Press Release

February 01, 2005

CAPSTONE PROVIDES INSIGHT INTO COSMETOLOGY TRAINING CONSOLIDATION

The Dynamics of Consolidation
With James Beakey

James Beakey is a Vice President with Capstone Partners LLC, based in Boston. His firm was involved in the sale of Blaine Beauty Schools to Regis Corporation.

Boston, MA - February 2005 - A cosmetology school owner entertaining ideas of selling shouldn’t wait too long to put a school on the market. The best deals will happen or be on their way to happening by June 2005. While there will still be consolidation after that, the valuation will start to drop. Quality schools will still bring fair prices, but as time goes on there will not be as much interest in taking up the smaller chains.

Why now?

The dynamics of the cosmetology industry are moving toward consolidation. It’s a super-fragmented industry where larger businesses have the potential to put together a very profitable company.

Empire and Regis are doing it, while others like Paul Mitchell, Aveda, and to a lesser extent Mascolo (Toni & Guy), are looking into the business. There could also be others who would build a business in this space. Each of them has a different take on how to build the business and, ultimately, different focus areas. Empire and Regis are the two principle consolidators right now, and my guess is that they began looking at schools because they got big enough. Regis is in salons, and had enough capital and ability to shift its attention to a new area. The company had been interested in schools for a long time. A similar statement can be made about Empire. It has done the local consolidation and has a partnership with Key Principal Partners that provides it with a significant capital base, so Empire can go out and do the deals.

Branching vs. Buying

Eventually I believe cosmetology groups will start branching, just as other career colleges did after doing a great deal of buying. However, there are change of control issues going on the Department of Education right now that might preclude that, particularly for the private guys. Certain businesses may not be able to branch as quickly as they want to. Ultimately, I think they will be able to, buy buying may be the only solution to growing a business in the short-term.

Over the past five years there has been a big push by private equity, which is really looking to put money to work. Many good deals have happened, and we believe there are many, many good deals left to go. The Blaine Beauty School sale is evidence of that. I’m 100 percent certain you will see some great deals happen over the next 6 to 12 months in the cosmetology space. These are the building blocks for a business, and even though the school groups are small there are still deals to be made. Maybe we’re building with bricks instead of cinder blocks at this point.

With private equity, it is harder to look at the smaller groups, but they need to deploy capital. The only way to do it is to build the wall of their business, and some smart guys are going to find that it makes sense to spend time and pick out the tight bricks and buy a bunch of them.

Making a School Attractive

I don’t want to give the wrong impression; there are some people in the fringe markets who won’t be able to maximize value. They won’t get an eight or nine time multiple in a non- densely populated area. They may have high quality schools, and be reasonably profitable, but if they are not in a big television market for a chain such as Empire they might not get much attention from them.

And when you take away one of the big buyers in a bidding process, you’re not going to see big multiples being paid. I recommend that schools adjacent to or around a larger population center combine with a friendly competitor across the country. If you have two schools and 300 students and your competitor has two schools, do a mini-consolidation around a particular population center. This will make the schools a much more attractive asset. In addition, cosmetology school owners hoping to sell should run the business in a professional manner.

At the worst, with clinic revenues coming in, some operators historically saw it as a tax avoidance mechanism, which is just plain illegal. Other owners had tended to have a passion for the profession, a passion for education, rather than business. Now we’re seeing more second-generation owners who are more focused on the business aspects of the company and maintain professional records.

They have relationships with a trusted advisor, like a lawyer or an accountant. These relationships are critical, for more than running the business. If an owner wants to sell, he or she needs to have those people in place. Administration has become much more complex as you deal with the DOE and financial aid. Those who have succeeded and continue to succeed have detail-oriented business folks on their team. These are people who have not lost the flare and creativity that is required in this business, but also have the ability to look at the numbers and to focus on profitability.

