Consolidations in the VAR market are heating up again.
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By Robert W. Scott
If Terry Petrzelka can accomplish half of what he is hoping, the landscape of the accounting software reseller market will be significantly changed. The owner of the Tempe, Ariz.-based Tectura has already accomplished a great deal, growing his operation to more than $40 million very quickly.
“We have $25 million to $35 million in acquisitions in the pipeline,” says Petrzelka. Then, there are talks going on in Europe that could add revenue that would dwarf that amount.
We’ve been here before, haven’t we? It wasn’t that long ago that a college professor named Robert Dunikoski rode through the market, on the first of what was supposed to be a series of rollups. Dunikoski’s firm, then known as TexSys RD, grew to what was supposed to be a $100 million run rate, then shrank back to $62 million as the company took on additional rounds of venture capital during lean times. There was also Aston IT, now known as Aston Business Solutions, which came from Denmark to put together a reselling operation in North America. But a lot of rollups ended up being little more than talk.
Today, Nordea, the bank that holds Aston’s debt, is looking for someone to shoulder that financial responsibility. Nordea owns another Danish reseller, Columbus IT Partner, which owns the former Scorpion Systems in the U.S., and is trying to find a partner for those operations.
Among the American consolidators, the greatest success has been RSM McGladrey, which built its reselling acquisitions activities around an existing practice, instead of trying to forge a new company from formerly independent resellers. So is anything different? There is a good chance. The current generation of consolidator seems to have learned from the past efforts.
“What do you get when you combine a half-dozen mediocre resellers?” says Howard Diamond, the new CEO of a refueled EYT, a reselling company based in Chantilly, Va., that recently acquired In2Gr8, a Seattle firm that had previously declared itself growth-minded. Diamond says that companies that grow by acquisition must find the right business model for the mid-market reselling space.
“A pretty fair comment is that ‘Nobody has really done it yet,’” he notes. And some other observers aren’t convinced that things have changed with the new crop of consolidators.
“I have yet to see where any sort of a roll-up strategy is working,” says Ron Eagle, president of the Information Technology Alliance. “That doesn’t prevent money coming in from people who are sitting on the sidelines. I don’t think the environment is strong enough yet or the partners are strong enough.”
|The 2003 Top 10 VARs|
1. ePartners $63 million
Revenue for the companies are for calendar 2003. At the current reported rates, Tectura and McGladrey would be tied in the $40 million range. EYT, with its purchase of In2Gr8, tops $17.5 million, and Altara expects to reach $17 million to $18 million. Clifton Gunderson reportedly hit $13 million for its year ended May 31.
Some vendors are encouraging consolidation. Exact Software North America has trimmed its channel to about 75 resellers, from more than 100 in 2003, by imposing a $10,000 annual fee to encourage VARs to band together, formally or informally, to be able to contribute that amount. About two years ago, the nominal number of resellers was closer to 200. But many were just names on a mailing list.
For Exact, the solution was suggested by a classic formula. “We fell back on 20 percent of our partners who were doing 80 percent of our revenue,” says David Krapff, senior vice president of North American sales. He adds, “We are at the point of building back up.”
Krapff also feels that size counts more with Exact’s applications because of the resources needed to sell them. “It takes so much more in our space, especially in the manufacturing and distribution arena,” he continues. “There is a lot more expertise required.”
Microsoft, for one, is not taking a position. “We take a hands-off approach,” says Don Nelson, general manager of managed partners for the Small and Mid-market Solutions & Partner Group, the organization that handles channels for MBS products. In fact, the new partner reselling contract and terms encourage smaller operations.
“If a one-person shop wanted to set up an MBS business, they could,” says Nelson. He believes that the small VAR will continue to have a role because small businesses buy from small resellers, not from the giants. Nelson also sees VAR operations as having a more limited ability than other industry sectors to experience the economies of scale realized from M&As.
“I think there is scale in this business regarding back-office operations and marketing. There is very little scale in sales and services,” says Nelson.
But the pressure comes from more forces than the vendors. Best’s Macdonald notes that the expanding product lines play a role. Some accounting software resellers buy firms with experience in selling CRM. For example, Miami-based NextLevel Information Systems, an Accpac reseller, recently acquired Chicago-based Apex for its SalesLogix expertise.
“I also think we are seeing some strategic acquisitions from a regional point of view, as firms fill out a particular region,” Macdonald continues. He points to the merger of AccuPointe and Software Solutions to form a strong operation in the Carolinas and Virginia. Macdonald sees a lot of acquisition activity in the lower ends of the market.
“It’s the seven-to-15-person firm acquiring the two-to-five-person firm,” he says. He expected some three to five such deals to occur between mid-April and mid-May.
There are several factors driving the smaller partners to get larger.
Art Nathan, owner of Solution Strategists, based in Cranford, N.J., says that his $1.6 million firm expected to combine with another reseller of the same size by this month. There is no choice except growth in order to survive or have an exit strategy, he has concluded.
“We are both of the opinion that in order to survive going forward, you can’t be small,” says Nathan. “The other thing that’s obvious is that nobody is buying businesses of small size. There is only value in larger businesses.” Nathan thinks there is little future for the $2 million reseller.
The easiest way to grow the business is merger and acquisition, Nathan believes. “We just see size as being really important,” he says.
A National Approach?
Still, some like Macdonald, a former reseller who spends most of his time with the channel, puzzle over the activities of the firms with national aspirations. “Do the national practices make sense in this business?” he inquires. One problem is that larger organizations simply add a layer of expense to the profit operations of local units, with the result that the big firms can easily bleed money.
Yet investors are starting to ante up money for the larger deals. Last fall, Tectura received a commitment for $12 million from Pequot Ventures, while in February, EYT and In2Gr8 raised $20 million from venture firms led by Charterhouse Group.
“Investors are funny animals. I pick on venture guys a lot, which is almost always deserved,” says EYT’s Diamond. “But in many ways, they are eternal optimists. In a space in which there is no clear model, there is lots of opportunity. I think that’s why you see a lot of investor interest. Whether that is a smart thing to do remains to be seen.”
Diamond predicts his company will do a larger number of integrations and acquisitions, although he did not specify the period beyond “over time.”
“We probably have the strongest balance sheet in the industry, which is damning with faint praise,” he says. However, he warns that acquiring niche software developers may make more sense than targeting only resellers in order to bring new capabilities to the MBS market.
Moreover, Diamond differentiates EYT’s strategy from Tectura’s. “Tectura is very interested in industry consolidation. I see consolidation as part of our model,” Diamond says.
Petrzelka believes that good financial operations can cure problems that plagued past roll-ups. One flaw, he cites, is letting acquired resellers continue to operate more or less as in the past without realizing economies of scale. “We look at redundancy and overlaps,” he says. “We gain some economies. We have centralized the functions of payroll, finance, and HR. Our IT staff is all common.”