Recently, my company, Ventana Capital Partners, has been involved with two companies that are seeking to go public through a reverse shell merger to implement a roll-up strategy of their respective industries.  Both of these industries are definitely not “flourishing” and in both cases the industries are staged for a full scale consolidation where only the strong will survive.  Both companies are considered manufacturers to their respected industry.  Both industries have been historically composed of mom and pop companies.

First of all I like roll-ups that involve consolidation of mom and pop business owners, especially if the business owners are being retained after the buyout.  I also like roll-ups that involve industries that are more traditional in nature and companies that have an established track record with previous profitability.

That being said, my personal insight into these two deals has brought me to some conclusions regarding the strategy of roll-ups.   Roll-ups, in my opinion, should be implemented when the popular opinion of a target industry is “business is bad”.  The opportunities are greater and companies can be acquired for a fraction of the price they would normally go for.  The acquirer can dictate better terms and conditions and by the time the dust clears and competitors realize what has happened, it’s too late.  While others are cutting back and hunkering down to survive and crying “the sky is falling” a new competitor can emerge that is now their worst nightmare – the new kid on the block, except this one is an 800 LB gorilla that is now eating your lunch.

Consolidation is best served when an industry is in a downturn.  The worse the downturn, the better the opportunities.  When there is blood in the streets that’s when you buy.  When things are at their worst is when and sellers are faced with going out of business or bankruptcy.  When a seller is approached by someone willing to “bale them out”, believe me, they will listen because at that point anything is better than their current situation.  Why embark on a roll-up strategy when an industry is thriving.  What’s the motivation to sell?  Why pay a premium?

My other observation is that roll-ups work best in industries that have a “barrier of entry”, take a certain amount of expertise and are not easily duplicated.  These conditions allow a company at least two years head start on any possible competitors.  It also allows them to “cherry pick” the best companies to acquire without having to worry about competing bids.  If a company is starting its roll-up strategy during an industry downturn by the time it has implemented its plan and acquired several competitors chances are the industry is beginning to see resurgence.   Once the industry completes its down cycle the company will be poised to substantially increase its business during the good times translating into greater earnings.

Properly executed, a public company will increase its stock price by acquiring competitors at below market cost during industry consolidation and further increase its stock price through earnings when its industry is on an upswing.

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