A Hot M&A Technique Targets Mom and Pop: The IPO roll-up relies on swift execution to consolidate dormant industries with potential for growth.

Ideas and money successful IPO roll-ups need a whole lot more than this to achieve success. In a fairly short period of time, roll-ups have become the new, hot structure in m&a. An IPO roll-up is a technique used by savvy consolidators (a.k.a. “promoters”) who target fragmented industries and merge a number of small companies simultaneously with a public offering, with the goal of transforming small private businesses into larger, more profitable public ones. The current roll-up/consolidation trend is stronger than ever, in part because the benefits of consolidation are being illustrated in the performance of previously consolidated companies. For example, the companies that comprise the Montgomery Securities Consolidator Index have outperformed the S&P 500 since the beginning of 1995, increasing approximately 150% versus 100%, respectively. Although the roll-up trend is hot, the market is more discriminating now than it has been in the past. Historically, a consolidation play (just by virtue of the fact that it was a consolidation play) could easily attract investors, but in the current market, one must have a credible consolidation story to tell. Promoters, as a result, must be extremely diligent in their analysis of a proposed roll-up, and swift in their execution. However, the scope of the promoter’s responsibilities, including identifying the founding companies, arranging for due diligence, negotiating and structuring the transaction, providing for legal documentation, managing the transaction through the offering, and selecting the underwriters, makes a fast-track scenario challenging. Add to those responsibilities the task of dealing with an often unwieldy group of founding companies. While some groups of founding companies may be very closely knit through industry, joint venture, or other ties, others may be very competitive. Even in the most cohesive groups, issues often arise as individual companies “compete” for a bigger piece of the consolidated company pie. The result? Promoters often can feel like they are trying to run a sprint in a sea of mud. Here are some insights that may help pick up the pace. More Than Just a Concept From temporary staffing to funeral homes, there has been no dearth of ideas to consolidate “mom-and-pop” companies in fragmented service industries. How successfully a roll-up concept can be executed, accepted by Wall Street, and turned into increased shareholder value depends on several criteria. How big is the industry? Many underwriters consider $5 billion to be a minimum. Size does matter, in part because the larger the industry, the larger the consolidation opportunity in terms of the increased opportunity to find properly motivated targets and the ability to get critical mass. Is the industry fragmented? Fragmentation very often represents an opportunity to take advantage of synergies and economies of scale. In addition, small private businesses are limited in their liquidity options. Are the people on board? Is the industry composed of owners who are interested and qualified to participate in consolidation? Do the founding company owners share the vision of the consolidation play? Can they be counted on to deliver as team players? Since the new public company will be used as a platform for the consolidation of an industry, the founding companies need to be of high quality and able to become the core of a newly minted industry leader. What are the growth and profitability trends in the industry? In addition to determining fragmentation, careful analysis is required to assess the growth rate, profitability, and other factors that make an industry segment and the founding companies attractive to underwriters. Consolidation within a high-growth industry is obviously more valuable than consolidation in a low-growth industry. Is there some reason to consolidate? In the case of roll-up concepts, simpler is better. If the concept is too complicated or appears contrived, or takes too much time, words and efforts to explain it just won’t sell. Some good reasons to consolidate include: * Threats to the customer base, typically represented by a consolidating customer base that desires national scale from its vendors; and * Opportunities for synergies, including cost savings from purchasing leverage, efficiency in production, distribution, and other functions, and shared marketing and technology costs. Are the people up to the job? Can the team (promoters, management, founding companies, advisers) handle the details? Roll-ups are complex transactions. It is absolutely imperative that a substantial amount of analysis be completed prior to settling on founding companies. Throughout this analysis, very close attention must be paid to the details surrounding getting the deal done and positioning the company for future success. Do accurate and auditable accounting records exist for at least the past three years? Can accurate historical quarterly information be produced, and thus relied on to generate sound forecasts for use in valuation? Are there legal and tax issues that could carry over to the combined group? Can public company initial and recurring filing requirements be met? Is the accounting acquirer poolable? Tempus Fugit During the process by which a promoter evaluates the above criteria and validates a consolidation concept, speed is of the essence. There are few secrets in any industry, and once a promoter starts to contact possible founding companies about merging with their peers and becoming part of a simultaneous IPO roll-up, other promoters and pursuers are likely to emerge. Thus it’s critical that a promoter lock up an industry’s quality companies quickly. Their participation in the deal will likely affect the pricing of the IPO, the ability of the company to attract high-quality follow-on acquisition targets, and the ultimate brand image of the new entity. Speed in getting to market is also paramount. If a roll-up with second-rate players in the targeted industry hits the market first, the pricing of a subsequent roll-up may be adversely affected. Also, holding the group of founding companies together during an extended IPO roll-up process gets tougher with time and increases the risk of earnings surprises as a result of “deal distractions.” Typically, a promoter’s operations are lean, and yet speed in moving through due diligence, negotiation, and closure requires a depth and breadth of resources. In order to increase deal speed, promoters need to surround themselves with experienced advisers who operate as an extension of their own staff. Since much of the day-to-day preparation for a roll-up happens simultaneously, promoters need many seasoned hands on deck. Who’s at the Helm of the New Public Company? Management in a roll-up is generally composed of the leadership that accompanies the founding compa-nies as well as a senior management team recruited to run the combined entity. Certainly, recent financials of the founding companies and forecasted earnings of the combined entity will drive the IPO valuation. In the long term, however, shareholder value will depend on the ability of the senior management team to find operating improvements, manage a successful follow-on acquisition program, and expand market share. It’s critical, therefore, that a roll-up’s senior management team have a profitable track record in the industry and significant experience in acquisitions. While management, like the promoter, will need to surround itself with experienced advisers, there is no substitute for a management team with access to follow-on acquisition targets, an understanding of the order of play critical to acquisition success, and an ability to get the deals closed. In short, senior managers must have the ability to think and act big, because success will mean they will soon be building a company targeted to be 20 to 30 times larger than it was at the IPO. What Makes a Good Roll-Up Idea Go Bad The manifestations of an unsuccessful roll-up are weak IPO pricing and unrealized shareholder value. Usually, this can be traced to one or more of the following examples: * The promoter settles for second-rate founding companies that do not express the best qualities of the industry to the public market. * Management is a collection of individuals inexperienced at managing a large company, executing a fast-paced acquisition strategy, and achieving the synergies touted in the IPO documents. * Late entry, i.e., too many roll-ups/consolidators have hit the market, leaving either few companies or weak companies as your targets for consolidation. * The promoter presents an overly optimistic story to the underwriters. When discovered, either the “new story” is not one that the underwriters support or the change creates a lack of confidence. Plan for a Successful Roll-Up Changing the face of an industry requires a plan and an experienced team that buys into the vision. Ideas that are implemented with speed, quality players, and good management are a winning formula for everyone the promoter, the promoter’s advisers, the founding companies, the underwriter, shareholders, and customers. Bundling Quality FirmsChanging the face of an industry requires a planand a capable team that buys into the vision ofconsolidation. Savvy consolidators are using the innovative IPO roll-up to swiftly consolidatefragmented industries by merging a number ofsmall companies and simultaneously taking the newly formed company public with the aim oftransforming small private businesses into larger,more profitable public ones. How successfully a roll-up concept can beexecuted depends on several criteria, includingthe size of industry, the industry outlook forgrowth and profitability, and whether the owners of the merged companies share the vision andcan be counted on to deliver as team players.