The anatomy of a deal | How Falmouth entrepreneur Chris Rhoades acquired an $8 million downeast hardware business

On a Tuesday afternoon in late October, the long table in a conference room at Portland law firm Bernstein, Shur, Sawyer & Nelson was covered in stacks of documents. The reams of paper, divided with heavy black binder clips, represented the last nine months of Chris Rhoades' life. Sitting next to his wife, Karee, Rhoades carefully read and signed each document that was slid across the table from his team of bankers and attorneys.

Karee sat quietly, nervously capping and uncapping a pen, occasionally leaning over to whisper to Chris. She watched as the pile of documents on the table slowly shrank; each one was tucked away into brown accordion file folders on the floor. Late in the afternoon, the last contract made its way around the table. Wendy Harlan, an attorney at Berstein, Shur, stood up and congratulated Chris and Karee. The Rhoades were now officially the new owners of H.F. Pinkham Inc., a 38-year-old hardware and lumber retailer in Washington County.

The mood in the conference room, which for hours had been dominated by legal banter and a handful of frantically tied-up loose ends, had lightened leading up to the signing of the last document. Rhoades answered the conference room phone by posing as a Kentucky Fried Chicken employee. David and Rhonda Pinkham, the owners of H.F. Pinkham, talked about plans to watch game three of the World Series.

But when Harlan announced that the last document had been signed, the enormity ˆ— and the emotion ˆ— of the situation filled the room. After nine months of work, Chris Rhoades' acquisition of H.F. Pinkham was a reality. And after decades of effort put into building the family-owned company, David and Rhonda Pinkham's involvement with H.F. Pinkham officially had come to an end.

During the month leading up to the sale of H.F. Pinkham, Rhoades allowed Mainebiz access to the acquisition process, including closed-door meetings with suppliers and employees, and a seat in the conference room during the closing. While no two business acquisitions are alike, Rhoades' experience purchasing H.F. Pinkham ˆ— from making financing decisions to assembling a crack acquisition team ˆ— offers a unique glimpse into the inner workings of the buyer's end of a business sale. "I'm emotionally drained," says Rhoades three days after the closing. "I've been working on this for nine months. When a corporation does mergers and acquisitions, they have a team of people working on it. But this was just me. Everything had to pass my eyes. It was very exhausting."

A healthy business
H.F. Pinkham Inc. was founded in 1966 by David's father, Harry, a Milbridge-based contractor who figured he could cut his materials costs by cutting out the middleman and becoming a local supplier of lumber and hardware. In the early days of the company, the bulk of sales came from Harry's jobs. During the next few decades, the company grew popular with local contractors, and H.F. Pinkham became a full-scale hardware and building materials retailer. David and Rhonda bought into the business in the mid-70s, and in 1986 developed a Machias location after purchasing a vacant field on Route One just south of town.

But nearly 20 years later, David and Rhonda knew their daughter and son, both in their mid-20s, weren't interested in continuing the family business. What's more, David Pinkham says the company is at a crossroads; it's grown to a point where investments must be made to keep H.F. Pinkham competitive. Those upgrades include new technology and equipment, ranging from pricey point-of-sale software that can cost as much as $150,000 to a replacement for the worn-out fax machine in the Milbridge store. But Pinkham worries that those investments might not trickle down to the bottom line for five or 10 years. "My style of running a small company is that I'd be in the truck half the time," he says. "When you're not obligated to the bank" ˆ— the Pinkhams had no debt on the business ˆ— "you can get away with doing things like that. But at the size we're at right now, I guess you need to have a little more accountability."

The company, which last year posted annual revenues between $8 million and $10 million, had experienced "a lot of growth" in the past few years, according to Pinkham. A drive along coastal Route One between Ellsworth and Machias offers a glimpse into a growing downeast real estate and construction market, where chunks of waterfront land are being parceled out for subdivisions and new homes are being built larger and more expensively than those that have stood there for decades.

So, in early 2004, the Pinkhams quietly put their company up for sale, listing the company with CBI, a regional business broker with offices in Portland. That's how they ended up doing business with Chris Rhoades, a blonde, 39-year-old Nevada native who moved to Falmouth with his family in 2003. Rhoades saw the potential in supplying the burgeoning market with framing studs and galvanized nails, but it was the business itself that attracted him.

What Rhoades found when he investigated the company was a retailer with strong profits. He understood the company and liked its strong brand and customer loyalty. Best of all, the price seemed fair and he saw a market with a lot of growth opportunity. In short, it appealed to the Warren Buffett fanatic in him. Like the famed financier and investor, Rhoades didn't want to find a fair company at a great price, but a great company at a fair price.

