The Private Equity Wave

During the heady days of the dot-com boom, the goal of every Silicon Valley start-up was to go public--where the investors and those lucky employees with pockets stuffed with stock options would get a big payday when the company started trading on one of the Wall Street exchanges. Even as the number of technology initial public offerings reached a post-bubble high last year, several large publicly traded companies are considering going the other way--private equity buyouts.

Direct-market powerhouse CDW came off the market last month when it sold out to private equity firm Madison Dearborn Partners for $7.3 billion. Giant solution provider Affiliated Computer Services (ACS) is considering a multibillion-dollar leveraged buyout sponsored by its chairman, Darwin Deason, and Cerberus Capital Management. And last year, big IBM partner Sirius Computer Solutions sold a share of its business to Thoma Cressey Bravo.

Private equity and channel consolidation are high on the watch lists of many solution provider executives, who see the wave of private investment as a reflection of the strength of the industry and confidence of investors in the ability of solution provider businesses to grow. If there's a good market for growing companies, it's the VARBusiness 500. This year's crop of the biggest solution providers in North America had 349 reporting top-line revenue growth, and nearly two-thirds of that number reporting double-digit or better growth.

Private equity, the CEOs say, provides funding for acquisitions and expansion, as well as management experience and leadership for business growth. Equity firms will often install their people on a company's management team and implement new strategies and performance measurements to ensure growth and return of their investments.

Sirius founder and CEO Harvey Najim says having a private equity investor has changed the way he looks at his business' performance. Before taking money from Thoma Cressey Bravo, he focused on two numbers: top-line growth and bottom-line profitability. Nowadays, he pays much more attention to cash flow, the balance sheet and EBITDA (earnings before interest, taxes, depreciation and amortization). Private equity firms want companies that can grow, but also look for those that can shed a lot of cold, hard cash to their coffers.

Private equity may fuel consolidation and expansion, but it isn't necessarily a reflection of market health. Cerberus certainly wasn't looking at Chrysler as a healthy company when it bought the ailing car company from DaimlerChrysler. In fact, financial market experts say private equity firms usually step in when companies show signs of slow or no growth to turn them around either by improving management, liquidating unprofitable ventures or providing strategic direction.

For large public companies like CDW and ACS, private equity is a means to escape the expense associated with being a public company. For small companies with low growth but solid cash flow, private equity can provide the capital for operations and expansion without having to go public.

Believe it or not, there's a contingent of solution providers that don't want to grow. Jim Simpson, CEO of MSI Systems Integrators, says he sees many regional solution providers wanting to slow down. Tempting as it may be to dismiss the drive for growth, Simpson says treading water is tantamount to being dead in the water--a surefire target for acquisition or elimination. Private equity could provide funding for midsize solution providers to snap up good, but stagnant, counterparts.

Given the limited financing, the expense of being a public company and the continual need to grow business, it's likely that this is just the beginning of the private equity wave washing through the channel. Private equity may be one of the accelerants for that consolidation, as private investors pump huge amounts of cash into companies with the express goal of fast growth.

Lawrence M. Walsh is editor of VARBusiness and GovernmentVAR magazines. Read his blog, Tidal Waves, at www.varbusiness.com/weblogs/tidalwaves.