VideoBut he, too, has stumbled on occasion. Take, for instance, Physicians Resource Group (PRG), which Harter established as a roll-up in June 1995 to consolidate ophthalmology practices nationwide. It quickly grew from 10 practices at the outset to 177 by the fall of 1997. But costs grew even more rapidly. In the third quarter of 1997, the company reported a loss of $18.4 million, even though revenues grew to more than $100 million from $60 million a year earlier. Harter refused to comment on PRG's problems, but Richard D'Amico, PRG's chief administrative officer, admitted to the Dallas Morning News, "We grew too fast." Last November the company, now the largest eye-care group of practices in the nation, announced it was holding off on any more acquisitions, closing 14 of its troubled practices.
It is a common occurrence in roll-ups, says George Koo, an analyst with Burnham Securities Inc., in New York. "They move too quickly, projections aren't conservative enough, and costs get out of control." That's created plenty of opportunities for acquisition-minded CFOs. "In a roll-up, each of the things a CFO focuses on--raising capital, making acquisitions, improving operations, and talking to Wall Street--is at a fever pitch all the time," says Mike Kirksey, senior vice president and CFO at Metals USA, a Houston-based consolidator of metals processing firms. Perhaps the consolidation trail wouldn't have been so rough for PRG if it had had a strong CFO. For the two and a half years the company has been public, there have been no less than three finance chiefs.
"The CFO is crucial to the success of a roll-up," adds Kirksey. "The complexity requires someone with the skill to do the deals, but also to make them work, operationally."
Harter turned to Kirksey, former vice president of strategic planning at Keystone International Inc., a publicly traded valves and controls manufacturer in Houston, when he wanted to consolidate the metals-processing industry. Along with CEO Arthur French, also from Keystone, they created Metals USA. In any roll-up he starts, Harter has used professionals from the industry to run the business, though he has sat on four of his six companies' boards. "My ego doesn't need to be called 'chairman,'" he says.
THE GOLDEN GOOSE
Harter at least has learned from his mistakes. Has Ledecky? He claims so. "One of the things I learned from U.S. Office Products is to focus," he says. But he already may be forgetting that lesson. In January, just days after USOP announced it was reversing its consolidation strategy and instead spinning off four separate roll-ups, Ledecky announced his plans for Consolidation Capital. The company will provide a variety of services to retail and office-building owners, including pest control, landscaping, and equipment maintenance. In February, it announced plans to acquire seven electrical contractors for $138 million, half of which would come in Consolidation Capital stock. When the acquisition is completed, Consolidation will be the fourth-largest electrical contractor in the United States. In a time when focusing on a niche is the standard, that will be a hard sell on Wall Street.
Eventually, many roll-ups will go the way of the LBO. When the stock market turns down, they will have a harder time using equity for acquisitions no matter how profitable they are. The cowboys themselves fear that day will come even sooner, as their corporate cattle drives fall victim to their own success.
"I have seen guys try to put these things together with mass mailings and Internet sites," says Harter. Fair warning for CFOs tempted to saddle up.
Joseph McCafferty is an associate editor at CFO.
RAISING SEC EYEBROWS
Regulators aren't quite ready to roll over.
------------------------------------------------------------------------ -------------------- Roll-ups are also receiving their fair share of scrutiny from the SEC. Part of the commission's concern lies in the accounting for roll-ups. In August 1996, the commission dealt a blow to the structure with Staff Accounting Bulletin No. 97, which pertains to accounting for business combinations. Until then, many roll-up artists managed to avoid the need to write off goodwill, the premium over the book value that an acquirer pays for a company's assets. They took advantage of a loophole that let them carry the acquired assets at historical cost, rather than at fair-market value, or shifted the goodwill to one of the minority shareholders. With those options ruled out by SAB 97, roll-ups can avoid goodwill only by qualifying for pooling-of-interest accounting, and few can surmount all the hurdles involved.
At first, many thought the ruling would kill roll-ups, because amortization of goodwill would be an on-going drag on earnings. "Everyone was a little concerned when SAB 97 came out," says Patrick Hurley of investment bank Howard, Lawson & Co. But so far, roll-ups have managed to defy the doubters. "They rolled right over the goodwill hurdle" by convincing the investment community to look at cash flow instead of earnings per share, says Hurley.
Although the SEC has not publicly indicated any further concern about roll-ups, Hurley says it is taking a closer look and has invited his firm to make a presentation to the staff on the nuts and bolts. The SEC is particularly interested in disclosure, says George Moosburner, a senior vice president of investment banking at Howard, Lawson. "Are we appropriately disclosing in a manner that can be understood by the investing public?" he asks. "The accounting gets very complicated because you're trying to present pro-forma financial results for a company that doesn't exist. More things go wrong."
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