I promised myself I would not use the over-used term “synergy” in this column. It was a mighty struggle! See if I won by reading on.
The term “roll-up” describes a financial engineering process used by private equity and strategic investors, where multiple smaller companies, typically in the same market sector, are acquired and merged.
The goal of the acquirer and participating companies in the merger is to increase the ultimate exit value of each member company and the new company by creating greater syn…syner… oh, let’s call it scale, along with improved market share, and enhancing the ability to deliver cost syn…syner… oh, let’s call it savings, that will produce improved EBITDA margins for the combined entity. These attributes can result in a higher selling price at close for the combined entity, more so than if the companies were sold separately, one at a time, to multiple buyers. In today’s LBM market, independent LBM dealers are selling for approximately a 5X multiple of adjusted EBITDA. From the perspective of the original selling prices, the combined entity of a roll-up can sell for an effective multiple of 8X or 9X a few years hence, if it performs well.
The typical acquirers of roll-ups are private equity groups (PEGs). PEGs will start with a “platform company” and then add “bolt-on” acquisitions to complete their roll-up objectives for a particular market segment, such as retail lumber dealers or truss/component plants. Since private equity groups seek to quickly acquire dominant market share on a regional or national basis, the constituent companies in a roll-up—once combined—must represent meaningful market share and improved syn… syner… oh, let’s call it profitability. But, most importantly, it also means that the combined companies will be in a better position to compete and serve their customers with improved purchasing, product offering, marketing, and financing.
The biggest challenge of any roll-up is finding the constituent companies that will be a good fit and that, once combined, will be worth more than its parts. It also means that the companies coming together must understand that some changes will be required to achieve this objective. Those changes could include new unified software systems, new purchasing procedures, new marketing programs, and syn… syner… oh, let’s call it efficiencies, to be found in a unified “back office.”
Roll-over shares: There’s a catch with roll-ups. The target companies usually don’t get all cash for their companies at closing when the roll-up is formed. Sellers will generally be required to put some skin in the game. PEGs often require that a portion of the purchase price be represented by shares in the new company (NewCo) created by the roll-up. This share type is called “roll-over shares.” Often, a minimum of 20% of the deal’s value could be represented by roll-over shares. With patience and prudent management, the roll-over shares can become valuable as the NewCo grows over time, potentially with other bolt-ons. As an example, let’s say a PEG acquired three independent LBM dealers for a total of $45 million. Each owner rolled 20% of the purchase price into the new entity, or $9 million. While the PEG paid $45 million for the transactions, $23 million was equity (a.k.a. cash), and $22 million was borrowed by the PEG, as senior and subordinate debt. In this scenario, because they took roll-over shares (and not all cash for their businesses) the three selling owners combined would own their percentage of 28.1% ownership in the new entity, and the buyer would have a 71.9% ownership. These percentages will change as additional LBM dealers are acquired.
Individual negotiation. The purchase prices for each member are confidentially negotiated with each LBM dealer. The only entities that need to see a company’s financials are the investment banks representing the sellers and the PEG buyers, only sharing the financials once the roll-up is completed.
Roll-ups are ideal for owners who want to stay in the game, but take some chips off the table. They reward those committed to finding syn…syner… oh, let’s call collaborative opportunities, and taking a “second bite of the apple.”
John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at j.wagner@1stwestma.com
