Client Success Stories
Reverse Merger has Aerospace Company Poised for Takeoff
Gales Industries, Inc. is an operating/holding and management services integrator group within the aerospace and defense industries. Its principal business activity is the manufacture of aircraft structural parts and assemblies for prime defense contractors in the aerospace industry. The way Gales came into being as a public company, says Louis Giusto, its chief financial officer, is “a real New York story,” and one in which a reverse merger played a critical role.
About three years ago, Giusto was working at home and flirting with the idea of retirement. He struck up a conversation with Michael Gales (who today is the company’s executive chairman) in a chance encounter on a Manhattan street corner. “Mike had lost a son at the World Trade Center, and he was deeply disturbed by it. He couldn’t work; he just meandered around town. We made an immediate connection with each other,” says Giusto, who has more than 30 years of financial control experience, both with major banking firms such as Fleet Bank and with entrepreneurial organizations such as Credit2B.com, a Web-based lending services venture.
During the course of that conversation, Gales mentioned he was interested in aerospace. It was an industry Giusto had never given much thought to, but he told Gales he would be “the financial guy” if Gales ever wanted to pursue something. “We got together again the next day, at a diner,” Giusto recalls. “From that point on, we worked intensively for a year-and-a-half.” During that time, they developed a plan to build a $300 million company in a specialized sector of the aerospace industry using a roll-up strategy, and they set a time frame of about five years to achieve their goal.
Honing In on a Target Acquisition
The partners began evaluating target companies they might acquire, and after a lot of dead ends, they came across a company called Air Industries Machining Corporation (AIM). Gales, who had aerospace industry experience, was familiar with the company and remembered having met some of its principals in the late ‘90s. Privately-held AIM was generating revenue of about $25 million a year by producing aircraft structural parts and assemblies for companies such as Sikorsky, Lockheed Martin, Boeing and Northrop Grumman. Its primary market was parts for military aircraft, including Sikorsky’s Black Hawk helicopter and Lockheed Martin’s F-35 Joint Strike Fighters.
“We were searching for a target with enough muscle to serve as a platform for what we wanted to do and enough legs to carry the plan forward. The key things we were looking for in a target were profitability, sufficient infrastructure and the right technology to deal with the very tight tolerances that are the rule of thumb in this industry.”
“We were searching for a target with enough muscle to serve as a platform for what we wanted to do and enough legs to carry the plan forward,” Giusto relates. “AIM was not perfect, but it was adequate. The key things we were looking for in a target were profitability, sufficient infrastructure and the right technology to deal with the very tight tolerances that are the rule of thumb in this industry.”
AIM was sophisticated enough from an engineering standpoint, but from a financial, structural and operational perspective, it was strictly mom-and-pop. “We had state-of-the-art CAD (computer-assisted-design) equipment in the back of the operation and an abacus up front,” Giusto deadpans.
Achieving Lift-off with a Reverse Merger
The challenge they faced was pulling AIM, which operated as a Subchapter S corporation, into the 21st century in terms of its financial architecture and getting a reporting structure in place that would comply with SEC regulations. The solution they devised was a reverse merger.
In a reverse merger, a private company becomes public through a combination with an existing public company (usually a “shell” company with no operating business or significant assets), and the private company controls the combined entity. A reverse merger can offer several important advantages over a conventional IPO, including potentially lower costs and faster time to market.
Gales Industries executed a reverse merger with Ashlin Development Corp. (the “shell” company) and through a newly-formed subsidiary acquired AIM. “The financial architecture of this deal was extraordinarily complex. We had six separate closings,” Giusto says. “It involved purchasing real estate from two companies. Ashlin was not as clean as we had hoped it would be; we sold $9 million of convertible preferred, and we secured a $14 million line of credit.”
The only way to get the deal done was by assembling a team of players, which included Geller & Company, Gales Industries’ principals and outside accountants, and the acquired company’s outside accountants. “It was like leading an orchestra, and I was the conductor,” Giusto laughs. “But we did it. We have executed the plan and are on our mark. Everybody learned a lot through the whole process, and now our executive chairman is busy putting together a new financial package to do more acquisitions.”
