One of the stock market darlings in Canada is a company called AutoCanada Inc. (ACQ Toronto). AutoCanada Inc., through its subsidiaries, operates franchised automobile dealerships in Canada. The company offers various automotive products and services, such as new and used vehicles, vehicle parts, vehicle maintenance and collision repair services, vehicle protection products, and other after-market products. It sells various new vehicle brands, including Chrysler, Dodge, Jeep, Ram, FIAT, Chevrolet, GMC, Buick, Cadillac, Infiniti, Nissan, Hyundai, Subaru, Mitsubishi, Audi, and Volkswagen. The company also arranges financing for customers through third-party financial institutions, as well as facilitates the sale of third party insurance products to customers comprising credit and life insurance policies, and extended service contracts. As of December 31, 2013, it operated 28 franchised dealerships and managed 5 franchised dealership investments in British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, New Brunswick, and Nova Scotia. AutoCanada Inc. is headquartered in Edmonton, Canada.
ACQ’s business model is what we used to call a roll-up strategy.
A roll-up is a term used to describe a company that is built primarily though the acquisition of smaller companies with common services or products. Usually, roll-ups are conducted by financial buyers in a specific market that is fragmented and can be consolidated. The market may be dominated by one player, with the balance of the competition made up of smaller private companies without sufficient scale and infrastructure to challenge the dominant player.
The financial buyer will identify the potential acquisition targets that offer products or services within the fragmented market, and usually acquire them through a platform company. The roll-up then entails putting the various businesses together under a common brand, administrative infrastructure, reporting systems, and sales and marketing, so the combined business is presented to the customer base as a single entity. In a roll-up, value is created by building a much larger, scalable entity that will command a higher valuation multiple on exit, and also by establishing a common platform of systems and processes that allows for easy integration of each acquisition.
A roll-up is also known as a consolidation.
Roll-ups can generate value, but they are extremely difficult to execute. The difficulty lies in the mix of different cultures and business practices inherent in each of the companies acquired, as well as the considerable change that these companies experience as they get integrated.
If the change is too immediate, the original owners may get disenchanted quickly and leave which causes a loss of value due to the usual dependence on previous owners in the early stages. Similarly, if the integration change is too slow, then the combined company remains fragmented with a group of companies under one common umbrella, but with no cohesion or infrastructure to operate as a scalable, single entity.
Roll-ups are better suited for company owners who wish to stay on and create value together with other operational and financial partners, rather than those sellers who are simply looking to monetize their company equity through a quick cash exit.
If you take a highly fragmented industry, like used-car sales, funeral homes, office supplies, air-conditioning services, veterinary care, or laboratory diagnostics. Buy up dozens, maybe hundreds, of owner-operated businesses. Create an entity that can reap economies of scale, build regional or national brands, leverage best practices across all aspects of marketing and operations, and hire more potent managers than the small businesses could previously afford.
Consider the dismal results from six leading roll-ups in the late 1990s—Waste Management Inc., AutoNation Inc., the funeral-home companies Service Corporation International, Stewart Enterprises Inc., and U.S. Office Products Company and its rival Corporate Express Inc. After significantly outperforming the S&P 500 for two strong years (1995 to 1996), these six roll-ups came crashing down.
Roll-ups, as we use the term, emerged in the mid-1990s as one form of the many waves of consolidation washing over the globe. Roll-ups differ from conventional merger-and-acquisition activity in three distinct ways.
First, roll-ups occur in highly fragmented industries as mentioned above, usually service-or distribution-related, but occasionally in manufacturing. As a result, consolidation involves not a handful of mergers and acquisitions, but dozens, or sometimes hundreds.
Second, companies acquired are generally owner-operators rather than large, publicly owned companies. This makes integration much more complicated, because people accustomed to seat-of-the-pants decision-making and complete control are suddenly required to play on a team, with corporate instead of personal goals in the forefront. Additional complications arise because the many small businesses use diverse accounting systems and technology.
The third way in which roll-ups differ from conventional merger-and-acquisition activity is that their strategy is not to gain incremental advantage but to reinvent an industry, creating an entity with a fundamentally superior value proposition.
The bet underlying a roll-up is that it can reduce costs and drive growth to create enormous value. In fact, kindling organic growth is particularly important as the pace of acquisitions begins its inevitable decline. Roll-ups take on considerable costs: premiums paid for acquisitions, debt, high-powered management teams. To make good on that investment, the entity must grow. When all goes well, we find a cycle of value creation that takes on a life of its own.
As acquisitions are made, value is created from a series of concurrent post-merger integration, each focused on forging a bigger and more competitive entity from many fragmented individual companies. The value created is shared with the customers (through more attractive pricing or higher quality of service) and employees (through better benefits or incentives). This results in accelerated organic growth driven by a superior value proposition. The market rewards this kind of growth with a higher P/E ratio, which creates the currency for more acquisitions.
Sounds simple enough, doesn’t it? So what can account for so many failures? Our experience shows it’s the inability of a roll-up to kick-start the wheel of fortune. Contemplate, for a moment, Waste Management’s saga. In 1998, USA Waste Services Inc., an up-and-comer in the solid-waste industry, merged with Waste Management, a faltering leader. Waste Management’s share value roared from below $30 to a peak of about $55 per share in mid-1998, when the merger was finalized and the combined company assumed the Waste Management name.
Its 1998 annual report assured shareholders, “We have met the challenges head on, moving swiftly to unify operations and take full advantage of the potential synergies. We have addressed operational issues on every front—consolidating routes and reducing transportation routes, streamlining field operations and facilities, standardizing systems and procedures, and eliminating duplication of administrative and managerial functions.”
But little more than a year later, in December 1999, Duff & Phelps Credit Rating Company, while reviewing Waste Management’s debt, noted “lingering systems issues” and “the loss of customers through systems and performance difficulties” after the consolidation with USA Waste. Waste Management faced difficulties for many years after that. It has still under-performed the Dow Jones Industrial Average for the last ten years.
When you review ACQ’s financial statements you will find a balance sheet heavily weighted by goodwill and other intangibles that have accumulated through the company’s numerous acquisitions. These balances will be tested for impairment regularly so if the business falters, the write-offs will begin.
The company has a lot of leverage. So time will tell what the inevitable increase in interest rates will do to the company’s operating performance given that it’s finance costs are considerably higher than it’s finance income.
As is normally the case, those who don’t learn from history will be doomed to repeat it. I’ll update the progress of ACQ from time to time. I am skeptical. Here is a recent news release on the company’s results. Buyer beware. “AutoCanada shares soar on record earnings, sales; prospects for greater expansion“. This is exactly the kind of results one would have anticipated from a roll-up strategy.
The Chazan File 