1. Introduction
Buy & build strategies are becoming increasingly popular in the M&A market. “Buy & build” describes an investment strategy primarily used by financial investors, which has the aim to consolidate highly fragmented markets through the targeted acquisition of various complementary or internationally supplementary companies and thus generating a premium valuation when exiting. In 2018, the total value of buy & build deals in Europe rose to a record level of EUR 10.7. billion. A study by Silverfleet Capital shows that European PE-financed companies made 702 add-on acquisitions in the past year – an increase of 8% compared to 2017.
2. Different Approaches for the Implementation of a Buy & Build Strategy
When implementing a buy & build strategy, two fundamental approaches are used in practice: the opportunistic approach and the strategic approach.
The opportunistic approach is more common in practice. When deploying the opportunistic approach, the first step is the acquisition of an anchor company serving as a “platform”. The second step is to acquire further add-ons. The anchor investment thus serves as the starting point.
The more rarely pursued strategic approach is preceded by a detailed industry sector analysis. Based on the results revealed by the analysis the strengths and weaknesses of a market are evaluated and the potential for implementing a buy & build strategy is estimated. Based on this analysis, the acquisition process starts.
3. Prerequisites
Market characteristics: The ideal market for buy & build strategies is highly fragmented and fast growing. It should also be of a certain size, both in terms of market volume (at least EUR 500 million) and in terms of market participants (at least 50 companies). A significant number of companies in a market is particularly important, since only a certain percentage of the shareholders is willing to sell their company. In addition to that, investors have to assert themselves against other bidders in today’s competitive buyer environment.
Target characteristics: For buy & build strategies, it is advisable to acquire primarily successful and healthy companies to prevent margin dilution while focussing on revenue growth. Business models that are depending heavily on individuals (e.g. advertising agencies, consultancies) are also less suitable for buy & build concepts.
Experience shows that relative size ratios among the individual investments play a subordinate role. The strategic and the cultural fit are much more decisive.
4. Crucial for Success
The success of a buy & build strategy depends entirely on a few critical factors. Constant adherence to basic principles and the avoidance of elementary sources of error must be ensured throughout the entire process.
Management and fit: As so often, people are the most important factor. It is crucial for the manager of the anchor company to have deep industry and transaction experience. Additionally, the cultural fit between the parties (PE and operative companies) is of high importance. Many investors underestimate the diverging influence of a single company in an established group of companies.
Moreover, the implementation of a successful buy & build concept requires constant support and guidance by the right management team. This greatly facilitates coordination and cooperation among the portfolio companies and the private equity firm.
Market dynamics: The success of buy & build strategies always depends on specific market conditions. The optimal market for buy & build strategies is characterized by a fragmented structure with low concentration and many smaller market participants. Dr. Ingo Krocke, Managing Partner and founder of Auctus Capital Partners AG, also confirmed this during an interview with Oaklins.
Examples of such sectors include logistics and e-learning services, facility management, as well as handicraft businesses, such as scaffolding, and retailers. Handwerksgruppe Philip Mecklenburg, for instance, has acquired and integrated a group of 123 craft businesses throughout Germany and will achieve a group turnover of approximately EUR 450 million in 2019.
Mr. Krocke furthermore highlighted market growth as another important key factor, “because strong growth forgives almost all mistakes”.
Direction of diversification: Buy & build strategies aim at achieving market consolidation. Therefore, it is obvious that target companies should be active in the same market in order to complement the core business of the existing portfolio. Mainly horizontal, and occasionally vertical integrations are carried out in the course of the buy & build strategies. Lateral diversifications, i.e. extensions that are not related to the platform company, should be avoided.
5. Causes of Failure
Buy & build as the wrong strategy: It is particularly harmful if an investor feels compelled to carry out a buy & build strategy without having proper experience on how to execute this strategy. A too quickly implemented, forced buy & build process can be dangerous, because at the end of the day this usually turns out to be just a blunt stringing together of different companies that cannot be integrated. As an investor, one must always bear in mind that the “build” factor is at least as important as the “buy” factor in the buy & build strategy. Before getting lost in a forced buy & build process, an investor should change his investment strategy.
