Finance management principles and practices

Finance Management

Engagement Overview

Louis Elson trying to determine how much a 51% stake in TeamSystem S.p.A. is worth. His firm, Palamon Capital Partners, is putting together a purchase bid. As a general fund, Palamon's objective is to take TeamSystem from a small private company to a larger public one. Palamon is undertaking this purchase with the understanding that they are neither attempting to operate the business nor are they intending to hold onto TeamSystem for the long-term.

The sources for information that they have right now are for the most part the private records of TeamSystem. The accounting statements are pro-formas. Much of the information about the operations of the company come from a few contacts in the industry and the present CEO Giovanni Ranocchi.

Company Background

TeamSystem is an Italian payroll servicing company, with over 20 years of history. They are run by cofounder Ranocchi. At present, they hold a 14% market share, which is second highest in the fragmented market in which they operate, the only larger competitor in Italy holding 15% of the market.

TeamSystem had earnings in 1999 of 9.5 million euros, on sales of 31.3 million euros. Over the past five years, the annualized sales increase has been 15%. The annualized EBIT increase has been 31.6% over the same period, due to increased efficiency.

TeamSystem develops and markets software that allows its customers to integrate their financial information and automate some administrative functions. Because regulations in the Italian market change frequently - up to four times a year - TeamSystem is in a state of constant development in order to keep on top of these changes and provide full value for their customers.

The nature of taxation means that for the most part, each individual market is closed. There are a handful of large firms that operate in multiple countries, but these are not a factor in the complex Italian market. Most of TeamSystem's 30-odd competitors are small, family-run enterprises. The industry is expected to see a round of consolidation over the next few years, a trend that has already begun in the past year.

At present, the management team at TeamSystem is heavily reliant one Giovanni Ranocchi. Though Ranocchi himself is considered to be a strong asset, having guided the firm through its strong growth in the past five years, he is essentially a one-man show. There is considerable doubt as to the abilities of the team underneath of him.

In terms of TeamSystem's ability to compete, they are viewed as an admired competitor by their rivals. There are going to be challenges going forward, however, as they will need to keep abreast of a rapidly changing business environment on account of the proliferation of the Internet, which may bring new competitors into the marketplace and put strains on the development side of the company to move more quickly in adapting their product to new technologies. At present, some of the platforms used by TeamSystem software are obsolete and will require significant investment for TeamSystem to continue its path for growth.

Analysis

TeamSystem is in a strong position. They have a healthy market share in a market that is subject to both growth and turmoil. There are opportunities for growth on many fronts. There is a round of consolidation in the industry. As many of its competitors are family run and thus do not have access to global capital markets, TeamSystem enjoys a strong position in terms of being able to make acquisitions. This can allow TeamSystem to grow into a position of market dominance prior to Palamon's exit.

The Italian market is growing. This makes it a reasonable proposition that TeamSystem can maintain its historic growth levels without exercising competitive advantages. In this industry - the way the tax codes are constantly changing - it seems reasonable that many firms expend much of their resources merely keeping up with the tax codes, leaving little time and money for strategic initiatives. The guiding hand of Palamon could add real value here, increasing the opportunities for growth.

Moreover, the rapid pace of technological change the industry is facing provides strong growth opportunities. Should TeamSystem be proactive and take a leading role in the adoption of new technologies, they can steal market share from slower competitors. That they need to do an overhaul on many of their programs to bring them to modern platforms seems like a great time to move directly into a leadership position - the money will be spent anyway.

There are strong opportunities for exit. If TeamSystem can capitalize on opportunities for growth, they can position themselves for either a sale or an IPO. In terms of an IPO, TeamSystem is expected to show steady growth. The market is kept relatively closed by the complexity of the Italian taxation system. Furthermore, the company has a strong leader.

The opportunity for a sale might be even better. Two factors are at work - the Internet and barriers to entering the Italian market. The Internet is increasing the pace of technological change in the tax software industry. This is going to increase R&D costs, meaning that economies of scale will become more important. Also, we are seeing at this time that other industries are leveraging the Internet to take their operations global, as physical barriers become less relevant, particularly in a service-based industry such as this. Put the two together and you have large firms looking to take their operations global to improve their economies of scale. The best way for such a firm to enter the Italian market would be to purchase an existing operation, and with few non-family firms to choose from, TeamSystem would be a natural acquisition target.

These considerations aside, there are risks. The biggest risk at present is the management team. Aside from the CEO, this team is considered to be weak. Yet, to achieve the growth objectives and goal of technological leadership, a strong team will be needed. If Palamon makes the purchase, their first objective should be to build a better executive and management team.

In terms of the valuation of TeamSystem, the free cash flow method yields a value of 14.4 million euros for the company today. This places a strong emphasis on achieving the growth objectives in order to make the purchase bid worthwhile. A case could be made for lowering the bid amount in order to reduce some of the risk.