and more capable in terms of geographic presence and skills," he said. "Capital investment is helping to drive consolidations. VARs need strong skills."
While taking private equity funding is not only about acquiring other solution providers, the possibility is nearly always present.
Being acquired by a private equity fund is a chance to quickly build out an existing business and increase one's customer base, said David Traxler, president of VSS, a Ridgeland, Miss.-based IBM solution provider that in May was acquired by Riverzone Group, a Richmond, Va.-based holding company.
"It may take longer to build out by yourself," Traxler said. "We are working really hard to grow up and out organically. Out in terms of geographical coverage, up in terms of our existing customer base. But if opportunities exist where an acquisition makes sense, maybe in terms of geography or complementary skills or complementary customer base, if the economics work, you have to ask yourself, 'Why not do it?' "
Network Hardware Resale, a profitable Santa Barbara, Calif.-based reseller of used Cisco and other network equipment that over the past 20 or so years grew annual sales to about $100 million with no debt, late last year took $50.5 million in debt and equity financing from Allied Capital, a Washington company, in order to expand its international opportunities.
In January of next year, NHR is slated to open an Asia-Pacific headquarters in Singapore, and next year plans to expand its European operations, currently based in Amsterdam, said Karen Anne Platt, CFO. The company is also expanding its business into reselling and deploying new networking equipment with its September signing of a reseller agreement with Force10 Networks, a San Jose, Calif.-based builder of high-speed Gbit and 10-Gbit Ethernet switch routers, Platt said.
"It complements what we're already doing, but also lets us offer customers something new," she said. "We would always consider the right acquisition opportunity. But there are no plans on the table, or even close to the table."
NEXT: How VARs are putting private equity funding to work.
MTI has used private equity funding, as well as strategic funding from vendor partner EMC, to transition itself from a name-brand storage manufacturer to a provider of storage products and services, and in the process has doubled its revenue since 2003 to hit about $175 million, said Thomas Raimondi, president and CEO.
"The investment was not a short-term thing," Raimondi said. "In 2007, you should see some really great results from us."
One common thread in nearly all of the recent investments in the channel is the move by the investors to keep the solution providers' management team as intact as possible, even though it is common for the original founder or primary shareholder to take the investment or acquisition as an opportunity to retire. In addition, private equity investment companies often bring in another resource needed by many solution providers: new members for their board of directors.
Having Michael Pehl from Advent and Ronald Heinz from Canopy on MTI's board of directors also benefits the solution provider with new industry contacts, Raimondi said.
"When we acquired Collective, it was nice to have our largest shareholder buy into the strategy," he said. "And because he's on the board, sometimes we're privy to non-public information. And people like Pehl have been CEOs of their own companies. It's nice to pair up with peers. It's like having a coaching staff with a hall of famer."
Even though Thoma Cressey will not be involved in the day-to-day management of Sirius, it is taking a seat on the solution provider's board of directors.
For now, Thoma Cressey does not plan to take a similar stake in other solution providers, Bravo said. "Sirius is our platform for expansion in the industry," he said. "We're looking to back Sirius to expand in this area. Sirius will be our platform."
For solution providers looking to expand with the help of equity funding, it is important to look at future growth prospects, especially as larger solution providers are growing faster than smaller ones, Mertens said. "Local or regional VARs will find it difficult to grow," he said. "They need to look at becoming supra-regional or national in order to grow."
Determining one's value is no simple task, Incentra's Sweeney said. "The straightforward way is much overrated," he said. "Sure, you need to look at profit and cash flow. But you also need to look at skill sets, certifications and of course your customer base."
Not every solution provider is a prime investment possibility.
Clarey said his company does not look at investing in startups, but instead looks for established companies that are making money, or at least are breaking even. Even more important is the quality of a solution provider's management team and customer base, Clarey said.
"Often when a company is bought, the management leaves and the company evaporates," he said. "We want to know if we buy a company that the management will continue. Also, we look at the customer base, types of data centers, types of services offered. We don't want a strict reseller."
Because there are many different types of investors looking at investments for different reasons, there is no simple guide for a solution provider to find equity funding, Bravo said.
"We look for scale," he said. "And you have to have a track record of consistent financial performance. And management who endorses partnership. If you have those three, and have the right expectations, there are investment opportunities. If somebody is looking to expand and really grow, finding a partner with a like mind can be a real benefit."