For more information, please contact Antonette Favuzza at afavuzza@gellerco.com.
Capital Trends
Multiple Factors Drive Record Levels of M & A Activity
Up 28% in the U.S. and 37% worldwide in 2005, according to market researcher Dealogic, merger and acquisition activity shows no signs of cooling off. The volume of private-equity backed deals in the U.S. has hit record levels this year, with the 500 transactions worth $157.4 billion completed through June 14, 2006 eclipsing the previous record established in 2000. Experts attribute the frenzied pace of activity to a variety of factors.
“A key factor is the abundant amount of capital and credit available in the marketplace,” notes Frank Cannone, chair of the corporate department at Gibbons, Del Deo, Dolan, Griffinger & Vecchione, a 200-plus attorney regional law firm with offices in New Jersey, New York and Philadelphia. “There is an increased number of buyers and investors around the world, which is driving the supply-and-demand dynamic, and the secondary market for financial paper is strong.”
“It is a very good time for mergers and acquisitions,” agrees Barry Curtis, national managing partner, private equity services, at Deloitte in New York. “Interest rates have remained relatively low, credit market liquidity is strong, and we have a very stable economy. Private equity funds are raising record amounts of money, and we expect that to continue.”
Ample Credit and Available Cash
Industry participants describe the current debt market as the best since 1999. The percentage of banks relaxing their credit standards in 2005 was at its highest level in a decade, according to the Federal Reserve Bank, while default rates continued a downward slide to a 10-year low. Purchase price multiples in mid-market (up to $50 million) leveraged buyout deals hit a 10-year high, averaging 8.5 times before EBITDA (earnings before interest, taxes, depreciation and amortization), up from 5.9 times in 2001, according to Standard & Poor’s Leveraged Commentary & Data.
“It is a very good time for mergers and acquisitions. Interest rates have remained relatively low, credit market liquidity is strong, and we have a very stable economy. Private equity funds are raising record amounts of money, and we expect that to continue.”
Mark Kuehn, a corporate and transactional attorney at Gibbons, Del Deo and president of the New Jersey chapter of the Association for Corporate Growth (ACG), believes macroeconomic factors are also playing a role. “There are paradigm changes taking place in the global economy. Production and other activities are shifting out of the U.S., leaving fewer opportunities to invest directly in domestic operating enterprises,” he says. “But there is still plenty of capital available. With more cash and fewer things to buy, prices get driven up.”
Indeed, acquisition-minded companies—many of which are finding organic growth more difficult to achieve as they max out on cost-cutting benefits—are facing stiff competition from hedge funds and private equity firms for the complementary companies they would most like to acquire. In a break with their past, hedge funds are no longer limiting objectives to short-term returns. Many are actively seeking deals, especially leveraged buyouts, and have greater latitude than some of their competitors when it comes to the size, industry involvement and price of their acquisition targets.
Desire to Increase Revenue Spurs Acquisition Frenzy
However, while M&A volume and the price multiples commanded by acquisition targets are up, there is less speculation evident in the marketplace than was the case when it last peaked. Today’s dealmakers are more disciplined and transact deals only after lengthy due diligence, according to Daniel Varroney, chief executive officer of ACG. They continue to make strategic deals versus the more speculative ones of the past, he says.
The greatest number of investment bankers and other M&A professionals polled for the ACG/Thomson Mid-Year 2006 DealMaker’s Survey, 46%, said their primary merger and acquisition objective was to increase revenue and profitability. A third were looking to grow market share and 5% were chasing new technology.
From an industry perspective, the sectors expected to be hottest through the remainder of 2006 are technology, cited by 27% of survey respondents, healthcare and life sciences (18%), and manufacturing and distribution (17%). The most important company attribute that matters to an acquirer today is sales and revenue growth (32%), followed by an attractive business sector (21%) and management strength (19%).
For more information, please contact Heidi Shore at hshore@gellerco.com.
Financial Reporting
Valuing Goodwill and Other Intagibles
Valuation is a critical consideration in any deal involving a merger, acquisition, initial public offering of stock or similar transaction. As the percentage of an enterprise’s value represented by intellectual property, goodwill and other intangible assets increases, the accounting and financial issues related to how those assets are valued becomes increasingly complex. Complicating things even further, changes in some key Financial Accounting Standards Board (FASB) rules on valuation in business combinations may take effect in the not-too-distant future.
