Roll-Up Success or Horror Stories
August 19, 2021
by a searcher from Cornell University in Sunnyvale, CA, USA
I’m considering a roll-up strategy for a couple related businesses in the food space that fit strategically and will scale well when combined. But the M&A community seems to be divided on roll-ups. I’d like to hear from others where and how they’ve had meaningful success and/or losses with roll-ups.
from Harvard University in Denver, CO, USA
My recollection of that study is that roll-ups tend to fail because of 1) financial leverage + recession/operational issue, and 2) lack of "returns to scale," meaning operational efficiencies and other competitive advantages that come from growing larger.
My own view on roll-ups is that they can absolutely work, but they need to exploiting one (or ideally both) of two strategies: 1) valuation arbitrage, and 2) scale-based competitive advantages. Valuation arbitrage is straightforward - mid-market companies often trade at 1.5-2x the multiple of lower market companies. You're basically getting paid to aggregate a "product" for the middle market private equity machine, which is only now starting to move down market and pursue strategies like this themselves. So, that's the siren song of just rolling a few related businesses together and getting a###-###-#### % premium. Sounds easy right? To me, the real question is whether there is a reason that larger companies should "win" in a given industry. Does scale give you leverage with customers or suppliers? Create operational efficiencies? It seems easy to feel like this should be true in most cases, but the data suggest that it's actually much more rare to have meaningful returns to scale, otherwise more roll-ups should work. That, combined with not using excessive leverage in the pursuit of that scale and removing needed margin for error when inevitably an integration goes awry....
from The University of Chicago in Chicago, IL, USA
Successful roll-ups have high equity infusion in early stages, high unit profit margin, regulated environment, low re-investment intensity for growth, tailwind for industry growth or tech driving the changes, fragmented industry, etc.
I have also seen successful roll-ups with low equity. In these case, buyer quickly improves margins, rolls-up few right away, but exit takes longer. There is also roll-up-1 with low-equity followed by quick exit to a deep-pocket party for roll-up-2 lead by same entrepreneur.
Recently we sold a healthcare business for ,<$10 M, 5 years later buyer sold it for $1 B.
Failed ones have high re-investment intensity (like CapX, high A/R), low A/P, low accrued expenses, "lumpy" growth investment, growth strategy is market share gain driven, mature industry, organization efficiency-dependent rather than automation, etc.
Few years ago, we looked at a failed roll-up. It was started by a highly successful Fortune 500 CEO known for execution. He wanted to do a roll-up in manufacturing (after-market home improvement products) . Banks had lined up to back him. After few years they had rolled up 20 businesses and realized the bad strategy. The business was profitable and the price was a significant discount to liquidation value. I advised my client not to buy the flawed model.