Interested in Smaller Schools

We are a large company, but we are interested in smaller deals in certain market areas. One of our strategies is to focus on companies that don’t get a lot of professional investment banking attention, but give the Wall Street level of service. On average, our fees are probably smaller than those of our competitors, but we’ve had some terrific successes over the last year. We are doing well enough to go from space on the seventh floor of a building at 18 Tremont Street to the 39th floor of One Boston Place in a year.

Out goal is to bring Wall Street-level investment banking services to the lower end of the middle market, or companies with less than 100 million dollars in enterprise value. Smaller companies like the Blaine Beauty Schools need business brokers. Blaine’s may have been small, but a transaction like that is right in our sweet spot. There was very strong interest in Blaine, both from within the cosmetology industry and from the private equity world. It had about 1,500 students in six locations, and had been in four of those locations for many years. Regis has been in the market for schools for some time. Finally the timing was right and the right asset came up for sale.

Matching Schools with Buyers

Our model is very appealing to entrepreneurs and family owned businesses because it’s different. We call it M&A underwriting, which involves investigating a particular area of investment and talking to particular potential clients. If we like the possibilities that they provide, and their willingness to move forward with the transaction at a certain valuation, then we partner with our clients. We do not charge a retainer or bill for out-of-pocket production in execution expenses the way some other banks and lawyers do. We charge for airfare or hotel stays when required, but that really resonates with entrepreneurs and small business owners.

We have no resistance to working with cosmetology schools. In fact, we think it’s a great sector that’s under appreciated. There are about 1,800 cosmetology schools in the United States, and the vast majority are single schools, run by the owner. Our somewhat arbitrary threshold is for a school or chain with 400 or 500 students. There is also a demographic component. If I can find a mom-and-pop operation with 500 or 600 students in a densely populated area, even though it may be competitive and challenging there because there are many others like them, that might be a good first step for a salon chain or private equity firm or anybody. A densely populated area is a good place to get started. In an area like Miami, I would guess that there are a number of schools there and that two or three are larger. If they’re doing well, they might be good targets for potential buyers.

Auction Model vs. Direct Representation

When it comes to the sale of the school, we generally prefer direct representation to the auction model. The auction model is good for certain situations and we would employ a broad option model for the right client. However, we take more of a personal approach and try to establish distribution channels before bringing an asset on. For example, after we talk to a school and get to know who they are, based on historical business performance, geography and any other number of factors, we can pretty quickly identify the right buyer for them.

In that case not much would be gained from the broad auction model, other than risking confidentiality disclosure issues. A client is better off targeting two or three logical buyers. The buyers in this market know who we are, and when we bring an asset they pay attention. Generally we get a deal done much more quickly and much more effectively at a higher valuation because we know where a client should go. A liquidity event may maximize value, but a school owner also wants to find the right fit. There are employees who have helped the owners grow the business, and are important to the owners. You want to find a buyer who’s going to treat these employees the right way, someone who’s going to be a good buyer, and that’s not necessarily the guy who’s going to pay the last dollar.

Identifying Niches

Our company intends to move into the entire career college sector. We will focus less on the distance learning component of it and more on the vocational-technical training schools. We think distance learning is a great sector, but our area of expertise and the long-term opportunities in the space are going to be in technical training and vocational schools. There are some major players and well-established investment bankers in that space, but our work with cosmetology demonstrates a willingness and ability to identify niches within larger markets and work with those. Some people would call these the smaller competitors, and we can help them realize great liquidity for their business.

Happy Talk

I am happy to entertain discussions with anyone. A mom-and-pop operation can call us and we’ll treat them decently. We have a different approach than most investment bankers. We don’t show up at meetings with a pitch about why we’re the greatest. We’re not business brokers. We are full-service financial advisors who provide a broad spectrum of services to our clients. We spend a great deal of time with people on the phone, learning about their business, exchanging information, and trying to get a handle on their position. We work with them to help them grow their business before we get into the selling part of it.

We are regular guys providing a high level of service to smaller clients. Integrity is important to us, and if we don’t have good referrals from our clients then we’re in trouble. We hold the hand of the client from the day we go in for our first pitch until the closing day, and beyond.