By Ben Robinson and Abbie Cox
As the competitive landscape has intensified for Private Equity (PE), the average multiple paid has risen. This, coupled with funds raised reaching a record high in 2018 (Financial Times), has resulted in investors seeking to create value in different ways to the traditional ‘buy and improve’ strategy. As a result, many PE houses have expanded their value creation capabilities.
This has led to significant growth in the number of PE houses opting for a ‘Buy and Build’ strategy, particularly here in London. The concept of ‘Buy and Build’ involves purchasing a target company with the view to making subsequent ‘add-on’ acquisitions in the same sector, harnessing the concept that the whole is greater than the sum of its parts. This ‘platform’ company is often an established business with proven management, systems and back office functions allowing the PE house to use the infrastructure of this platform as a base to grow and realise synergistic benefits.
The possible value created through ‘Buy and Build’ has seen many firms adding multiple ‘bolt-ons’ to an initial investment, often achieving significantly higher internal rates of returns than with a standalone business.
The benefits of ‘Buy and Build’
There are many possible benefits to this strategy when compared to organic growth. Revenue growth can be achieved from improved market positioning and shared marketing techniques, as well as expansion into new geographic markets and an increased product base. All of this can be achieved at a quicker rate than through organic growth.
Additionally, cost savings can be achieved through synergies, economies of scale and rationalisation of support functions. The increased size of these groups also allows significant financial leverage opportunities, making them even more attractive to PE houses.
For example - this has been exemplified by the rapid consolidation of the Vet industry. Once dominated by numerous owner-managed practices, the industry has seen consolidation with the largest four companies now owning 30% of all UK practices by 2016 (VIN News). The buying power of these large businesses can help achieve rapid margin improvements after the acquisition of small ‘bolt-on’ companies, often only a few practices in size. This has been demonstrated with VetPartners who, founded in 2015 had amassed over 300 practices in little more than 2 years, prior to being sold for a mammoth £700m in August 2018 (Sky News). Once at scale, these businesses can start to become attractive to corporates as well, as demonstrated by Mars Petcare’s recent acquisition of Anicura at a rumoured price of close to €2bn.
The fast gains from such strategies suit PE buyers due to the relatively short holding period of investments compared to corporate investors. Traditional organic growth can take longer to shape whereas certain ‘Buy and Build’ benefits can be almost instantaneous.
These benefits can significantly increase the capital returns achieved. According to Private Equity News, there were 619 add-on deals in 2017 with a combined value of £7.8bn, representing an increase of 8% from 2016. The possibility of realising these benefits is so attractive that certain PE firms, such as London and European based Silverfleet Capital, focus their strategy of investing around ‘Buy and Build’ (or ‘Buy to Build’ in their new lexicon).
The challenges of ‘Buy and Build’
However, this strategy is not without its challenges. Research conducted by Boston Consulting Group (BCG) shows ‘Buy and Build’ strategy creates the most value when the platform company is small itself, as even smaller add-ons may not yet be mature businesses who can benefit from the leverage ‘Buy and Build’ offers. For larger PE houses, this size of acquisition may not be appealing.
Additionally, the management team of the platform company play a pivotal role in the success of the strategy. Without a stable management platform capable of integrating bolt-ons and harnessing the value opportunities, the increased returns may not be achieved, so demonstrating previous success can become key in achieving higher exit multiples.
Key factors for a successful ‘Buy and Build’
Despite the challenges, the benefits achievable make it an appealing strategy for many PE buyers. However, certain critical success factors are often prominent in the markets most attractive to ‘Buy and Build’;
A highly fragmented market with no clear dominant player or oligopolistic characteristics. This often lends itself towards industries dominated by owner managed businesses, such as the Veterinary industry for example..
Having a stable platform company capable of being used as the building block for growth. The platform company will have stable management and well developed infrastructure, capable of supporting and driving the rapid growth of the business in the future.
Industry is also key for the value creation of a ‘Buy and Build’ strategy, often industries with low growth and low profitability make excellent targets. This is driven by the low multiples required to enter the industry and where small margin improvements can be hugely beneficial.
Industries that can benefit from the increased use of technology are often targeted as part of a ‘Buy and Build’ strategy. The economies of scale achieved can make the investment in technology pay off and pave the way to greater value creation.
Clear benefit from vertical/horizontal integration can also help in achieving an exit, with complementary markets such as those demonstrated by the Mars (Pet food) and AniCura (Vet) transaction creating an attractive proposition.
The availability of international expansion can be highly attractive too, with BCG indicating cross border ‘Buy and Build’ being far more lucrative than domestic.
Our view is that the competitive nature of markets, along with pressure for PE to deploy the record amount of cash held by the industry, is likely to result in an increase in the number of firms looking for alternative ways to create value. The increased returns achievable through the opportunities for revenue growth, coupled with synergistic benefits and economies of scale, make the use of the ‘Buy and Build’ strategy highly appealing. However, careful consideration of not only the platform company but also their industry is a critical factor for the success of ‘Buy and Build’.
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