Why Bigger is Better: A Look at the Recent Wave of Consolidation in the Information Management Reseller Channel
InStream Buys Tallega
The recent acquisition of Tallega Systems by InStream (http://bit.ly/InStreamTallega) is just one of many M&A transactions we’ve seen executed recently among the document imaging reseller community. There have been ongoing rollups by larger entities like DataBank and Konica Minolta. Larger VARs like KeyMark and InStream have also gotten in to the acquisition game. We’ve also seen acquisitions by VARs like CASO and MetaSource that have expanded their capabilities into related by new markets.
Xamcor recently caught up with Mark Hinson and David Gerber, the principals at InStream and Tallega and discussed the recent joining of the two organizations. Sean Nathanial, the GM of FileBound at Upland Software, whose application is resold by both companies, weighed in with his opinion on how the reseller channel is evolving.
Paul Carman, President and CEO of Xamcor, an industry veteran with almost four decades of sector experience, also shared his thoughts on what we are seeing in the industry, as well as with this particular acquisition. Finally, Sean Parnell, president of Innovaxis Marketing Consulting, shared his views, honed through working with more than 40 imaging resellers over the past 15 years.
Xamcor: Why are we seeing an upswing in M&A among resellers?
David Gerber of Tallega: If you look at what is included in a basic document imaging software package today—10 years ago, that type of system was selling for $250,000-$300,000. Today, you are getting $50,000-$60,000 for the same thing. Also, it used to be that the larger ISVs could generate $300,000 in professional services on $200,000 worth of license fees. Nobody is going to pay a quarter of a million dollars for professional services on a $70,000 software sale. This is all great for customers, but it makes it more challenging for VARs. Basically, you now have to sell two to three times the number of installs just to generate what you’d consider to be normal revenue.
Mark Hinson of InStream: There are a lot of VARs stuck in the $1-2M range. They are still getting deals, but the deals are smaller, so they are making less. The market for these guys is becoming harder and harder.
Sean Nathaniel, the GM of FileBound at Upland Software: On one end, you have what I call commodity resellers who are basically selling search, storage, and retrieval applications. On the other end, you have VARs selling value-driven solutions. The commodity resellers are selling out to the value-driven guys.
Sean Parnell, Innovaxis; Many document imaging resellers were founded in the ‘80s and ‘90s as spin-offs from large vendors like Kodak. For awhile, life was good in a growing market. Those that survived the Great Recession are now facing retirement with the unpleasant realization that they may not be able to sell their business for enough to fund their golden years. This, combined with the desire of companies to grow through acquisition rather than organically, has led to a wave of consolidation that has steadily intensified over the last 5-10 years to the point where it’s either grow through acquisition, be acquired, or put your head into the sand and recede into the distance.
Paul Carman of Xamcor: This acquisition is very typical of what we have seen in the past and what we will see in the future. As an industry matures, it enters a consolidation phase, which we are well into in the ECM space. This consolidation is taking place in companies of all sizes and in all regions of the world. As we continue to see the placement of mission critical solutions, the scale of the solution providers becomes more important. All companies, large and small, want to assure themselves that the vendor is large enough to support their needs wherever they may occur in the country or the world, and they want to deal with vendors who have a solid financial footing.
Not that Tallega would be classified as a commodity reseller. In addition to FileBound, it resells software from Kofax, ABBYY, Ephesoft, and Eccentex.
Gerber: We bring extensive expertise in advanced capture and invoice processing that will complement InStream’s current offerings. We also have some very large customers.
Hinson: This acquisition puts us squarely in the top handful of FileBound resellers. In addition, Tallega is very strong with Kofax, which is a big advantage for us. Tallega also has a tremendous install base east of the Mississippi which was attractive, and their being headquartered in Irvine, CA, gives us a West Coast presence.
Tallega was co-founded in 2005-06 by Gerber and CTO Peter Klentos, who had worked together at document imaging ISV Magellan, which was acquired by German ISV Gauss. After Gauss was acquired by Open Text, Gerber spent some time as director of global alliances for Kofax.
Gerber: In that position I got to travel all over the world and meet a lot of people in the market. The more I talked with resellers, I learned that most really had no clue how to present a completely objective opinion to their customers and recommend a solution that was right for them.
They’d say stuff like, “I’ll put in what I want to put in.” That’s because they only offered one product that they would shoehorn in to everything. I thought to myself, ”If the market gets tight, you have no chance.” And sure enough, a bunch of those resellers ended up going out of business.”
Tallega has offered multiple capture and document management products over the years, starting with the old Magellan software and bringing on FileBound in 2007.
Gerber: Two years ago, you really started to see the start of the consolidation trend for resellers. DataBank was one of the first to recognize that if you mash together a bunch of resellers with overlapping products, your margins go up because you establish yourself as a top level partner—whether that’s diamond or platinum, and you can consolidate back-end services. We’ve seen others like Konica-Minolta, Ricoh, and KeyMark follow suit.
Nathaniel: Larger resellers are able to invest more heavily in technological resources, which means they know the FileBound product better. This increases the breadth and depth of what they can do and leads to better and bigger deals.
Hinson: Our increased size definitely helps us get into larger deals. It gives us better support capabilities. We now have seven people certified on FileBound. Most of the smaller $1-2M VARs have an owner/operator that is dividing his time between sales and support.
