Somehow or another Armin hears about the potential divestiture of a small ($55 million) unit within a Fortune 500 firm. As is not infrequently typical, no one else knows about it and there is no banker. The unit isn't performing poorly exactly, but it is dragging down the otherwise very hot division it is in and running it requires a great deal of managerial attention. This particular Fortune 500 has the managerial attention of an 8th grade boy in a co-ed gym class. Since SarOx the fact that the Fortune 500 is forced to consolidate these financials irks them to no end. Bright lights hurt the eyes of little captive units who are below par for the division.
Our quest to secure this unit I have labeled "Project Spy."
Spy has its main operations in Europe divided up seemingly haphazardly in six different locations in the United Kingdom. It was acquired in a corporate shopping spree about 5 years before along with two other similar businesses, which explains the fact that it has more locations than it does products. We like this, actually, because we will, in theory, immediately be able to consolidate the locations and enjoy the gains. The parent hasn't had the will to make these changes so far, even though they have drawn up a "consolidation plan." I understand also that some relatives of the CFO work in the unit. Always a sign that tough but important decisions that should have been made have been deferred.
I know nothing about Spy when Armin takes me to the meeting with the COO. We meet at a private club in Manhattan and I don't get a chance to ask Armin many questions on the drive over as he spends most of his time on the phone. Two minutes before we arrive he chimes in, "I want to you be a little tough with this guy. Wait until the main course, when he has food in his mouth and pepper him with some tough questions, you know the kind I mean." So it's "bad cop" for me. I shouldn't have played that part well in the past, now I'm getting typecast. If I'm not careful I'll be as pigeon holed as Macaulay Culkin.
I feel out of place usually in the conservative establishments that are private New York clubs. I think that I hide it well though. We sit and Armin makes introductions. He calls me his "Deal Veep." I almost squirm with pleasure at the public compliment, but instead I manage just a shy smile.
Spy's COO is a measured and quiet guy. He spends a lot of time listening and his pace of speech is almost slow enough neutralize any attempt to rattle him with question peppering. Someone once told me that New Yorkers talk fast and think slow and southerners think fast and talk slow. Spy's COO must have been from Florida.
Armin and the COO spend some time exchanging war stories. It's during this back and forth that I discover the connection between them. The COO actually reported to Armin "back in the day" at a large conglomerate, though his position was two levels below Armin's at the time.
The progress of the private club business lunch, at least in this particular private club, is decidedly Not-New-York. Two hours could easily pass at the rate the meeting is going. The break and chance of pace is actually quite refreshing, though it plays to the COO a bit too much for my taste. Things could stretch to three hours without much effort. The salad course finally draws to a close (I had the most magnificent cold salmon salad in recent memory) and I have hopes that the lunch entrée is at least cooking by now. There seems to be some unwritten understanding between Armin and the COO that no new business can be discussed before the entrée.
They are in the middle of a conversation about what ever happened to the upstart Director at the firm they once shared when the dishes finally arrive. The COO has a massive steak in front of him but begins so delicately that I wonder if ever I am going to get a chance to catch him with food in his mouth.
As if literally on cue, Armin inaugurates the business discussion when the COO's fork first pierces his steak.
"So, tell us how we can help you with your little... difficulty."
The COO begins by reminding us that this is all very, very confidential and that news that the unit is being sold should be considered highly sensitive. As is typical in such situations, none of the management at the unit itself knows that a sale is even being considered. At the moment it is just the COO, CFO and CEO of the firm who have any idea that a sale might be in the works and, if it is all the same to us, he'd appreciate it if we kept it that way for the time being. Armin gives placating reassurances and I nod in agreement. He describes the unit in more detail, pointing out that there are a series of sacred cows there and that even the senior management at the Fortune 500 parent is having a hard time cutting the cords that need to be severed. The business is cash flow positive, but they spent far more than they should have when they picked up the businesses, and they haven't written down much of the costs yet. The value on the books is somewhat high and they are looking at taking a punishing write-down if they can't extract some value in a transaction. The CEO himself has directed that this unit is history, one way or another, even if it has to be closed down, yesterday. Closing the unit would also be quite a pity as several net operating loss carry forwards (NOLs) which could be applied to reduce taxes on future profits will be lost. As they are already on the books as assets, these too would have to be written off. The picture is ugly, but mostly for accounting reasons. This is, of course, all music to our ears.
Armin doesn't react positively. "Look, we are just not going to get into a situation where we do the heavy lifting and give you an idea of what it is worth to us if you are just going to shop it around later and drop us into an auction. We can put together an initial LOI in 48 hours or less, but I need a long exclusive on the due diligence. I need to know this is our deal, otherwise, it's just not worth our time." I almost come out of my chair when he says this. Not worth our time? The unit is perfect for us in about nine different ways. I'd happily sit in an auction for it.
The COO is compliant. "That's fine. We aren't going to play around with this. It has to be handled. Fast. If you can commit to a quick closing, we have no problem with an exclusive diligence period."
Agreement seems close. Armin leans back a little in his chair and addresses his food. Then, he glances at me. Just a split second of a look. My turn. I wait for a few rounds of entrée slicing before I catch the COO with a moderate piece of steak. I watch out of the corner of my eye for him to chew at least once so he doesn't just put it back on his plate or something and then I strike.
"If the business has been profitable all these years, where are the NOLs from?" I ask this almost innocently. Like a junior executive who just needs a simple mistake explained. My timing is near perfect. Suddenly the steak seems as rubber and the chewing gets slower and more measured as the COO gesticulates in a manner that is supposed to indicate he is getting ready to say something witty. Finally, something emerges, in-between the last few chomps and two swallows.
"I'm not exactly sure. I will have to talk to the CFO but I think we obtained them during the acquisition." This sounds fishy to me, so I press a little.
"How old are the NOLs? When do they expire?" I almost add "Do you know?" on the end to be polite, but I don't want to make the "I don't know" answer too easy.
"Well, I think they are only 3 years old, but I will have to check." I follow this up with another quick and hopefully annoying question.
"Do you plan to keep using the services of the unit? Will we have some guaranteed stream of revenue after the transaction? If the unit has always been an internal staff like resource it's hard to justify anything other than a negative sale price unless there is a steady and secure revenue stream. And if the parent no longer wants the product, well, then I get worried about trying to sell it to the rest of the world." This time the COO, furiously sawing to get a large piece of meat in his mouth to buy time before he has to answer, is caught a little off guard. Armin takes up the cause, leaning forward and interested again.
"You know, Equity has a point. We are going to have to make a very careful analysis of the costs required to make this a stand alone business again." After a long bit of chewing and far less gesticulation, the COO has little comment.
The rest of the lunch was quite subdued.