– Phill Namara
In a roll-up, an acquirer typically purchases many smaller, usually private companies to add to their business. The acquirer is often expanding its geographic presence or product portfolio in a fragmented industry and hence these acquisitions are used to fuel strong top-line sales growth for the acquirers. In-fact a large proportion of these serial acquirers report double digit growth numbers quarter over quarter, as-long as they can identify acquisition opportunities. This business strategy enables the acquirer to immediately reap the benefits of being a scale player within a fragmented industry. An example of one of these benefits would be greater bargaining power with suppliers – when it comes to prices and payment terms for inventory.
So we can clearly see there are awesome revenue benefits for serial acquirers, but what about their investors? Because these companies are usually acquiring these smaller businesses at lower multiples than they themselves trade at; every acquisition is accretive to earnings, which drives their stock price higher. As such you can see, we have a flywheel effect forming – whereby the companies report strong sales numbers driven by acquisitions, investors reward this growth by buying the stock resulting in the share price going up, and at this higher share price the expectations of future earnings increase too, so management must again consider acquisitions to keep the wheel spinning.
As equity investors, we here at Montaka, are not dazzled by top-line revenue growth numbers but rather care about returns on capital and the quality of the underlying business. And so in evaluating these types of businesses, we implore our readers to consider what would happen to the business if that wheel I described earlier stopped spinning. What if management could no longer find attractive targets? We must question- Is the base business model sustainable? Does it have a sufficient moat or competitive advantage? Or is it instead a poor business that has merely grown via debt-fueled by acquisitions and positive investor sentiment – because that wheel could stop spinning at any time.
Phill Namara is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.