Private Equity Roll Up Industry Considerations

Summary

This video explores the key factors that make an industry attractive for a private equity rollup strategy. Using the example of Leonard Green's investment in Mr. Car Wash, it highlights how a successful rollup can create exceptional financial gains. The video identifies five essential variables for a rollup strategy: multiple arbitrage, economies of scale, industry fragmentation, avoiding oversaturated markets, and choosing a growing industry with limited cyclicality. It also emphasizes the importance of a well-defined thesis, strong dealmaking mechanics, integration processes, and a focus on people when executing a rollup strategy.

Takeaways

• 😀 Private equity rollups can lead to exceptional financial gains when executed well, as demonstrated by Leonard Green's investment in Mr. Car Wash.
• 😀 A successful rollup strategy requires understanding industry attractiveness, including factors like competition, fragmentation, and business model innovation (e.g., subscription services).
• 😀 Over two-thirds of rollup strategies fail to produce value for investors, highlighting the need for careful planning and execution.
• 😀 Sufficient multiple arbitrage is critical for a rollup to succeed—businesses acquired at a lower multiple than the exit multiple create value.
• 😀 A rollup strategy can be made more effective by acquiring businesses at lower multiples, leading to an accretive result in enterprise value.
• 😀 Acquisitions can often be financed with debt, reducing the need for additional equity investments if done strategically, leveraging multiple arbitrage.
• 😀 To benefit from economies of scale, a rollup strategy should target industries with reduced overhead, increased purchasing power, automation potential, and cross-selling opportunities.
• 😀 An attractive rollup industry should be highly fragmented, with a large pool of potential acquisition targets, ideally ranging from $5 million to $20 million in revenue.
• 😀 Industry consolidation by larger players can still provide lucrative exit opportunities for rollup strategies, even in industries with existing big players.
• 😀 Rollup strategies in industries with limited cyclicality (e.g., stable, non-seasonal demand) are more likely to succeed compared to highly cyclical industries.
• 😀 Successful rollups require not only a strong acquisition thesis but also a solid understanding of dealmaking mechanics, integration processes, and cultural alignment across multiple companies.

Q & A

What is a private equity rollup strategy?

A private equity rollup strategy involves acquiring smaller companies in the same industry and consolidating them into a larger entity. This is often done to create economies of scale, reduce competition, and increase the overall value of the business, which can be later sold for a higher multiple.

What made Leonard Green & Partners' investment in Mr. Car Wash successful?

The investment in Mr. Car Wash was successful because it entered a fragmented industry with little competition, implemented a subscription-based model for consistent revenue, and had significant room for consolidation, allowing the private equity firm to grow the company from 134 locations to 400 locations.

Why do most private equity rollups fail to produce value for investors?

Over two-thirds of rollups fail because they struggle with integration challenges, unsustainable debt, and the failure to execute the strategy effectively. This can lead to a lack of value creation or even value destruction.

What is the importance of multiple arbitrage in a rollup strategy?

Multiple arbitrage is crucial in a rollup strategy because it involves acquiring businesses at a lower multiple than the expected exit multiple. This allows the acquiring firm to create value by increasing the enterprise value without having to invest proportionally more equity.

How does capital versus enterprise value relate to rollup strategy?

The 'capital versus enterprise value' concept demonstrates that a rollup can be successful if businesses are acquired at lower multiples. By combining the acquisitions into a larger platform, the overall enterprise value increases, creating more value than the capital originally invested.

What role does economies of scale play in a rollup strategy?

Economies of scale are vital for reducing overhead costs, increasing purchasing power, automating processes, lowering financing costs, and enabling cross-selling opportunities. These factors contribute to the value creation potential of a rollup strategy.

Why is it important for an industry to be fragmented when pursuing a rollup strategy?

A fragmented industry provides more acquisition opportunities, which gives the rollup strategy greater negotiating leverage. The availability of numerous small targets also facilitates consolidation, a key component of the rollup strategy.

How can consolidation in a B2B supply side impact a rollup strategy?

If the demand side of a B2B market is consolidating, larger, more sophisticated suppliers are often preferred by customers. This can make it easier for a rollup strategy to negotiate with customers and increase the appeal of a larger combined supplier platform.

What are the risks of consolidating in an industry that's already popular with consolidators?

If an industry is already saturated with consolidators, many of the best acquisition targets may have already been acquired. This can erode the potential for multiple arbitrage and lead to higher acquisition costs, making it more difficult to generate value.

Why is it important to choose an industry with limited cyclicality for a rollup strategy?

Industries with limited cyclicality are ideal for rollups because they avoid the challenges of dealing with economic downturns. Highly cyclical businesses may struggle during the down periods of the cycle, making it difficult to maintain a steady acquisition engine and execute the strategy effectively.