RESOURCES

Basics

A rollup is a powerful strategy for building value, but is only feasible under certain conditions. Much depends on the industry in question and the management team undertaking the initiative. The following are characteristics of most rollup opportunities:

• Fragmented industry with several small players. The industry should be stable and comprised of mature companies.
• The consolidator has a strong management team.

Industry

A rollup strategy is predicated on the industry being highly fragmented and without a dominant player. The opportunity must exist to build a large, dominant franchise by combining many smaller players. Therefore, it must be an industry where big is better and where size gives operational or competitive advantages. It is important that the industry has stable dynamics that don't change from acquisition to acquisition. In such industries there is little risk of new and unforeseen competitors and mature industries tend to be sleepy and therefore do not achieve their true profit potential. Also, the companies in the industry should be similarly operated so that management's values and methods can be easily transferred to newly acquired companies.

It is extremely important that the consolidator or platform be a strong company with some amount of critical mass that can get the process rolling. Trying to cobble together a platform out of smaller companies, or pretending that a small company without many competitive advantages can pull off a rollup is wishful thinking. Furthermore, it will be difficult for such a company to receive financial backing for a rollup strategy

Small companies are often valued at much lower multiples of earnings than large companies. This allows a consolidator to build a large company with a high valuation multiple by acquiring smaller companies. Because large companies usually trade at higher multiples, the market rewards the work of building a large business. A successful rollup will acquire small companies at, for example, 5 times EBITDA, integrate them and then sell the combined business for 7 times EBITDA.

Management

Management must be seasoned industry experts and have demonstrated their ability to build a company by acquiring and integrating other businesses. In a rollup, investors essentially capitalize a management team who will go forth and build a franchise through acquisitions. Accordingly, the management team must have a great deal of experience in the industry as well as a good rapport with investors.

Rollup Advantages

Properly executed rollups enhance a company's operations, competitive position and financial health. Successful rollups can often achieve the following:

• Expand geographic coverage. This often allows the consolidator to service multi-location customers and win larger contracts.
• Expand the consolidator's services or product line. This is done by acquiring companies that provide services or products that the consolidator currently does not offer.
• Increase name recognition. This is often a result of the two prior points. Increased name recognition further drives the business' momentum and can also provide access to cheaper sources of capital.
• Leverage off of the consolidator's infrastructure and spread fixed costs over a larger revenue base. For example, rollups often leverage existing back office operations such as accounting, marketing, invoicing and executive management and consolidate purchasing efforts which increases the company's purchasing power.
• Breathe new life into the acquisition targets. "Cross-fertilization" occurs as the consolidator brings fresh blood into the target companies but is also exposed to new ideas itself.

Financing

Financing a rollup strategy usually requires commitments from multiple sources of capital. Because the consolidator will engage in a number of acquisitions, it is important to partner with capital providers who understand the strategy and who commit to providing funds for future transactions. The acquisition strategy will require both debt and equity capital.

Securing financing is usually made easier if there is a precedent in the industry that a buy and build strategy works. Most rollup financiers are usually not interested in being pioneers and are more comfortable backing a venture which can learn from another's successes or mistakes.

Equity

To initiate a rollup strategy, the consolidator will need a strong equity base. This often requires partnering with an equity sponsor who will properly capitalize the platform and provide it with financial backing. A substantial equity commitment gives the platform the firepower and confidence required to make acquisitions. Furthermore, an equity base positions the company to assume debt in the future, allowing it to fund add-on acquisitions primarily with borrowed funds.

Stock Swap

A stock swap often funds some portion of the purchase price in rollup acquisitions. In other words, the consolidator pays the seller with it's own stock. If the consolidator has been successful, its stock will become an important currency to fund acquisitions. Stock swaps are very common in mergers or acquisitions among companies whose stock is publicly traded. A stock swap is more difficult in private transactions because the acquiring stock is illiquid (i.e. cannot be quickly sold). However, if the seller manages the target and his or her future involvement in important to the success of the acquisition, stock swaps are valuable to the consolidator. Partially funding the purchase price with stock aligns the interests of the buyer and seller.

Debt

One advantage of initially capitalizing the consolidator with equity is that subsequent acquisitions can then be financed primarily with debt. For this reason it is important for the consolidator to have strong relationships with senior and subordinated lenders. Under most rollup models, add-on acquisitions are financed primarily with debt. Although each target company will have different characteristics and therefore a different debt capacity, an ideal debt arrangement is to have a lender commit to lending a set multiple of cash flow. In this arrangement, for example, the lender commits $100 million for add-on acquisitions and agrees to provide 3.5 times the target's EBITDA for each add-on transaction. If acquisitions cost the consolidator 5 times the target's EBITDA, the lender provides 3.5 times and the equity sponsor finds the additional 1.5 times. Another arrangement is to agree on a ratio of debt to equity to fund each acquisition.

Anatomy of a Rollup Strategy

Step 1: Equity Capital positions company as platform in a fragmented industry.

 

Step 2: Company finds first suitable acquisition, borrows funds to acquire it and works on achieving synergies related to geographical coverage and cost structure.

 

Step 3: While integrating Target 1, company finds second suitable acquisition, borrows funds to acquire it and works on achieving synergies related to expanded services and cost structure.

 

Step 4 and Beyond: Incorporate previous acquisitions while identifying additional acquisition candidates. Borrow funds to acquire third target. Work on achieving synergies related to streamlining cost structure, utilizing infrastructure, etc.