Roll Ups

[stockspinoffinvesting]

I'm doing work on Ensign (skilled nursing operator) which recently announced it's going to be spinning off its home and hospice services business & senior living businesses into a new company called the Pennant Group.

 

Ensign and Pennant have both used the roll up strategy. Both companies operate in a fragmented market so the strategy seems to make sense and Ensign has been very good stock.

 

My question doesn't really relate to Ensign but more so to the roll up strategy. If executed successfully, it is a compelling strategy (Constellation Software, Jarden, Waste Management, and AutoNation). However, there are the obvious disasters like Valeant. Nuance is another company that has made numerous acquisitions for years and it's stock price has done nothing. Any others that come to mind?

 

My question is this. Ex ante, what are the tell tale signs of good roll ups? What are the tell tale signs of bad roll ups?

 

I saw the below thread, but it is more focused on valuing a roll up as opposed to separating "good" roll-ups from the "bad"

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/how-to-value-roll-up-companies/

 

Thanks in advance.

 

[BG2008]

Look into Berry Global, it's a plastic packaging.  They buy 5bn pounds of resin and their targets typically buy 5-10% of them.  If you buy 5bn of resin, the resin manufacturers want your volume to absorb the bulk of their overhead.  So you get a 2-5% of revenue savings in resin.  Thus you buy a target that has a 10-12% EBITDA margin and right off the bat you're shaving a lot of that cost off just through being a larger operator in the space.  Thus, it makes sense to pay 8-9x EBITDA which is really 5-6x EBITDA after synergy.  Cable operates the same way where there used to be lots of little guys around.  They can use scale in buying content cost to lower the cost. 

[Saluki]

Well, think of a classic example, LTV (Ling Temco Voight).  They had a high P/E and they would buy low P/E companies and it would immediately make a positive impact on stock price because their earnings kept going up. So if they had a P/E of 30, and bought a company with a P/E of 10, that portion of the P/E 10 company's earnings becomes P/E 30 when valuing the acquiring company.  The problem is that LTV had to keep borrowing to buy more and more companies and they had a low P/E because they were terrible companies and the end you have a company that's made up of other terrible companies and loaded down with debt. 

 

That's sort of what Valeant did (although they raised prices, which helped them boost earnings) and it's what a several dot com companies did in the 90s.  Bricks and Mortar + clicks = a Low P/E company being bought by a high P/E company and having the earnings being revalued by the higher P/E by a gullible public.  AOL Time warner, anyone? 

[Guest cherzeca]

some industries lend themselves to the roll up.  funeral industry for example.  I dont know that you need a national brand (like Car Nation for car dealerships) as much as you need to provide superior marketing and management for the local practitioner.  in fact, having a local touch is an advantage.  repeat customers (fast foods) rely on branding and franchising takes the place of roll ups there.  seems to me hospice/elder care is closer to the funeral industry example than fast foods, where you are just going for margin improvement.

[Spekulatius]

Look into Berry Global, it's a plastic packaging.  They buy 5bn pounds of resin and their targets typically buy 5-10% of them.  If you buy 5bn of resin, the resin manufacturers want your volume to absorb the bulk of their overhead.  So you get a 2-5% of revenue savings in resin.  Thus you buy a target that has a 10-12% EBITDA margin and right off the bat you're shaving a lot of that cost off just through being a larger operator in the space.  Thus, it makes sense to pay 8-9x EBITDA which is really 5-6x EBITDA after synergy.  Cable operates the same way where there used to be lots of little guys around.  They can use scale in buying content cost to lower the cost.

 

There are a lot of roll ups in the packaging sector (containerboard, plastic packaging ) that seem to work out well. It seems that economy of scale and a relatively predictable business with a good cash generation are a winning strategy.

[BG2008]

Look into Berry Global, it's a plastic packaging.  They buy 5bn pounds of resin and their targets typically buy 5-10% of them.  If you buy 5bn of resin, the resin manufacturers want your volume to absorb the bulk of their overhead.  So you get a 2-5% of revenue savings in resin.  Thus you buy a target that has a 10-12% EBITDA margin and right off the bat you're shaving a lot of that cost off just through being a larger operator in the space.  Thus, it makes sense to pay 8-9x EBITDA which is really 5-6x EBITDA after synergy.  Cable operates the same way where there used to be lots of little guys around.  They can use scale in buying content cost to lower the cost.

 

There are a lot of roll ups in the packaging sector (containerboard, plastic packaging ) that seem to work out well. It seems that economy of scale and a relatively predictable business with a good cash generation are a winning strategy.

 

I read a packaging primer once that essentially said that packaging companies are bonds masquerading as equity.  Their cashflows are so stable that they can continuously lever up to do acquisitions and then use FCF to de-lever.  Berry has done this multiple times in their private/public life. 

[EricSchleien]

Can you point me to where you found that packaging primer? I'd love to read it.

 

Look into Berry Global, it's a plastic packaging.  They buy 5bn pounds of resin and their targets typically buy 5-10% of them.  If you buy 5bn of resin, the resin manufacturers want your volume to absorb the bulk of their overhead.  So you get a 2-5% of revenue savings in resin.  Thus you buy a target that has a 10-12% EBITDA margin and right off the bat you're shaving a lot of that cost off just through being a larger operator in the space.  Thus, it makes sense to pay 8-9x EBITDA which is really 5-6x EBITDA after synergy.  Cable operates the same way where there used to be lots of little guys around.  They can use scale in buying content cost to lower the cost.

 

There are a lot of roll ups in the packaging sector (containerboard, plastic packaging ) that seem to work out well. It seems that economy of scale and a relatively predictable business with a good cash generation are a winning strategy.

 

I read a packaging primer once that essentially said that packaging companies are bonds masquerading as equity.  Their cashflows are so stable that they can continuously lever up to do acquisitions and then use FCF to de-lever.  Berry has done this multiple times in their private/public life.