Carman: InStream truly understood the market needs and the need to scale and provide the right solution, no matter what that might be.
Parnell: It’s not often that an acquisition makes as much sense as this one. There is a synergy in both product and market expertise, as well as nice geographic coverage.
Upland’s release of FileBound 7 last year was designed to move its software upstream into the more complex implementations that enable resellers to thrive into today’s market.
Nathaniel: In version 7, we improved our workflow, and when you marry that with our new e-forms and analytics capabilities, the software can be used to create a value proposition that really resonates with customers. The types of solutions that our partners are being pulled into with the new software are much more complex and require a certain level of domain expertise.
For example, we are now addressing complex logistics around scoring and evaluating applications. While formerly we were able to capture information from an application and process it in our workflow, our software can now capture and evaluate the information, and not only get it to the right people, but get it there scored correctly. The traditional jack-of-all-trades reseller is typically spread too thin to support these types of higher-level implementations.
When we are looking for new resellers, we are looking for those with specific domain-level expertise. They may have ECM experience and they may not, but we can help them with ECM technology. The domain expertise is what resellers today have to bring to the table.
Hinson: With document outsourcing services, you can’t just offer scan, indexing, and storage anymore. What we offer to healthcare payers is an entire backroom operations solution. Our secret sauce has to do with enrollment services. We offer a service that is able to bring in all documents—whether they are paper, faxes, e-forms, coming in through a website, etc. We are able to extract the necessary data and then, using other data, can make a preliminary decision on whether the applicant should be accepted or rejected and route their application into the correct workflow.
You need to offer a more complex model like this to be successful. It helps us avoid the whole cost per page conversation.
Nathaniel: Customers aren’t looking for ECM solutions anymore. Everyone already has one or two ECM systems. But, if you tell an organization that you have software that will help them manage something like their loan origination process, they are willing to pay a premium.
Part of it is being able to speak a customer’s language. Six different purchasing departments might need the same solution, but call it six different things. A reseller’s job is to figure out what the buyer wants and offer a solution to them described in their own language. That’s where the value of domain expertise comes in.
Before being acquired by InStream, Tallega had been on the acquisition trail itself.
Gerber: We tried a couple of deals that ended up falling through. After that, it came to my attention through FileBound that Mark was interested in talking with us. I knew Mark, so I liked that idea a lot.
We didn’t do anything special before putting the company on the market. Our goal was always to average a 50% gross profit margin, which is very hard for a VAR. But, we were able to succeed by focusing on selling high-value systems and not offering a lot of discounts.
Gerber and Klentos each have multi-year contracts with InStream. Gerber is now InStream’s director of Western operations.
Gerber: In the first year, we expect some disruptions as we move our office and go through the consolidation of our accounting and sales systems. But, InStream offered very attractive incentives to deliver growth, so that’s exactly what we’re going to do.
Hinson: You have to take care of the employees of the companies you buy, as well as the customers. If you take care of the customers and employees, the financial side will take care of itself.
Tallega is the third acquisition that InStream has done. In 2011, it acquired Infotek, a Knoxville, TN-based ECM reseller. Last year, it acquired the FileBound install based of another reseller.
Hinson: Acquisitions are a great strategy for us. Tallega is going to help our company grow 30%. Organically, we could not grow near that rate. We’d like to continue to do an acquisition a year. We are funding them through our existing cash flow and a line of credit. I now spend more time focusing on acquisitions than anything else.
InStream has developed a formula for success that is based on certain qualities it is looking for in a potential acquisition:
Hinson: The acquisition target should be a certain size. If it’s too large, it will be more than we can handle. If it’s too small, the deal is not worth doing—we could just hire a sales rep and his quota could add the same amount of revenue.
If we are able to reduce spending in certain areas due to eliminating redundancies, that obviously makes our operations more efficient. With the Infotek acquisition, because they were only a few hours away, there was a tremendous opportunity for consolidation of back-office, as well as document outsourcing, functions. Tallega dealt with a lot of the same products and vendors, so we can consolidate some support functions.
We look at opportunity for geographical expansion. There are some places we are interested in being. With the addition of Tallega, really the only area in the U.S. we don’t have coverage in is the Pacific Northwest. There are some geographies where we are looking to create a more substantial presence, particularly in the Midwest.
Finally, if someone is doing something entirely different from us, but we see it as a trend, we would clearly take a look at that.
Carman: It is clear he has a plan and strategy, and evaluated opportunities based upon this strategy and vision. Having a solid plan is the key to success, and enables an acquirer to know when to move forward and when to decline a possible opportunity.”
Parnell: It will be interesting to see who acquires and is acquired next, and if a synergy in each case is actually achieved that leads to an increase in market share – and/or if some of the acquirers implode because of poor acquisition decisions and financial management. It will also be interesting to see how software vendors, the majority of whom sell direct, are affected by this channel consolidation and if the vendors who are more channel friendly, like FileBound, Digitech Systems and the hardware vendors like Kodak Alaris, gain a competitive advantage through having larger, stronger channel partners.
Hinson concluded that is he also excited about adding some youth to the management team at InStream, as Derek Gerber, Dave’s son, joins the company.
Hinson: There are not that many people in their 20s and early 30s entering this market,” he said. “Derek is very strong in marketing and we are excited about his coming over with some new ideas in that area.”