As time moves on trends in private equity change. In the 1980s and 1990s financial engineering was synonymous with private equity. However, today private equity firms are more frequently employing a buy-and-build strategy.
Bain & Company’s annual Global Private Equity Report illustrates how effective a buy-and-build strategy can be. Case in point: “When Investcorp acquired Chicago’s Berlin Packaging for around $410 million in 2007, it was already a strong player in the container business. Yet seven years and four strategic acquisitions later, Investcorp sold out to Oak Hill Capital Partners for $1.43 billion, creating a better than three times return. Since then, Oak Hill and Andrew Berlin, the company’s well-regarded CEO, have doubled down on the buy-and-build strategy with four more major acquisitions and a scattering of smaller ones. In November 2018, they attracted $500 million in new capital from the Canada Pension Plan Investment Board. The objective: more acquisitions in North America and Europe.”
This is on the larger scale, but the buy-and-build strategy is alive and well in private equity firms at all levels of the market today. In March, Incline Equity Partners, a Pittsburgh-based lower middle-market private equity firm, announced that its portfolio company Continental Batteries had made its sixth acquisition in just over seven months. Continental acquired Battery Sales & Service, a full-service aftermarket battery distributor to the automotive, commercial, solar, golf, and marine markets. This is a common strategy for Incline.
“Buy and build can be beneficial in industries where there are benefits to being big or bigger. When you are a bigger company often you can lower our cost of production by sourcing and buying better and gaining efficiencies in route density as is the case with Continental,” says Jack Glover, a managing partner with the firm.
According to the Bain report, the reason for the popularity is simple: “Buy-and-build can offer a clear path to value at a time when deal multiples are at record levels and GPs are under heavy pressure to find strategies that don’t rely on traditional tailwinds like falling interest rates and stable GDP growth.”
“Pursuing a buy-and-build strategy and employing add-on acquisitions is a solid way to achieve above market growth and shareholder value in a 3% GDP environment,” says Gretchen Perkins, a partner with Huron Capital, which added its eighth add-on acquisition to Ronnoco Coffee, a manufacturer and distributor of coffee and tea, in 2018.
The buy-and-build strategy gives GPs a way to take advantage of the market’s tendency to assign big companies higher valuations than smaller ones. It’s no secret that smaller companies consistently trade for lower multiples than bigger ones. According to PitchBook Data, in 2018, companies of less than $25 million had a median purchase price multiple of 10 times while companies between $500 million and $1 billion enjoyed almost a 20 times multiple.
“A buy-and-build strategy allows a GP to justify the initial acquisition of a relatively expensive platform company by offering the opportunity to tuck in smaller add-ons that can be acquired for lower multiples later on. This multiple arbitrage brings down the firm’s average cost of acquisition, while putting capital to work and building additional asset value through scale and scope. At the same time, serial acquisitions allow GPs to build value through synergies that reduce costs or add to the top line. The objective is to assemble a powerful new business such that the whole is worth significantly more than the parts,” states the report.
“When we are looking at a buy and build we need to see a large addressable market preferable more than $2 billion and we need to see a fragmented competitor base that would be available to buy,” says Glover.
That said, a buy and build strategy is easier said than done. It’s critical that the platform is stable enough to support the acquisitions—infrastructure like IT systems, repeatable financial, and operational models must be scalable and ready for expansion.
When looking for new acquisitions a few things are critical, according to the report. The firms that get it right do deep due diligence, execute swiftly with clear plans for integration. Winners also understand that pattern recognition counts, which comes with experience.
“The most important thing to consider when pursuing a buy and build strategy is to assess the fit of the add-on candidate,” says Perkins. “Is it really complementary and accretive? Don’t buy add-one just for incremental revenue. If the businesses don’t actually mesh properly your valuation will reflect it upon exit.”