The heart of the matter
Rhoades is in a unique position to make that assessment: After getting his MBA from Northwestern University's Kellogg School of Management, he spent two years on Wall Street working for investment banker Merrill Lynch before transferring to the company's San Francisco offices. Rhoades was a managing director responsible for the firm's west coast international equity division, which racked up more than $100 million in annual revenues. In 2001 he married Karee Amato, a Casco native; the pair met during a get-together with one of Rhoades' clients in southern California. In 2003, the couple decided to move to Cumberland County after the birth of their first son, Harrison. (Nine months ago, they added another son, Griffin, to the family.)

After settling in Falmouth, Rhoades spent much of his time managing his family's investments. His flat-panel Dell monitor is hooked into Bloomberg, the streaming financial data service found on the desktop of virtually every investment banker, and during meetings he periodically scans the blinking charts and tickers to monitor his investments. He describes his family's portfolio as conservative ˆ— "all stocks, no mutual funds," he says, adding that his investment philosophy is driven primarily by the teachings of Warren Buffett and Buffett's mentor, Benjamin Graham, the father of value investing.

To add income to their family's investments, the Rhoades earlier this year purchased a six-acre plot of land on Route 302 in Windham that previously was owned by Bob Amato, Karee's father. The land, which originally held the Amato's Italian restaurant that Bob ran and Karee grew up working at, was cleared and split up into small subdivisions that Rhoades leased to developers. An Applebee's restaurant will open there by mid-November, and construction recently began on a Tim Hortons franchise.

But like Buffett, whose Omaha, Neb., empire was built on a mix of stock market holdings and ownership of operating companies, Rhoades wanted to add another layer to his investment and real estate holdings. The third leg of his financial stool, he decided, would be an operating company.

To that end, in early 2004 he contacted Steve Vlachos, a CBI broker in Portland. With Vlachos' help, Rhoades pored through dozens of business prospectuses that offered highlights of company finances and operations. To get such information from CBI, a prospective buyer must sign a confidentiality agreement and subject himself to a financial review, a process Vlachos says helps weed out less-than-serious buyers. Rhoades considered a handful of different companies, including a marina and a semiconductor packaging firm. But it was the report on H.F. Pinkham, which fills 15 pages with a wide range of operational and financial details, that helped convince Rhoades the company was worth pursuing.

The report showed that the company was profitable ˆ— very profitable. In fact, Vlachos says H.F. Pinkham is one of the most profitable businesses he's ever listed. What's more, the company's asking price, which, along with profit figures, Rhoades declined to disclose, was "tempered," according to Vlachos, by its location in rural downeast Maine. "Of course, with Chris being an investment buyer, he was attracted to it immediately," he says.

The buyers Vlachos works with typically fall into one of two categories. Lifestyle buyers might look to acquire a restaurant on the side of a ski mountain or a company that would afford easy access to their sailboat. Investment buyers, on the other hand, are more concerned with a company's fundamentals, including revenues and operating margins, than with its location or industry.

Rhoades is a classic example of an investment buyer, applying a Buffett-like screen to determine if acquiring the company made good financial sense, including evaluating the type of business, the appropriate price to pay for that business and the size of the return he could expect. "Buying an operating company is very illiquid and pretty risky," he says. "Was the return on capital [at H.F. Pinkham] enough to offset that risk? At the end of the day, I felt that it was."

Rhoades also was attracted to H.F. Pinkham's intangibles, particularly its role as a small-town hardware store and lumberyard with deep roots in the communities it serves. In March, he went back to Steve Vlachos, who offered more background on the company.

Rhoades followed that meeting with a late-April trip to visit the H.F. Pinkham locations in Milbridge and Machias ˆ— his first trip to the area. He spent time looking at the H.F. Pinkham stores and scouting out the downeast area. He liked what he saw ˆ— stores were busy, house construction was active and H.F. Pinkham had trucks driving in and out of its parking lots. "It was already a very successful business," he says. "It's not like it had to be turned around."

Bringing in the muscle
Rhoades was increasingly interested in H.F. Pinkham, but he knew he wouldn't transplant his family if the acquisition went through. For one, he says he couldn't see himself running two hardware stores in downeast Maine. "If I went up there to Machias to run the stores, I wouldn't fare that well," he says, laughing. "I'm a California boy."

Besides, running the company he acquired was never part of Rhoades' equation. Taking another page from the Buffett playbook, Rhoades wanted to find someone to run the company for him. With a trusted employee handling the day-to-day operations, Rhoades could work behind the scenes as a long-term strategist and so-called capital allocator, infusing certain areas of the company with cash in order to boost returns.

Both Vlachos and Glen Cooper, president of Portland-based Maine Business Brokers Network, say such a plan is atypical in Maine, where most business acquisitions result in the buyer working at the purchased company. "Eighty percent of all of our prospects are buying themselves a job as well as a business," notes Cooper, adding that the other 20% are mostly corporate acquisitions, with one company snapping up another.