“One critical issue in valuation for mergers, acquisitions and IPOs is getting the values right for the acquired intangible assets, including identifiable intangibles, in-process research and development (IP R&D) and goodwill,” says Mark Shayne, a managing director at Empire Valuation Consultants LLC in New York.
Because properly identifying, valuing and weighting intangible assets can involve both subjective and objective factors, it is a process best left to qualified valuation experts, Shayne adds. “Transparency is a hot-button issue with the SEC and in all segments of the financial reporting community. They look very closely at valuation of goodwill and other intangibles,” he says.
SFAS 142 Seeks to Clarify Intangible Assets
Valuation of intangibles gained prominence on the SEC radar screen following the Enron accounting scandal, prompting the FASB to implement many changes requiring the release of more transaction details and greater independence in the development of information. The FASB said it developed Statement of Financial Accounting Standards No. 142 (“SFAS 142”) because: “Analysts and other users of financial statements, as well as company managements, noted that intangible assets are an increasingly important economic resource for many entities and are an increasing proportion of the assets acquired in many transactions. As a result, better information about intangible assets was needed.”
Intangible assets are assets with future economic benefits, no physical substance and a high degree of uncertainty concerning the future benefit. Common types of intangibles include patents, copyrights, franchises, goodwill, organization costs, trade names and trademarks. They fall into five main categories: marketing-related, customer-related, artistic-related, contract-based and technology-based.
“One critical issue in valuation for mergers, acquisitions and IPOs is getting the values right for the acquired intangible assets, including identifiable intangibles, in-process research and development (IP R&D) and goodwill.
Prior to the implementation of SFAS 142, companies were able to carry overvalued goodwill assets on their balance sheets for long periods of time and to amortize goodwill for up to 40 years. Now, companies are required to write down goodwill immediately upon it being deemed overvalued, and they may leave it on their balance sheets only as long as it remains valuable.
Such write-downs are de facto impairment charges, since they tacitly acknowledge a reduction in the ability of the company’s assets to generate as much cash as previously projected. That information, of course, is material to the consideration of a merger, acquisition or IPO, so it becomes increasingly important to secure accurate, verifiable valuations of goodwill.
Recognizing Assets Apart from Goodwill
Another FASB standard, SFAS 141, deals with the recognition of intangible assets other than goodwill: “An intangible asset shall be recognized as an asset apart from goodwill if it arises from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired entity or from other rights and obligations).”
Under SFAS 141, an intangible asset that does not arise from contractual or other legal rights is recognized as an asset apart from goodwill only if it is separable (i.e., capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged)—regardless of whether there is an intent to do so.
“It’s very important to identify all intangible assets and value them properly,” Shayne says. “The SEC is looking very closely at this issue and wants to make sure it is done properly, preferably by a qualified firm.”
FASB Proposes Valuation Rules Changes
As part of its joint project on business combinations with the International Accounting Standards Board, the FASB has proposed a number of rules changes affecting valuation of intangible assets, some of which may take effect in calendar year 2007, although no definitive dates have been set. Two of the proposed changes are of particular interest to companies that may be involved in business combination deals in the future, Shayne says.
One would shift IP R&D from its current status on the expense side of the ledger (where it can be written off) to the asset side (where it could not). The other would change the accounting for partial and step acquisitions. “Right now, if a deal is structured with a $20 million payment up front and two $5 million payments in each of the next two years—contingent on certain targets being reached—that’s accounted for as a $20 million deal,” Shayne explains. “Under the new rule, the future payments would have to be valued and included as assets under goodwill at the time the deal is transacted.”
It should be noted, however, that while both changes were included in the project’s Exposure Draft, they have been among the most contentious points addressed in comment letters during the feedback period, says Marta Vessels, a project research associate at FASB. As of the project board’s July 2006 meeting, discussion had not begun on either item.
For more information, please contact Joe Gitto at jgitto@gellerco.com.
