The Devcon deal: What's in a multiple?

Some transactions are more complicated than others
Thursday, October 22, 2009

HOLLYWOOD, Fla.--When a big, traditional alarm company like Devcon Security is sold, there's only one question on everyone's mind: What was the multiple?

What does the multiple paid mean for buyers, sellers and lenders out there? A point of references for future sales, a coveted piece of gossip, or an important metric that should be read in context of the specific deal at the time it was made?

The answer, according to those involved, is yes to all three. On Aug. 28, Devcon president Robert Farenhem sent a letter to shareholders asking them to approve the sale of Devcon to Golden Gate Capital, a $107 million deal that translated into a 30.5 multiple of Devcon's RMR.

How was that multiple arrived at? That information--in the form of 200 pages of history and analysis, including intrigue associated with Devcon International's offshore businesses that had nothing do with the security business, details of SEC rule changes, and investors' deadlines and deals--accompanied Farenhem's letter to shareholders, a copy of which was received by Security Systems News.

The security world may think of the deal as the purchase of a major alarm company, yet Devcon International is not your average alarm company.

"The multiple paid was not for what Devcon Security is, but for what Devcon International was, a holding company that'd done business in the Caribbean for 50 years. It did construction and owned various aggregate and ready-mix operations businesses. [And with those] came risks, business exposure and a handful of lawsuits that were material," Farenhem said.

Michael Barnes, a partner in investment banking firm Barnes Associates, which specializes in the security alarm industry, and who worked on the deal, concurred: "It is probably correct to say that Devcon traded at a multiple of RMR in the low 30s, but there were elements associated with the deal that suggest it traded higher relative to more typical industry transactions," he said.

Barnes points out that this was a stock deal, Golden Gate acquired shares of the company rather than purchasing assets. "Most transactions in the industry are still done on an asset purchase basis, which from a tax perspective is typically more beneficial to the buyer and less so to the seller," he said.

Barnes noted that the stock deal meant that Golden Gate assumed the liabilities of Devcon's construction business, which included outstanding litigation being adjudicated in foreign countries, which entailed substantial risk. "Most transactions in the industry have purchase price holdback and adjustment provisions that provide certain protection to the buyer for such things as near-term attrition rates. This deal did not have that type of provision--it was effectively cash and carry," Barnes said.

The timing of the deal should not be overlooked either. Most of the tenets of the deal were agreed upon in April 2009, a time Barnes called "one of the worst times in recent history to try to sell a business." That month, "the Dow was 20 percent below where it is today. It is easy to forget how tough and uncertain things were, especially in the financial markets," he said.

Golden Gate Capital, the $8 billion private equity firm that bought Devcon, is accustomed to complex deals, but, "Even with that frame of mind, we were surprised with what we found here," said John Gilligan, Golden Gate Capital partner.

Golden Gate, and three other suitors who tendered offers in the spring of 2009, initially wanted to buy only the security company. The offers of the three rejected suitors are not included in the shareholder letter, but Golden Gate's offer for the security business alone was $118,000,000.

An internal committee and the Devcon board of directors, according to the shareholder package, "determined that it was not in the best interest of our stockholders to sell our most valuable assets and leave the company and its shareholders saddled with the remaining legacy construction business liabilities."

Golden Gate and another buyer referred to as "Sponsor A" made offers for the entire business. In March, Devcon began negotiating in earnest with Golden Gate.

Devcon International was solely a construction and material and aggregate business until April 2004 when, looking to invest in businesses with predictable recurring revenue, it bought Security Equipment co. for $4.5 million. In 2005, Devcon changed its entire focus to security, and began shedding its construction businesses. It acquired Adelphia Security for $42.8 million, Guardian International for $65.5 million, and Coastal Security for $50.4 million. 

Pressure mounted in 2006, with operating losses, changes in the way SEC handled PIPE (private investment in public equity) investments, and pressure from three major investors, namely HBK Main Street Investment, a hedge fund out of Dallas; CS. Equity; and one investor who was bought out in 2007.

As Barnes describes it: "Devcon chose to pursue a transaction in the face of these tough market headwinds, due primarily to its capital structure not giving the company the flexibility it needed in such uncertain times and pressure from a class of shareholder that was seeking liquidity. The company determined that the right transaction could satisfy its shareholders, give it the financial depth to implement its business plan in a higher risk environment, and aggressively pursue the attractive acquisition opportunities that invariably arise during difficult times."

So, who was at the table this spring and summer?

"It was a multi-sided negotiation," Farenhem said. "HBK had certain rights, not the least of which was their ability to convert their investment into a control stake in the company." Devcon had an interesting debt structure, he said. Because the senior debt was funded by the operating subsidiary, (Devcon Security) the senior lender had a seat at the table as well, Farenhem said.The board was interested in protecting all of the stakeholders, he said, anyone interested in the health and well being of the company including creditors and a group of retirees.

"It took a long time to get the transaction analyzed and negotiated ... to find solutions to some of the longstanding problems ... and position the deal ... and it took an unusual buyer to have that level of patience," Farenhem said.

Golden Gate said it wanted Farenhem to have a "clean slate ... We wanted to get company in a place that when they opened their doors on day one, they'd be a pure security company, be capitalized as such and ready to focus," Golden Gate's Gilligan said. "Robert now has two extra days in his week," Gilligan joked.

In the end, "I think the market worked," Barnes said. "Devcon did well by its shareholders, especially given the structure of the transaction, and is now wonderfully positioned with a great financial partner. Golden Gate did well too. Particularly with the benefit of hindsight, I am sure this will prove to have been a great acquisition for them ... and one that is complementary to their Pinnacle investment. The industry also showed well. In one of the worst markets in history, an alarm company with pressures to do something, operations focused in Florida and New York City (two of the hardest hit areas of the country), and a host of non-security operations-related issues, was able to command a very respectable valuation. It speaks highly to the quality of these businesses."

Aside from its deep pockets and stated enthusiasm for the industry, Gilligan said Golden Gate is structured differently than other funds. "We have a permanent capital fund ... we don't have investments with an agreed upon time-horizon," he said. "We can exit after one year or 10 years and we can easily put more capital into an investment," Gilligan said. Adding more capital and making more investments, that's Golden Gate's blueprint for Devcon and the security industry in general. "We're open to any interesting ideas as we continue to build out our ... broad-based business in the security industry."