Rhoades was certain that this was the right move, and in the early summer began searching for the right person to run the stores while he oversaw operations from his home office nearly two hundred miles to the southwest ˆ— a crucial decision. He made overtures to a handful of local business people he had met in southern Maine, but none panned out. "I couldn't find the right fit," he says. "Either they were happy in Portland or they didn't have the right background."

In early June, Rhoades hadn't found anyone to run the company and considered pulling out of the deal. He explained his interest in acquiring H.F. Pinkham to a golfing buddy, Jim Vigue, who suggested Rhoades have a conversation with Vigue's brother, Steve Veilleux.

During much of the 90s, Veilleux worked for EBS Building Supplies, a successful hardware, lumber and home décor retailer with 10 locations from Rockland to Calais ˆ— and a direct competitor to H.F. Pinkham. During the next two months, Rhoades and Veilleux spoke regularly about H.F. Pinkham; Rhoades bounced his worries and thoughts about the company off Veilleux, whose experience in the industry offered a perspective Rhoades lacked. Veilleux at the time was working for a marina in Florida, but in July decided to move back to Maine. He mentioned his move to Rhoades, who offered him the job; Veilleux accepted.

With Veilleux on board, Rhoades decided to pursue the acquisition of H.F. Pinkham, and in early August began putting a team into place that could handle all of the details surrounding the deal. The team included legal counsel to shepherd the acquisition process and an accountant to study the company's intrinsic value ˆ— in short, whether the deal made sense.
At Bernstein, Shur, Rhoades was matched up with Wendy Harlan and Bill Welsh, attorneys with extensive corporate law backgrounds who began by helping him draft the letter of intent to purchase H.F. Pinkham. The purpose of the letter was to keep the negotiations between the prospective buyer and seller exclusive. But it also signaled a tentative agreement between the parties ˆ— a fact Rhoades admits made him a little nervous, especially since much of his due diligence research on H.F. Pinkham remained. "It was a little like playing poker without looking at the cards," he says.

Welsh says the letter of intent helped lay out the progression of the acquisition and, in broad strokes, the details of the transaction. "Our job was to get down on a piece of paper Chris' understanding of the deal, and part of that is to protect him," he says.

Harlan and Welsh followed the letter of intent by beginning to draft the purchase and sales agreement, a much more detailed document. The agreement laid out big-picture points (Rhoades' purchase of the Machias property, and his lease of the Milbridge real estate from the Pinkhams) and smaller details (the number of work vehicles included in the deal, including their condition and mileage).

As part of the purchase and sales agreement, Harlan and Welsh worked on Rhoades' behalf to begin the due diligence process, which included making sure there were no liens against the company's assets and working with surveyors to properly assess the real estate. Rhoades took on a large chunk of the due diligence himself, including hiring consultants to draft an environmental study of the two locations and reviewing employee compensation and benefit plans.

Next, Rhoades hired Tom Taton, an accountant with Marshall & Libby in Portland, to figure out if the company's asking price was a fair representation of the business. Taton studied financial statements and evaluated H.F. Pinkham's assets, including real estate and inventory. In addition, Taton and Rhoades spent the weekend before the closing at the H.F. Pinkham stores ˆ— along with Veilleux, Vlachos, the Pinkhams and the company's employees ˆ— doing a thorough count of the stores' inventories.

The work continued past midnight on Saturday, when the first game of the World Series between the Boston Red Sox and the St. Louis Cardinals was played. "The whole time up there was spent physically looking at the assets, the condition, the location and trying to determine the inventory," says Taton, a die-hard Sox fan who declined Rhoades' entreaties to return to their Milbridge hotel to watch the game. "Our role was to supervise, but it turned into such an enormous job that Chris and I were on our hands and knees counting thousands of plumbing and electrical parts because it needed to be done."

Meanwhile, Harlan and Welsh made revisions to the purchase and sales agreement to reflect information that came to light during the due diligence process. For example, when Rhoades and Taton reviewed the company's accounts receivables, including the company's 400 or so credit accounts, they found a handful of high-risk collectibles that the Pinkhams agreed to remove from the books, chalking up those accounts to bad debt. Those changes were conveyed to Rhoades' attorneys, who amended the purchase and sales agreement, which was constantly in transit between Harlan, Welsh and the Pinkham's Ellsworth-based attorney, Jeffrey Jones, who also negotiated revisions on behalf of his clients.

