- December 3, 2019
- Posted by: webo
- Category: Mergers And Acquisitions
Buy and Build Strategy
Confronted with rising asset valuations and dim growth possibilities, private equity firms are looking for value creation strategies that don’t bet on increasing multiples. A buy-and-build strategy can achieve by applying multiple arbitrages to develop scope, generate synergies, and decrease expenses at a fair combined cost. They create value without depending on current tailwinds like plunging interest rates and steady GDP growth. buy-and-build strategies require a level of due diligence, M&A know-how, and execution that private equity companies sometimes assume.
When I discuss buy-and-build, I don’t intend portfolio businesses that accumulate up to one or two acquisitions during a holding period. I am also not attributing to prior mergers expected to strengthen scale or scope all at once. I describe buy-and-build as a specific strategy for generating value by utilizing a uniquely placed platform company to secure at least four consecutive add-on acquisitions of smaller businesses.
Buy-and-build tactics are attractive because they extend a potent remedy to soaring deal multiples. They provide general partners (GP) a means to gain an advantage of the market’s trend to charge big businesses costlier valuations than smaller ones. A GP can support the primary acquisition of a nearly expensive platform company by tucking in fewer add-ons with cheaper multiples later on. These multiple arbitrages reduce the firm’s average cost of purchase while setting funds to work and developing further asset value through scale and scope. On the other hand, successive additions allow GPs to create value by synergies that decrease costs or add to the revenues. The intention is to model a robust new business whose whole is worth significantly more than the individual parts.
Every deal is complicated, but the highly productive buy-and-build strategies share some significant features.
Buy and build strategy feature 1 – An industry segment with scope to operate
Sector kinetics can have a tremendous bearing on the success or failure of a buy-and-build strategy. Value creation relies on a regular flow of acquisitions, which indicates a sector has to render an adequate number of targets and a steady environment in which to proceed. Notably, the platform company usually makes the add-on acquisitions—not the PE fund—so the firm must produce steady free cash flow to fund deals in succession.
The most potent buy-and-build tactics focus on areas with expected growth and a low likelihood of disruption (except when the platform business is the disrupter). They further target fragmented enterprises with ample acquisition targets of the correct size. This strategy puts two inquiries in diligence: First, will possible add-ons have cheaper valuations than the platform firm so that purchasing them offers a genuine multiple-arbitrage opportunity? Second, will implied add-ons be substantially accretive? In short, does the sector provide a plethora of targets that are less than the platform business, but not too small that obtaining them doesn’t score value?
Buy and build strategy feature 2 –Loads of blank space
The segment’s “white space” is dependent on bid and offer. Does the opportunity for acquisitions in this area present sufficient pathways for the buy-and-build strategy to generate significant value? Too much demand for over a few targets will push up prices and fight away the multiple-arbitrage opportunity.
GPs can evade being stuck by centering on their exit strategy from the beginning. If the sector remains attractive to buy-and-build opportunity, it offers pathways for the subsequent buyer to extend the merger, which should raise exit price. After buy-and-build gets widely consumed, the exit narrative requires to exhibit an evident change in strategy. The opportunity changes from buy-and-build to scale M&A, where a consolidator acquires other consolidators. Otherwise, the most pertinent next buyer might be a strategic buyer that is contemplating to grow in the sector and sees a benefit in a recently scaled-up platform company.
Buy and build strategy feature 3 –Beginning with a stable platform
The most efficient buy-and-build strategies imply that the platform company’s free cash flow will feed acquisitions. For an active acquisition strategy, the buyer requires the appropriate underlying infrastructure—sound IT systems, a solid balance sheet, replicable financial and operational models, and assets like distribution and sales networks that are placed up for expansion. It’s an immense advantage to commence with a powerful current management team that has previously proved its expertise to pull off acquisitions.
A fundamental question in diligence is how much effort the platform company requires to initiate the strategy. If the response is a lot, it can drastically alter the timing of value creation. The platform company might then have made acquisitions and inadequately integrated. Go-to-market strategies may be contradictory. It is settling problems like these demands both time and investment, which may generate a return if the opportunity is large enough. The solution, though, is identifying what the up-front costs are. A years-long recovery process can cut sharply into return on investment.
Buy and build strategy feature 4 –Targets that attach significance
While screening the best companies for buy-and-build includes all the standard M&A diligence questions, the principal factors are decisive: How does an add-on enhance value? More is not beneficial; an acquisition has to click into strategic reasoning that considers the whole is valuable more than the sum of its parts.
For this purpose, winning buy-and-build strategies aim acquisitions that are confined to the core, rolling up a set of remarkably similar companies to realize the benefits of scale. Swaying into adjacencies can make the insight, but it’s essential to recognize the risk. The farther a company deviates from its core, the higher the likelihood that something goes amiss.
A company’s core defines the customers, products, and services that (a) run the bulk of its profits and profitable growth, and (b) render its principal competitive advantage. Establishing a company’s core is the core of strategic planning and a crucial component in assuring that each acquisition adds worth to the platform. Each move away from the center builds a gap between the purchase and what the firm does best. The topic becomes, how much overlap is there within the two businesses’ customers, costs, channels, capabilities, and competition? A roll-up strategy considers meaningful, if not total, overlap. Close-in adjacencies have a small overlap, and two-step adjacencies have notable distinctions. Looking at likely acquisitions—or the entire strategy—through this microscope, deters firms from attempting to join together relevant businesses that are distant from the core than they appear.
The buy-and-build strategies that exceed usually depend on varied paths to value creation. They take full benefit of multiple arbitrages; they recognize and gain synergies and operational changes. They create top-line growth by enhancing commercial abilities and executing more intelligent go-to-market strategies at each business acquired. Identifying these openings has to be the exact purpose of due diligence so that the fund can start drawing each of these levers from day one of control.
Buy and build strategy feature 5 –A champion strategy
The firms that win buy and build strategy know three impressions going in:
Broad, comprehensive diligence is crucial In buy-and-build, due diligence doesn’t begin with the initial acquisition. The most competent practitioner’s application for the total opportunity, not only the component elements. That implies learning how the strategy will generate value in a given sector using a particular platform company to acquire a specific type of add-on.
Performance is as critical as the investment — exceptional diligence guides to a comprehensive playbook. The most respectable firms have a specific strategy for what to buy, how to integrate it, and what functions fund management and platform company management will perform. This plan begins with developing a leadership team that’s suitable for the mission.
Pattern recognizing matter. Being capable of knowing what works evolves with time and practice. Knowledge, however, depends on a deliberate purpose to interpret what went well (or didn’t) with recent deals. This postmortem should cover the selection of targets, as well as how choices produced or impaired value. Results better only when leaders use acumens from past ventures to gain better picks the next time.
The potential for value creation in buy and build strategies demands refined due diligence, a precise playbook, and adept, skilled leadership.