Second Mover: The chances of successfully implementing a buy & build strategy when entering a potential buy & build market too late is very small. This is particularly relevant due to the fact that only a small number of shareholders of conceivable targets is willing to sell. It is therefore essential to enter a market as a “first mover”.
Further failure components can be derived from the success factors already described. Investors must therefore always have an eye on experienced management teams and cultural fit. They also need to avoid markets not suitable for buy & build strategies and diversification directions.
6. How to Create Value via Buy & Build
The reason for the significant increase in buy & build deals is obvious: they outperform single PE deals by generating an average internal rate of return of 31.6% from entry to exit compared to an IRR of only 23.1% for stand-alone deals. Various market participants assume a multiple arbitrage of two to four points. The main driver for this is sales growth. Dr. Ingo Krocke of Auctus Capital Partners AG confirms during an interview with Oaklins that the old investment rule of thumb “size matters” applies. Increased margins also have a positive effect on the valuation. In practice, however, these can rarely be realized to the extent initially assumed until the exit and should therefore have a lower influence on the purchase price when acquiring the individual target companies. The same applies to synergy effects and cross-selling potentials – they are considered “nice to haves”, but should not have a significant impact on the valuation.
Due to the reasons outlined above, only few financial investors are willing to add a buy & build premium to their valuation. Especially the platform investment is usually valued on a stand-alone basis. However, some investors pay buy & build premiums for the add-on acquisitions – albeit very conservatively. The reason is obvious: If it turns out after an acquisition that a buy & build strategy cannot be realized, the target company has been acquired at an excessive price.
If one also takes into account the effect of financing the purchase price with a significant proportion of debt capital, very attractive money multiples can result. An example for this is the multiple of 16x recently realized by the Aurelius Group in the Solidus deal in four and a half years.
7. The Importance of Post-Merger-Integrations
Integration speed: It is not particularly surprising that companies which implement rapid integration can get into day-to-day business more quickly. The faster the acquired company is fully integrated, the higher the profit from the positive effects of the generated synergies. A time-consuming integration process can have a negative impact on employee satisfaction, which is the main reason why the majority of the integration process should be completed within the first year. Florian Korp, partner at Liberta Partners, also emphasizes this in an interview with Oaklins: “If you still have two different companies after twelve months of post-merger integration, then you’ve actually only made 2 out of 1 + 1 and not 3 or 4”.
Culture and change management: Culture and change management is an extremely important factor for successful post-merger-integrations. However, it causes problems for many investors because it is difficult to measure and verify. Experience shows that cultural differences between the buyer and the target company are one of the main reasons why integrations fail. Florian Korp of Liberta Partners also sees a sticking point here: “Hard facts, such as IT systems, are always easier to integrate than soft facts”. It is therefore of great importance to carefully examine whether the cultural match between the buyer and the target enables a successful acquisition at all. “The human component is the most difficult to integrate. The most important drivers here are mutual appreciation as well as the coordination and implementation of a coherent strategy,” adds Dr. Henning von Klitzing of Possehl Holding.
8. Three Recommendations
Do not lose patience. In many cases, the acquisition of an add-on is not immediately successful in the first year. However, investors should always focus on quality rather than on quantity. No hasty process should take place, but in case of doubt, investors should not wait too long, either. A professional M&A consultant with industry experience can open doors here and support the private equity team. Nevertheless, it may turn out that the platform investment can achieve a better development through organic growth than through acquisitions. It is important to make the right decision at the right time.
Establish cooperation at eye level. The strategy must be communicated openly and rigorously among the portfolio companies. The feeling of being a secondclass participant demotivates almost every employee and has negative effects on the working atmosphere and success.
Use market threats to your own advantage. Particularly well-suited markets for buy & build strategies are those in which market participants are exposed to concrete threats. This can be of a regulatory, technical or international nature. Facing the pressure of a particular threat, shareholders are usually more willing to sell and investors can take advantage of this.
9. Summary
Due to the aspects described above, the implementation of a buy & build strategy is often attractive for financial investors. A well-managed corporate platform can become a pioneer in an industry and thus deliver the desired success for financial investors. However, the shareholders of the target company also benefit, as they can expect further economic development of their company and, in some cases, valuation premiums. This results in a win-win situation, as both the buyer and the seller profit from the correct execution of a buy & build strategy.