Why a Roll-Up Makes Sense
Finding the perfect manufacturing acquisition can be tough. Buyers usually have a list of criteria or “must-haves.” For most of the buyers we work with, that list includes a business that can be scaled up, something with little competition in a fragmented industry where there are no or few dominant players. Most of the buyers that contact us are also looking for a minimum cash flow of $1-$2 million. The problem is that these manufacturing companies are few and far between. I spoke to a buyer last week that has been shopping for two years. When they find something that fits, the competition is fierce. Buyers like this are making one fatal mistake while searching for an acquisition. They can get to where they want to be a lot faster if they simply do one thing differently. Allow me to explain.
These companies are focused on size first. They’re ruling out smaller companies that have great products, great customers, systems and people in place for ease of transition and incredible growth potential. Manufacturing is a highly fragmented industry in the United States, especially in the metal-cutting sectors. A call to any mailing list provider will provide a surprising education on how low the revenues are of most companies in these SIC codes. Does that mean they should be ruled out for acquisition?
Buyers that have had trouble finding an appropriate acquisition should consider a roll-up of several smaller companies to achieve the desired result. Because the industry is so fragmented, an acquirer with the appropriate business development and management skills could potentially combine several manufacturing companies and dominate a particular type of manufacturing in a geographic region. What if, through acquisition, you become the largest provider of fabricating and welding services in New England? What if you can acquire your way into domination of the architectural wood products sector in the southern USA or the pump & valve repair sector in the Midwest?
There are challenges to this strategy, but before we address them, let’s look at the issue of size. Institutional buyers oftentimes assume that a small acquisition is a bad one.
The misconception is that because the company is small, they are not managed well, would be hard to transition, are too dependent on the owner, and would provide a horrible return on their investment. They, however, don’t spend time in the industry the way I do. Each week I talk to amazing manufacturing business owners that run incredibly efficient businesses that are totally automated, updated, and systemized. If you’re saying to yourself, “Yeah, but their cash flow probably sucks,” you would be wrong. When is the last time you saw a manufacturer whose SDE was 50% of sales? That same company has long-time customers. The owner never touches the manufacturing process. There are managers in place that do the quoting and customer relations functions, and EVERYTHING is computerized. If you think this can’t be scaled up, you might be shocked at what I’m going to say next. The company has NO website, and they’ve NEVER marketed themselves, ever. What happens to this company with a few small tweaks and some marketing savvy?
In conversation recently with a private equity on the issue of buying large vs. small, the managing director said, “Yeah, Fran, but it takes just as much effort to buy a small company as a larger one, and we can make more with a larger one.” Really? So what if you spend $10 million instead of $4 million? Isn’t it about the return on your investment? Go find me a manufacturing company for $10 million that can produce 50% for the owner in profit!
There are tons of businesses out there just like this one. The fact that they don’t have a website should be attractive to an investor. If they can pull off what they have without one, just imagine what you could do. Everything else about them has the hallmarks of a much larger business. The founder, however, was content with a certain amount of money. He still had a “life” while his kids were going to school.
A roll-up of several smaller companies can provide several advantages, including:
- Geographic control and brand recognition
- Increased buying power with key suppliers
- Cost savings for things like insurance
- Cross-selling of products & services
- Establishing a corporate headquarters can provide increased manufacturing productively with managers no longer responsible for administrative functions
There are challenges and dangers to roll-up strategies, too, that should not be ignored. One of the biggest issues is the difficulty of establishing uniformity of systems and procedures. Equally important is the issue of merging company cultures. However, with the skill set that most institutional buyers bring to the table, these issues can easily be mitigated, and the benefits far outweigh the risks. Consider entering a buy-side engagement with an M & A professional that specializes in the sector you want to be in. If they can help you find the right roll-up matches, it will be money well spent.
In conclusion, if you’ve been having trouble finding an appropriate manufacturing acquisition, here’s my advice:
Think small to grow big – and….size doesn’t matter as much as you think it does!