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Heard off the Street: Rolled over by a rollup

Monday, April 30, 2001

By Len Boselovic, Post-Gazette Staff Writer

A few years ago, Blockbuster Entertainment executives had a grand idea: Buy a bunch of successful family owned florists, apply professional management, achieve economies of scale, earn greater clout with suppliers and live happily ever after in a rose garden.

So they formed Gerald Stevens (ticker: GIFTE.OB) and purchased a host of flower shops, including two of Pittsburgh's finest: Shackelford's & Maxwell's and Johnston the Florist.

Using a combination of cash and stock, they spent $170 million in 21 months to acquire over 300 retail shops, a flower importer and a catalog business.

The Blockbuster execs didn't originate the concept, known as a rollup because consolidators roll up a bunch of small businesses into a big ball. Other entrepreneurs have tried to consolidate the same way, achieving varying degrees of success and failure.

In Gerald Stevens' case, the roots never took hold. Last week, the Florida floral giant filed for Chapter 11 bankruptcy protection.

"The problem was not with their plan. The problem was with the execution of their plan," says one florist who sold his business to Gerald Stevens.

What happened to Gerald Stevens is reminiscent of what happened to the big vision guys who tried to consolidate the scrap metals industry a few years ago. Both industries are dominated by mom-and-pop operators and both efforts offer lessons for investors tempted by the concept's lure.

For starters, companies that buy a lot of competitors over a short period of time routinely pay too much and don't know what they're buying.

In the scrap industry, there were three consolidators -- Philip Services, Metal Management and Recycling Industries -- who bid up the price of acquisitions in their frenetic desire to be the biggest. Metal Management disclosed it didn't even bother taking soil samples at junk yards it was acquiring, which meant it didn't know what environmental liabilities it was buying into.

Whether he's buying a scrap yard or a flower shop, the consolidator must decide what to do with the owner of the acquired company. Obviously, the owner knows the local market better than acquirer, especially when the acquirer's experience is renting videos. Gerald Stevens' problems, according to the florist, were that it got rid of a lot of the owners and tried to impose a nationwide plan for products and pricing. As a result, it ignored the fact that different markets have different tastes.

"It's not a cookie-cutter [business] like McDonald's," the former owner said.

However, if the consolidator retains former management, will the former owner work just as hard for the consolidator as he or she did for themselves? Even if they do, there could be problems. After running their own business for years, owners will have a hard time being part of a big corporation.

"They don't fit in. They're entrepreneurs," says one Pittsburgh businessman whose company was swallowed up in the scrap industry rollup.

He says the accounting and other business systems of the companies acquired typically aren't compatible with one another. It takes time and money to convert them to a common system. Until that's done, the consolidator won't be able to achieve many of the efficiencies that would make the rollup work.

"The basic philosophy of the rollup makes sense, but you can't do it in all industries," he says.

He found that out the hard way. He sold his company for the acquiring company's stock, which eventually proved to be worthless. At least florists who sold to Gerald Stevens got a combination of cash and stock. The more cash they got the better and the sooner they sold their stock the better. Gerald Stevens shares closed Friday at 19 cents, or less than 4 cents a share if the stock hadn't reverse split 1-for-5 in November.

That's something for investors to think about the next time a rollup artist rolls into town.

A column two weeks ago explored the choices companies have in dealing with underwater stock options, a disease afflicting many industries but none so much as tech companies. Options have become an important tool to attract and retain employees.

Once a stock's price falls far below the option's exercise trigger, however, the tool doesn't do the job. So companies are issuing new options, lowering the exercise price and exchanging options for restricted stock in an effort to prevent employees from leaving.

One Pittsburgh company proves the same tools may be needed to get someone out the door.

In October, iGate Capital Corp. (IGTE) signed an amended employment agreement with Bruce Haney, the information technology service company's chief financial officer. Haney held the same job at the former Fore Systems and came to iGate in March, just as shares of the company were peaking at $77.13.

It's been all downhill since then. On Friday, iGate shares closed at $2.11.

Haney's new employment agreement was outlined in an annual report iGate filed with the Securities and Exchange Commission late last month. It gave him a $25,000 a month job until March 31, which is when he walked out the door. It also provided for $225,000 in severance pay.

And it allowed Haney to exchange 300,000 underwater options for 40,000 shares of restricted stock that became Haney's on March 31. Of the options, 250,000 had a trigger price of $25.21, a level iGate hasn't seen since last spring. The other 50,000 had an exercise price of $8.78, about where iGate was trading in early August.

It would have been some time before Haney's options were worth something. At Friday's closing price, the stock is worth $84,400.


Len Boselovic can be reached at lboselovic@post-gazette.com



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