Tip of the Week: Rolling Up
By David Feldman at 30 April, 2009, 5:57 am
Several of the projects we have recently been working on include a strategy of taking a fractionalized industry that is hot but made up mostly of Mom and Pop type operations (whoever gave our parents such preeminence in this?) and trying to combine a bunch of those companies into one public company as “first mover” in an exciting space. Even in this struggling economy, there are more than a few pockets of very strong growth and activity. For example, any company involved in strengthening our infrastructure is doing well right now. Almost any government contractor, same thing. Just about anything involving our cell phones. And on.
One of the best uses of a public company is to make acquisitions. Why? Because you can use your stock as a form of currency to make acquisitions. When you are private, it is difficult to convince a target of the value of your stock, much less its liquidity opportunities. With a public stock, you have the market to tell you its value and there is an absolute path to liquidity either through registration or an exemption sometimes as little as six months after acquiring the stock. This means you have to come up with less cash to give the target.
Many rollups fail. Why? Because some builders of these mega-companies focus on the “size matters” theory of entrepreneurship, that adding revenue streams for their own sake is good almost regardless of the fit and growth opportunity. In other cases, that old canard “integration” becomes problematic. You buy six entrepreneurial companies and suddenly have six people in charge who each likes to be the big boss. For what it’s worth, I think a great model is Jamie Dimon of JP Morgan Chase. That bank has made a succession of very successful acquisitions and has an internal model for integration that really works.
In any event, it all works better if you don’t have to utilize cash or debt any more than necessary to make the acquisitions. Hence a reverse merger or self-filing (as we know IPOs simply don’t exist right now) gets you there.
David:
You are right on point about the issues in roll ups. Have you seen reverse mergers where multiple operating companies go in simulatenously?
As you probably recall, the mid to late 90s saw numerous roll-up “poof” IPOs with a traditional S-1 registration statement raising the acquisition consideration, followed by an S-4 acquisition shelf to be used to issue stock in acquisitions. Many of these roll-ups failed miserably because there was a “land grab” for acquisitions, driving multiples up. And these companies were so aggressive in buying companies, that they did not focus on integration and then at the end of the day they were left with 50+ operating companies run by entrepeneurs that don’t like to be told how to run their businesses (eg., they want to maintain their relationship with their insurance vendor that they play golf with every friday rather than take on a new vendor imposed on them by the parent company, even though it may be less expensive b/c of purchasing power). A key component to roll ups is making sure the entrepeneurs are incentivized to stick around, which typcially means trying to avoid cashing them out in the initial deal and implementing a meaningful incentive plan. Of course it’s not that easy convincing them to sell their businesses and give up control without a nice cash component.