Playbook: Head in the Cloud

Playbook: Head in the Cloud

A private equity firm sees a Minnetonka IT reseller as the foundation of a big opportunity.

I have always been intrigued by the concept of private equity investors agreeing to provide a slug of capital to an executive or group of executives who have nothing but a plan. When they invest, there is no product, or customers, or assets—nothing to acquire. I guess that means there should be no argument over valuation.

Any private equity manager would persuasively argue to his investors that, in fact, he or she just invested in an asset, meaning the skill and reputation of an executive team. Just such an investment—funded by Goldman Sachs Private Equity Group by way of Atlanta—recently took place involving Minnetonka technology services provider Nexus Information Services, which began 25 years ago as a St. Cloud–based storefront dealer of Apple Computer products.

Nexus was acquired by Stratos Management Solutions, which was founded last year by three executives with deep backgrounds in the information technology service industry. The business plan I heard summarized by Stratos Cofounder and Chief Client Officer Ken Brown is far from revolutionary. I would characterize it this way: They seek to restore great customer service to the field of information technology services.

Brown offers just one example of what he is talking about. He used to work at Hewlett-Packard, where he says he can recall client visits at places where management took IT seriously and had invested well in the heavy infrastructure. The server closets were in great shape. The regular users, on the other hand, were more or less on their own. He would walk through an office suite of managers and see that half of the network printers were offline because they lacked the right print cartridge, and PCs repeatedly popped up warnings about out-of-date virus protection software.

Stratos intends to buy IT services firms and value-added resellers (VARs) in the central United States and offer expertise for all IT sectors, from server closet and data in the cloud down to printer cartridges and syncing corporate systems with the CEO’s new iPhone. The company’s plan as of today is to find firms to buy that fill in a big L shape across the country, with the Twin Cities at the top of the L, heading down to Houston and then over to Florida. Stratos wants companies with a client base that is pure middle market, the kind of organization that larger service providers often ignore and smaller ones lack the capability to serve well.

It’s searching for firms in the right markets, with a mix of business between system sales and services that favor services. It also is looking for firms with annual revenues of $25 million or more.

“There are literally thousands of value-added resellers in this country between $2 million and $9 million,” Brown says. “It’s a whole different ballgame when you get to $15 [million] or $25 million,” which tend to be looking to grow and take things to the next level, as was the case with Nexus.

After a national acquisition search, Stratos ended up in Minnetonka. Nexus may have begun as a little Apple shop in St. Cloud, but the entrepreneurs who led the company moved it several times, changed the name twice, and changed the focus most recently to corporate users. And survived—no small feat. The day of a recent tour, the last boxes were going out the loading dock door for a deployment at Fairview Health, hardly a mom-and-pop-size client.

When Stratos got there, Nexus was, in fact, a pretty significant value-added reseller, which is a dealer of sorts that clients hire to source and install IT solutions and make them work. Big software firms and hardware providers all have a network of VARs of various sizes to work with the many thousands of smaller customers they could not possibly all reach with a direct distribution model. Cisco Systems, NetApp, and VMWare are among the logos prominently displayed in Nexus’ marketing materials. Nexus has more than 80 employees and had revenue of $32 million in 2011.

Nexus President John DeRocker says he and his partner, Dan Evans, had been exploring options for more than a year and had seen several letters of intent by the time Stratos appeared. Some of the proposals, he says, were drafted by prospective buyers who appeared to want to change the focus of Nexus.

DeRocker says he has been to the merger rodeo before, adding that maybe up to 40 percent of his staff had been through some sort of merger situation. And despite all the reassurances, DeRocker says, an employee’s world is always turned upside down post-closing. He says that Stratos executives insisted otherwise, and that Nexus was the very asset they wanted.

DeRocker and his Nexus team would stay and work with their clients, and build out more services. DeRocker and Evans came to believe in the Stratos approach, and acquisition discussions moved forward; the transaction closed in the first quarter of this year. Stratos has plans to buy two or three more firms about the size and scope of Nexus, grow to $200 million in revenue within three years, then focus on organic growth.

The Stratos founders, with backgrounds at places like Hewlett-Packard and EDS, have the money to build the firm. Goldman Sachs provided the capital to form Navigation Partners in 2006 and put up all of the capital for Navigation’s next fund, which is the pot of money funding Stratos. Stratos and Navigation Partners have, in effect, made their “make versus buy” decision, concluding that it was easier to get to their 20-plus percent investment target by making a big company out of Nexus and other IT firms rather than paying much higher valuations for a large IT services provider.

Nexus has lost just two employees since the date of closing, which DeRocker and Brown point to as a sign that the integration appears on track. One or more of the Stratos partners spends at least three days at Nexus each week. Dan Evans stepped down from the firm upon the closing of the sale to Stratos, but DeRocker is very much on board. He says that he is working without a contract for as long as it is fun and Stratos wants him.

“Believe it or not, the hardest part has been to convince people that, guys, the change isn’t coming,” DeRocker says. “It’s all about adding things on top of what we were doing. We now have open headcount [postings] for sales, services, consultants, data center managers. It’s pretty exciting.”

Lee Schafer, a former managing director of Minneapolis-based Sargent Advisors, was recently named a business columnist for the Star Tribune.

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