This week I learned something new. Something I had completely ignored up until now – but that is absolutely integral to the success of many penny share companies.
I had just visited the drab headquarters of a software group at the fringe of the City. Now this was not a place where you expect to find an explosive penny share story. But walking along the pavement I thought to myself: there is serious potential for profit in that place.
The company is called Dillistone (DSG). It provides software for the executive search market. And for a few years now it has faced a serious dilemma. Dillistone would like to expand its business by acquiring another company. But how to find the right one?
Let me take you through their dilemma – because having found the right company, Dillistone could soon see a rapid transformation in its fortunes.
How do you inspire a company after you’ve taken it over?
Dillistone is buying Voyager, which aims its software at the broader recruitment agency market. Dillistone is paying £1.89m up front, comprising £1.5m in cash and £390,000 of Dillistone shares. But it has also agreed to a further deferred payment of up to £2.1m, which is dependent upon Voyager’s revenues over the next two years.
Basing such a deferred payment on future revenues may not sound anything special. But structuring acquisitions is always a tricky matter for any company, large or small, and I think that Dillistone has hit just the right formula.
Consider the problem of acquiring a small company that’s heavily reliant upon key staff. You have three options. You can either pay cash lock, stock and barrel up front. That puts you in control from day one. But on the other hand you have spent all that cash without knowing exactly what you are buying. Staff in the acquired firm, especially if they have pocketed a chunk of this cash, have little incentive to stay with the newly merged business.
Deals are often structured to include deferred payment in order to avoid this problem. Sellers are promised more money if the business performs well in the year or two following the deal. This keeps the sellers onside, ensuring that they work hard to get the extra money. It also ensures that they stay with the business in the transitional phase, making their experience available to the buyer.
These deferred payments are often contingent upon profits made by the acquired business after the deal. But that can create problems. The sellers could, for example, cut right back on marketing and research spending, ensuring that they meet the profit earn-out target but weaken the business in the process.
The deferred amount that Dillistone will pay to the seller of Voyager depends upon revenues achieved by the end of 2013. As Dillistone’s Finance Director Julie Pomeroy put it, ‘without revenue there cannot be any profit’. Although theoretically Voyager could find ways of boosting revenue at the expense of profit – by slashing prices for example – I don’t think that this would happen, or that Dillistone would allow it to happen.
This takeover could transform Dillistone
So the structure of this deal looks good – but what does it do for Dillistone? Dillistone is the global leader in the supply of software for executive search operations. Its core FileFinder product is used by over 1,100 clients in 60 countries. It added 177 new customers in 2010, mainly executive search agencies but also, increasingly, amongst big corporates that duck hefty agency fees by recruiting in-house. The business is profitable and cash generative, so Dillistone pays a generous dividend.
Voyager is based in Basingstoke but have an office in Sydney. Its acquisition broadens Dillistone’s customer base and offers possibilities for the sharing of back office functions, new product development and marketing. Before the deal Dillistone was valued at about £13m – three times its annual revenue – and it is paying two times sales for Voyager. The company believes that it can increase Voyager’s profit margins to match its own, so there could be additional financial benefits to the deal.
Acquisitions don’t always work out, so Dillistone’s Chief Executive Jason Starr will need to manage Voyager’s integration carefully. But he and Dillistone have hardly put a foot wrong in recent years. This cleverly conceived deal makes me expect more of the same. I’ll be watching them very closely in the months ahead.
• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.
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