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Acquisitions a Growing Trend Among Large Corporations

Flush with lots of cash from improved balance sheets and increased productivity, public companies found buying up smaller companies a popular way of growing last year.

Besides a trend in acquisitions, overall capital investment into businesses was on the upswing and likely will continue in 2006.

The evidence was found in many industries, including health care, biotech, financial services, high-tech and retail.

Alan Cinzori, vice president of the Software Equity Group, a San Diego-based investment banking firm focused on the software industry, said the overall number of deals and dollar volume of the deals appeared to be higher last year than in 2004.

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During the past year, many software firms have shored up their earnings and as a way of increasing their revenues, made acquisitions, he said.

Capital spending was definitely up, and showed no signs of slowing, Cinzori said.

“The software industry is driven by IT spending, and IT spending is continuing to improve,” he said.

The biggest acquisition affecting the local landscape was New York based L-3 Communications’ $2 billion purchase of Titan Corp., a San Diego diversified provider of communication technology products and services mainly to federal agencies. Combined with L-3 assuming some $508 million in Titan debt, the total deal that closed in July was valued about $2.6 billion.

That was better than the price Titan agreed to sell itself to Lockheed Martin in 2004 after Lockheed reduced an earlier bid because of an ongoing federal probe into bribery allegations on the part of contracted Titan workers at several overseas outposts.

Titan, with more than 12,000 employees and more than $2 billion in revenues, was big, but in September, an even larger blockbuster event was announced when Science Applications International Corp., better known as SAIC, said it planned to issue public stock.

SAIC, which bills itself as the largest employee-owned research and engineering company in the nation with more than 44,000 workers and annual revenues of more than $7 billion, has consistently maintained a low profile, as befits its business. The great bulk of its contracts are with federal government agencies, and many in recent years involve high-level security clearances for work on behalf of the Pentagon and the Department of Homeland Security.

How the fact of issuing publicly traded stock may change SAIC is hard to guess. Company officials were reluctant to say anything and simply refer all queries to its securities filings.

Chief Executive Ken Dahlberg, who took over after founder and former chairman Bob Beyster retired, told employees management considered several alternatives to determine the best way of growing the company before going public. Maintaining a costly internal stock exchange was cited as key reason for the change. During the past five years, SAIC had spent more than $2.5 billion of its cash to balance the exchange called Bull Inc.

While the initial public offering will open things up on the ownership, the process that provides multiple share allotments to existing stockholders ensures between 80 percent to 90 percent of ownership will remain in employee hands.

Though the stock price won’t be known for months, and because stock ownership among rank and file employees is so high, the process will result in thousands of instant millionaires, according to one former employee.

In mid-December, the company postponed the shareholders meeting to approve the stock offering until after it filed its annual audited financial report in April. Dahlberg said SAIC needed more time to resolve ongoing problems with a contract it had with the Greek government during the 2004 Olympic Games.

Whatever the reason for the delay, SAIC’s plan to go public wasn’t the most common route for smaller, growing firms to take their business to the next level.

“There’s no question that (going public) is being re-evaluated by more companies in light of all the costs and the incremental work associated with the fact of being a publicly traded company,” said Ed Lake, CFO for SYS Technologies Inc., a San Diego based engineering services firm whose stock is traded on the American Stock Exchange.

Not only does the fact of running a public company bring increased scrutiny from outside auditors, regulators, and shareholders, it results in higher costs from detailed quarterly and annual financial reports, as well as legal expense.

Public companies’ accounting expenses climbed considerably starting in 2004, when new provisions of the Sarbanes-Oxley Act of 2002 took effect, requiring public firms to provide detailed explanations about their internal control systems, how these operate, and how effective these are in identifying mistakes.

In many instances, those additional reporting requirements more than doubled their annual auditing costs, and caused many to hire outside accounting consultants to ensure that the reports were done correctly and on time.

One local accountant said for companies that didn’t maintain detailed internal controls reports, spending about $1 million wasn’t that unusual.

On the plus side, the demand for experienced auditors and accountants increased so much one accounting professor labeled Sarbanes-Oxley as “a full employment act for our students.”

Peter Shaw, CEO of Akonix Systems Inc., a private San Diego-based maker of software aimed at protecting instant messaging systems, said due to higher costs associated with public reporting and increased personal liability by executives, many smaller firms were considering other alternatives to going public to continue growing. Many were also thwarted from seeking public status by a generally anemic stock market last year, he said.

From the acquiring company side, many firms were flush with cash and looking for a better return than what their money would garner in stocks or bonds, Shaw said.

“The cost of money was still low and many companies felt it was much better to use their cash by investing it into other enterprises rather than leaving it in the bank,” he said.

Yet in spite of all the added hurdles, some companies continued to tap public investors as a way to obtain needed capital to expand their operations, and grow.

Through December, four local firms issued stock, including three biotechnology firms and a savings bank. And last month, the biggest potential IPO (except for SAIC’s) was announced when Vista’s Directed Electronics Inc., a maker of car alarms, announced plans to issue 9.4 million shares at $16, which would raise nearly $150 million, not counting expenses.

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