With the public markets still largely closed, buyout firms are doing whatever they can to achieve returns during the short term and long term. Sponsor-to-sponsor sales have been a popular route to exit, while other firms are adding small companies to existing platforms in hopes the cumulative size will matter when the IPO market returns.
But while buyout firms may be exploring several avenues, one route most of them aren’t willing to take these days is rollups.
“Buying a bunch of little guys and putting them together is out of fashion because they were disasters,” says David Lobel, a managing partner with Sentinel Partners. “These are small-time companies that never worked in big companies. They are usually very thin on management and don’t understand the corporate mentality. The public has lost interest in them, and banks won’t finance them anymore.”
Stewart Kohl, a general partner with The Riverside Company, agrees: “It’s too hard to be successful, and there is just too big of a risk for something to go wrong with all these companies being sewn together.”
Add-ons Hot, Rollups Not
While rollups are out of favor, add-on acquisitions aren’t. According to Buyouts’ data, 15% of the deals done in the first half of 2003 were add-ons, while 65% were LBOs or MBOs. Carve-outs account for the remainder of the deals done in the first half. Although the number of add-on acquisitions is never going to reach the same proportion of acquisitions of platform companies, the strategy has clearly become more prevalent.
“Add-ons are important, but most equity groups would rather get a platform business than an add-on. It is and always will be the number one priority,” says David Barnes, the national director of private equity for Houlian Lokey, adding that now is a great time to invest in platform companies. “Purchase prices are at an historic low. You can get a company at five times EBITDA rather than eight times. So you get a cheaper purchase price and better company, that makes for good buying.”
The fact that debt multiples are hovering around four times EBITDA undoubtedly helps push buyout firms toward platform companies, but whether firms make platform or add-on acquisitions, the driving force is the more $100 billion of overhang that has to be put to work before LPs start asking for their money back.
“There has been an increased level of activity across the board. There is a huge overhang and it is driving the market,” says Mark Opel, a principal with American Capital Strategies. “The loosening of the cash flow is helping increase activity too. We are seeing modest but real increases in leverage multiples.”
Jim Freeman, a managing director with Barrington Associates, says buyout firms are divided among all types of deals and are generally doing what’s best for them in the moment. “The private equity community is very interested looking for good companies and doing well in this environment, [but] they are indifferent to add-on or platform deals,” he said. “They are being cautious, but still aggressive because they have lot of capital to put to work. They want to show LPs returns.”
Of course, many buyout pros ask, what good is an add-on acquisition without platform acquisitions? Riverside has completed eight deals this year. Five have been add-ons while three have been platform companies. In 2002, the firm completed a total of 13 deals with six being platform companies and seven being add-ons. When Riverside acquires a platform company it is already identifying add-on targets. “You used to be able to sell the business at higher sales and high profit and get a good return without doing much. You assumed you were a genius. Now you have to do something to make the businesses more valuable, so you have to add to it,” says Kohl.
Sentinel’s Lobel says the 60% of the platform acquisitions his firm completes require add-on acquisitions. “I don’t track statistics, but in our operations when we make an investment in a platform company we know whether an add-on investment is going to be part of the strategy or not,” he says. “You need to have an add-on strategy process in place to make it happen. You can’t just wait and see.”
David Hoffman, a partner with Charterhouse, says businesses become 50% more effective when they are added on. “You have to understand the day-to-day operations of your platform company’s business, then you have to integrate new businesses to build up the company,” he says.
Although many buyout shops are using add-on strategies to build their companies, none claim to be trying to create colossal-sized companies.
“We’re not looking to create powerhouses,” says Hoffman. “We just want to build a business with the add-ons. The desire is to have the company get a broader array of services rendered.”
In the Meantime
If and when a platform company grows to enough size and profitability so it is ready to exit, many buyout shops will likely turn toward their peers to unload their portfolio companies.
“Sponsor-to-sponsor sales are increasing. Financial buyers have lots of capital to spend and there aren’t many other options for exiting a company,” says Kohl.
Lobel adds: “The exit market is much stronger than it was, but doesn’t mean the IPO market is. That is not strong. Sellers are looking to the buyout market to unload.”