On Roll-up Acquisitions

If you have been reading about mergers and acquisitions or have spoken lately with investment bankers or private equity fund managers, chances are that you’ve heard about roll-up acquisitions – or roll-ups.

What’s that all about, you might think. Simple. The basic concept of a roll-up play is to acquire or form a platform upon which you’ll build by adding to it smaller businesses operating in the same arena. Many PE Funds are fond of roll-ups because it is a quick way to build scale and improves chances of having a good exit (oftentimes meaning, selling at a higher multiple than you bought the original platform).

Let’s take a very simple, yet true, example to explain how this works.

When working in California, I met a man who once realized that if you wanted to rent a portable toilet, you had to do it through a small, local mom & pop company. There simple wasn’t any group offering the service, say, statewide, let alone nationwide. Not being afraid to get his hands dirty, he then thought what if he started such a large group.

He started to poke at the industry, visiting various owners and offering them to buy them out or partner in building a portable toilet empire. Some rebuked, sending him down the drain and others expressed interest. He finally found his “platform”, buying a controlling stake in a group that was led by a man who seemed to know his business and who had built a good customer base of repeat users. They then started to buy out the local competitors, adding 20, 30, 50, 100 portable toilets at a time, most often at a bargain.

The group started to grow and to gain momentum. On the one hand, the back-office structure and fixed costs remained virtually the same with a park of 100 or 500 portable toilets, so the margins improved as more toilets were added. On the other hand, since the sellers had “lifestyle businesses”, generating low revenues and profits, purchasing them was cheap and could mostly be done with the cash flow generated by the business itself.

Soon, they had Southern California covered and continued their growth up north. Upon reaching national coverage, they looked east and went on with their roll-up strategy in Arizona, Nevada, etc. In a few years, they were running a regional portable toilet empire. As would say a friend of mine, “that shit is real!”

At this point, you start to reap more benefits from your roll-ups: economies of scale. All of a sudden, you’re a big account to your suppliers and have more muscle to negotiate terms and discounts. You no longer buy 10 or 20 porta potties at a time but hundreds. The same goes for the sanitation supplies, etc. Little by little, the company went from buying 10 porta potties at catalog price paying upfront to buying hundreds at a discount and paying them 60 days later. It improved but its profitability and its cash flow, allowing it to expand even faster.

Additionally, having a regional presence allowed them to reap yet another benefit: corporate accounts. If you do your job well, people want you back. Especially in this sector, mess it up and shit starts hitting the fan real fast… Having a single provider to deal with in a 3-4 state area can be a huge benefit to group organizing events or running construction projects across those states. The same goes for national and multinational firms, handling few authorized providers reduces headaches and allows for volume discounts. As a result, the company saw a shift in its customer base towards larger accounts with higher rental frequency, thus improving its industry metrics and strengthening its brand name.

5 to 7 years later, Private Equity funds started to notice and sweet talk them into selling. So did strategic groups, both locals in complementary industries and competitors in other geographic markets. They ended up selling the company to a strategic buyer at a high premium.

That’s so easy, I’m going to start doing that tomorrow!

Not so fast! First of all, it does sound easy but it’s not. Oftentimes, time is of the essence to build scale, so you need to commit significant capital and/or debt to fund the expansion… needless to say that one wrong move and you’re deep into… well, you know…

Jokes aside, PE funds have been at it for decades by now, and, in many industries, so are some of the largest companies dominating their respective sectors. This leads to industries being less and less fragmented and, therefore, roll-up strategies being harder and harder to execute. For example, in the Pharmaceuticals industry, many of the top Generics manufacturers such as Valeant or Mylan or Novartis (to only name a few) are a results of years of mergers and consolidation.

Another point to consider, from the beginning, is your exit strategy. What are you going to do with that empire of yours? Who’s going to buy it? Is doing an IPO a valid option? What’s the likelihood of reaching a proper scale to become a sexy target? How much do you need to invest to get there?

Then, come in operational considerations: Are you able/capable of running that business as you grow it? Do you have a solid team lined up? Can your platform seamlessly integrate tens of smaller companies in a short term? What are the drivers of this industry? What’s its cost structure? What controls to put in place to ensure your group is growing soundly? What threats do you need to prepare for? Are there any regulations that could potentially hinder your growth?

Then, let’s not forget the obvious: How fragmented is the industry? Why so? What leverage do you have now? What leverage will you have as you get larger? Who are your targets? What drives their owners? Who are your competitors and how strong are they? Who else is doing it? Will somebody notice your endeavor and beat you to it?

Naturally, these are only some of the questions to take into consideration as you are to embark on a roll-up acquisitions journey.  I think a point that is too often ignored is that of trying to understand why an industry is fragmented. Don’t necessarily think that every fragmented sector gives the same opportunity for consolidation. Some sectors are fragmented simply because that’s one of their unique attributes. Here’s a good article on that point, dating 2005 but still accurate.

Image Credits: Earth by Mosaic Maniac.