Watch this space

With cheap debt no longer available and little hope for significant improvement, private equity houses need to find ways to do attractive deals and ensure decent returns. A study conducted by BDO Stoy Hayward in September 2008 stated that 51% of all portfolio companies interviewed expect to make bolt-on acquisitions over the next 12 months.

Recently, the market has seen ISIS Equity Partners acquire the vehicle rental management division of roadside repair and recovery business FMG Support Ltd for its portfolio company Nexus Vehicle Management (page 30). Duke Street has supported 2e2 in delisting Netstore in October (page 27). 2e2 was under Gresham Private Equity's ownership until 2006, during which time it made nine acquisitions in three years. And August Equity announced in November that it will embark on a buy-and-build strategy in the domiciliary care market with the acquisition of Enara Ltd as a platform and First Call Care Services as the first acquisition target (page 33).

Whether the current climate makes buy-and-build deals an attractive option to broaden one's horizon or whether it is the safest way to deploy funds, this deal type is clearly en vogue.

Buy-and-build is an effective way of deploying capital in a market that is otherwise tough. To boot, growing a company through acquisitions offers opportunities for very high returns. "If a platform and its management team are performing well, we will provide it with more equity to enable further growth. As the platform achieves more critical mass, the cashflows coming back to the centre can be used for additional management staff or for geographical expansion," says Andrew Hayden of Sovereign Capital. He mentions another advantage that leads to flexibility within the group: "If we acquire a target company and it has a better method of doing certain things, we would adopt that strategy for the whole group," he states. Buying a range of small companies and selling it as a group gives investors good chances to grow their money. "Higher multiples will be expected from either trade or another equity house for the combined group against those paid for the individual targets," Paul Russell from BDO says.

Devil in the detail

But buy-and-build is not necessarily a short cut to sky-high returns, as Russell points out. "You might have mapped out a platform and the first two targets, but then you cannot find a suitable, scalable platform. And also, one bad acquisition can turn the whole platform sour." Hayden points out that the investor should not leave all the work to its portfolio company. "When the management team of the platform has to do the deal sourcing and supervise the due diligence, it is not able to do its core business just as well." Therefore, Sovereign finds suitable targets itself and then develops the deal in cooperation with the management team. More than 50% of the deals financed by Sovereign's second fund are proprietary.

Skills

The art of buy-and-build is a tricky one, with many inexperienced GPs learning this when they embark on this path. Hayden warns: "There is a large amount of detailed work necessary. It requires a lot of man power to source the bolt-on deals as they are typically off market, and to build strong long-term relationships with possible vendors to ensure closing the deal in the future." Hiring one or several specialists might enable a generalist GP to gain ground. "You are acquiring a lot of value in buy-and-build, so you should have either specialists in-house or a management team with experience to acquire and integrate," Russell advises.

Typical targets for mid-market buy-and-build strategies are mainly small companies with turnover below £10m whose owner is often motivated to sell his company because of the wish to retire and/or succession problems. Thus there is often a strong bond between staff and owner. Russell therefore sees an important skill for a buy-and-build investor as "keeping the business motivated to perform on the same level after the owner is gone." Similar to a venture capital investor, "a buy-and-build investor needs to have the skills to handle small deals when acquiring a business and skills to handle large deals when the group gets sold for possibly several hundred million," he adds.

Buyout house NVM just created its first platform, CloserStill, a company to consolidate the UK events management market, alongside the former Ithaca management team, a former NVM portfolio company. Mauro Biagioni, investment manager at NVM, believes "there is always the element of a buy-in in each acquisition; however, we are mitigating this risk by working for a period of time with the incumbent team."

Do your homework

Pursuing a buy-and-build strategy, which is similar to buyouts and buyins, yet simultaneously so different, has implications for deal sourcing and due diligence. Russell views sourcing as a long process which involves a high amount of research in the sector to identify suitable companies. "For a mid-market buyout, the suitable companies are easier to find as they are larger and fewer in number, whereas the bolt-on targets for a buy-and-build are typically smaller and hence need dedicated research to identify them." His take on due diligence is that one could be a bit lighter on the due diligence of a target company, as these are relatively small businesses. "But at some point," he says, "the bank may require due diligence to determine how the group as a whole is performing."

