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John Sumser

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(September 20, 2002)  - The article about Workstream (WSTM) appeared under the "small business" banner in a recent edition of the Wall Street Journal. It described Mike Mullarkey's endeavors to assemble a working company from the various pieces that are lying around damaged by the downturn and the dot-com bust. Mullarkey has his eyes on at least 70 acquisition targets.

The sad state of our industry is clearly defined by Mullarkey's view. There are 70 companies in various stages of decomposition, hanging on for life, who look like prospects for Workstream's roll-up approach. It has been a long, hard, eighteen months. Strapped for cash, behind with creditors and or at the steep end of pipeline development, any number of entrepreneurs are looking for the way out of the daily grind. While the situation is arguably worse elsewhere, all of the 70 companies are clearly having their first experience with a recession.

Watching the industry respond to the recession has been, um, interesting. The economic change did not hit all of the players all at once. Rather, it moved like a wave. It hit consulting firms first, ad agencies second, media properties third, software firms fourth and finally settled in to the admin companies. It was often quite comical to watch novice CEOs play "blame and sue" with the layer of companies who were a step closer to the customer in the supply chain.

How a company fared during this difficult time depended more on the sheer volume of cash in their treasury at the moment the recession arrived at their doorstep than any supposed level of managerial competence. Each firm in our business experienced a round (or two or four) of cutbacks, downsizings and wrenching changes in atmosphere. Our back of the envelope estimate is that the ranks of professional recruiters (corporate and third party) were slashed by nearly 50%. HR departments in general were cut by nearly 35%. Intra-industry spending on advertising and services plummeted to 30% of the prior year.

Business is a delightful mindset that makes one person's difficulties another's opportunity. A few companies were clever enough to hunker down for an 18 month downturn. Operations like Salary.com and Hire.com figured out how to grow in spite of the circumstances. Exult and the other outsourcers were able to secure their niches as a component of the broader economic cost cutting.

Mullarkey and Workstream began to see bargains.

A typical component of survival during an economic downturn involves renegotiating outstanding debts and rearranging relationships with investors. Often called "cleaning the balance sheet", investors and creditors are often offered (in a move that resembles the famous 'don't move or I'll shoot scene from Blazing Saddles) the opportunity to recover 'some' of their investment in cash (for investors) or services (for creditors) if the existing terms can be rearranged. The gist of the deal is that it's better to get a little bit back than it is to get nothing.

A Workstream acquisition works that way. Distressed companies with impossible financial circumstances can be acquired by 'rinsing' the balance sheet. Often, investors are given shares in the new entity while creditors are guaranteed smaller but reliable payments. It's not unlike flea market or garage sale shopping. The acquisitions involve little cash. Instead, the leaders of the failing entity are given the opportunity to get out from under the terrifying stress of unhappy investors and angry creditors. At pennies on the dollar (usually a tiny multiple of cash flow), the companies are folded into the larger concern.

Financial stakeholders, also well beaten by the downturn, are often quite happy to have the promise of something. It gives them the opportunity to get out of legal proceedings, to stop taking collection actions and to refocus on their real businesses. Generally, everyone walks away from the deal relieved. Joy and happiness (which were a part of the acquisition process during the bubble) are left for another day. Survival is the issue.

Workstream has built an impressive collection of firms and functions. Business by business, it's an anti-cyclical (recession proof) set of services that meet a broad range of needs in our customer community. With jewels like Icarian, Pure Carbon, and 6 Figure Jobs the company has cash flow and the potential for market leadership. It's becoming, on one level, a very solid mid-market play.

The risk, and this is business, there's always a risk, is that the integration of distressed companies into a single functioning whole will prove either impossible or too expensive. One look at TMP's non-Monster acquisitions should be enough to tell you how difficult, risky and expensive the integration of acquisitions actually is. Mullarkey's success will depend on one of three scenarios:

    1. Finding an investor who wants to cover the integration costs (the quick fix and unlikely);
    2. Saving enough money from operations to pay for the integration (a 24 month solution requiring extreme discipline); or
    3. Finding a buyer in the next year and a half who is willing to bear the integration risk.
Each of the success scenarios requires that market innovation remains flat while Mullarkey runs an extremely cost conscious and well disciplined endeavor internally. We believe that he's capable of the operational requirements but wonder about the firm's ability to accomplish the minimum levels of integration. While we can clearly imagine scenarios in which Mullarkey and his core team make a solid return on the play, it's much less clear that they will actually build an enduring enterprise.

- John Sumser © TwoColorHat. All Rights Reserved.

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