Closing up
With his acquisition team in place, Rhoades concentrated on crunching numbers, lining up financing and evaluating the company's list of suppliers. The company's valuation was laid out in deep detail in a thick three-ring binder that Rhoades constantly updated with new spreadsheets and projections. Dealing with complex financial data was old hat for Rhoades, who spent much of his time at Merrill Lynch analyzing SEC filings and other reports, and pulling out useful valuation data like price-to-earnings ratios and cash flow assumptions.

He consulted four years of H.F. Pinkham's financial data to sketch out a range of best- and worst-case scenarios for the company's sales, gross margins, capital expenditures and interest rates. Those projections ˆ— which went out 10 years ˆ— allowed Rhoades to figure out what his rough after-tax income would be in any number of given scenarios. He was encouraged by the middle-of-the-road, conservative projections, which gave him confidence that the firm's cash flow would let him pay down the debt while still growing the company and making a profit.

Meanwhile, Rhoades auditioned a number of Maine-based banks to arrange for the financing. In September, he chose to work with Gorham Savings Bank, but not because of killer interest rates or a sky-high line of credit. The decision, Rhoades says, came from the "warm, fuzzy feeling" he got from his meetings at the bank, and through working with Rick Vail, senior vice president of commercial banking at Gorham Savings. Vail made a number of trips to Rhoades' home office to discuss the acquisition, and was willing to work with Rhoades to find the right mix of financing to satisfy both the bank and the buyer. "The chemistry was there," says Rhoades. "We had the ability to be very flexible and creative to accommodate very specific and unique financing hurdles on this particular transaction. He made me feel that the bank wanted to grow with me and wanted to be part of this endeavor and future endeavors."

To pay for the acquisition, Rhoades also worked out a seller financing package with the Pinkhams. (Rhoades declined to say how much of the purchase price was financed by the Pinkhams.) That's not an unusual strategy, says Vlachos, who notes that seller financing often is good news for the banker involved with the deal. "Banks love having something covering their backsides; it's kind of like a security blanket," he says. "It's also great for the bank because the seller has an investment to make sure the buyer is trained properly and knows everything he should know."

With the financing in place, Rhoades spent an increasing amount of time reviewing H.F. Pinkham's operations ˆ— specifically its deals with hardware and building materials suppliers. The two H.F. Pinkham stores since 1999 had been part of the Ace Hardware cooperative, a network of more than 4,000 independent hardware retailers. As part of the co-op, H.F. Pinkham was able to cut inventory costs and benefit from Ace's national advertising campaigns. But it also meant branding the Machias and Milbridge locations as Ace retail stores, which meant Ace dictated items ranging from signs to how merchandise is displayed. Rhoades wasn't sure that heavy Ace exposure was needed at the stores that, around Machias and Milbridge, are known simply as "Pinkham's."

After researching a handful of hardware suppliers, Rhoades eventually settled on Memphis, Tenn.-based Orgill Inc., a national supplier that in recent years has been making a concerted effort to break into the northeast market. Over coffee at a Falmouth Dunkin' Donuts in early October, Rhoades met with two of Orgill's regional sales staff, who explained how the transition from Ace to Orgill would work. They also provided Rhoades with references at a number of companies in Maine, New Hampshire and Massachusetts that had switched to Orgill in the past few years. Rhoades checked in with a handful of the companies to ask about their experience moving to Orgill and was sold, despite knowing that the process of replacing thousands of pieces of Ace inventory would add to Steve Veilleux's already considerable workload. (Rhoades and Veilleux discussed the change at length and agreed it was the right decision.) The pair also chose Portland-based Emery-Waterhouse as a secondary hardware supplier. At the same time, Rhoades and Veilleux opted to stick with H.F. Pinkham's current supplier of building and lumber materials, New Windsor, N.Y.-based ENAP Inc.

In mid-October, Rhoades and the Pinkhams sent personal letters to each of the company's 23 employees, delivering the news that H.F. Pinkham was, in a few weeks, going to be under new management. The Pinkhams explained to employees that the new management would help the company grow.

Shortly before the Oct. 26 closing, many of the operational details had been cleared up. Rhoades was confident in his decisions to switch from Ace to Orgill, and to keep ENAP on. The financing was in place and his attorneys were in a holding pattern, waiting to factor the final numbers from the weekend's inventory count into the purchase and sales agreement. Those numbers continued to trickle in even during the closing ˆ— Steve Veilleux faxed some revised figures down to Wendy Harlan as Rhoades and the Pinkhams sat at the conference table, signing document after document.

After the last paper was signed, Chris and Karee took the Pinkhams out for a celebratory drink at the Old Port Sea Grill in Portland. When Mainebiz caught up with Rhoades three days later, he had a cold and exhaustion was evident in his voice. But despite being run down, he already was thinking ahead to his next acquisition. This time, he explains, he wants to find a family-run company where the family wants to stay on board. "That's where Warren Buffett found success," he says.