Biagioni, on the other hand, thinks that NVM's way to approach due diligence for its platform is right for the investor and the future group: "We are doing a similar level of due diligence we would do for a vanilla MBO." In the case of CloserStill, the pipeline is already full of potential deals and the management will do most of the deal sourcing but will need the investor's approval for an acquisition.

NVM plans to let the target companies keep their own names. "We do not plan to centralise all of the functions of the group in CloserStill," Biagioni says. Hayden sees the integration process between platform and newly acquired businesses as a very individual process. "It depends on so many things. We ask ourselves for example 'Do we have to replace the owner because he wants to retire? Do all people involved share the same vision for the growth of the business?'" To keep the business motivated during the transition and once it is part of a group requires good quality management. "The owner wants to find a good home for his business and his staff, and is usually concerned about a smooth handover with cooperation from both sides. And there is always the opportunity for him to gradually step down from his tasks to ensure an unobstructed transition," he adds. Often, the integration process does not leave Sovereign with synergy effects. "We have rarely achieved cost savings by putting two companies together," Hayden states. For the investor, it is more about rolling out into new geographies, creating cross-selling opportunities and building scale.

Wooing lenders

Though acquiring small businesses does not always require debt initially, there will eventually come a point when the platform needs leverage. "The biggest debate tends to be around the point at which the critical mass of the buy-and-build group has become sufficient to get a decent amount of leverage on board," points out Ian Sale, managing director at Lloyds TSB Corporate Markets, responsible for the bank's mid-market acquisition finance team. As a bank, "Lloyds wants to see cash-generative businesses which are well embedded in their chosen markets, good margins and an impressive management team. It is also important to see the quality and the track record of the private equity house. Some are much more focused on doing buy-and-builds than others," he says. A GP who is new in the market would have to expect the bank "to look at its individual's track record working with previous institutions and at the potential deals on its own merits," Sale says.

Russell believes that in the current climate, a bank will support a platform that is running smoothly and performing well. "In some cases, the bank will make an agreement to finance acquisitions with the investor. Generally, the platform gets the debt on its books based on the assets of the target," he says. Biagioni agrees: "I believe it is more difficult to get financing for a platform plus acquisitions." For CloserStill, the investor has allocated an amount of equity to fund the first acquisitions. With 10 acquisitions planned for the platform, it wants to apply for debt at a later stage. "We don't anticipate the need to raise debt for at least 18 months," he adds. For Sovereign, the provision of debt has been a mixture. Some banks provided an acquisition line from the beginning; others made case-by-case decisions. Sovereign has long-standing relationships with a series of banks and benefits from a diversified lending base when seeking finance for their different projects. As always, the banks will look at the quality of the sponsor, its track record and what it is bringing to the group.

Can I do it?

Buy-and-build can work for a generalist GP if he does it by establishing a platform with a known management team and a healthy pipeline. It can also work if the GP can put the manpower into deal sourcing or specialise in his sector of expertise - given that there is enough fragmentation to consolidate the market. But Hayden and Russell both believe that buy-and-build is not like an MBO or MBI, and GPs trying to pursue the strategy will soon find out that things are a lot more complex than they may seem. "If a buyout house does a bolt-on, or even more than one, for one of its portfolio companies, it is to boost the business in its market. The bolt-on could represent approximately 20% of the market value for example, which is much safer than doing buy-and-build where the platform might count for 20% of the market value and each acquisition adds 10% to that," Russell believes. Hayden says: "Normally, you have a willing buyer and a willing seller and a private equity house is part of the plan. From then onwards, the process is routine. A buy-and-build player has to make a call on the quality of the business and the management team and specific targets. Also setting a strategy and integrating all members of management into a team is essential." Hayden and Russell both believe that there is enough room for competition. "I am constantly surprised how fragmented most market sectors are," Russell concludes.

A growing trend

Buy-and-build activity has been lumpy over the years, however 2008 stands out as a consistently buoyant time for acquisition finance. The second quarter was a record for bolt-ons, while Q3 was also strong, in stark comparison to the same time in 2007, when Q3 recorded a single bolt-on.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Investments
• UK / Ireland