VideoThe day before last Thanksgiving, then-39-year-old financial whiz Jonathan Ledecky pulled off a bold deal. He went to the public equity markets and raised half a billion dollars for his company, Consolidation Capital Corp., in an initial public offering. What made this deal so brazen was not just that Consolidation had yet to earn a dime. In fact it had no revenues, no assets, no operating history, and no identity. Ledecky hadn't even settled on an industry for his new venture. He raised the capital in a blind pool on the strength of his reputation alone.
That reputation rests on his ability to build so-called roll-ups. These are companies created to consolidate fragmented industries by gobbling up small mom-and-pop businesses. But unlike regular consolidations, in which strong industry leaders buy up weaker rivals, roll-ups are started from scratch.
Here's how it works: A promoter like Ledecky finds between 5 and 10 private companies in the same industry that agree to sell their businesses for cash and stock from the proceeds of an IPO that has yet to occur. The IPO and the merger of the founding companies occur simultaneously. Using its stock as currency, the new company continues the acquisition binge in the hope of eventually creating a national power-house that will dominate the industry.
Roll-ups are red hot on Wall Street. At last count, about 90 roll-ups had gone public since one of the first, U.S. Delivery Systems Inc., debuted in 1994, including 50 in 1997 alone. And the frenzy continues, with an average of 5 coming to market each week.
Also called "poof" companies because of the way they seem to materialize out of thin air, roll-ups are consolidating such industries as funeral homes, dry cleaners, flower wholesalers, bus lines, home builders, and air-conditioning repair services. In fact, roll-ups have popped up in every fragmented industry.
But the risks in these deals are as great as the rewards. "There are so many hurdles to overcome that it is very difficult to pull these deals off," says Patrick Sullivan, partner in charge of acquisition advisory services for Coopers & Lybrand LLP in Los Angeles.
That hasn't stopped Ledecky and those like him from trying. They are financial cowboys, '90s style. But unlike 1980s' corporate raiders T. Boone Pickens and Carl Icahn, who made a killing preying on conglomerates and selling off their pieces, these cowboys make money by putting the pieces together. In that sense, roll-ups are the reverse of the leveraged buyouts of the '80s. Sullivan calls them "leveraged buildups," because they leverage equity to build the company.
The king of consolidators is H. Wayne Huizenga, owner of the Florida Marlins baseball team. Huizenga pioneered the technique by rolling up garbage-truck businesses to create Waste Management Inc., the nation's largest waste company. He went on to create the largest video chain, Blockbuster Video, and is trying to work his magic on the auto retail industry through Republic Industries Inc.
Now promoters have taken the concept to the next level, with roll-up IPOs. Ledecky, who created one of the earliest and now largest roll-ups, U.S. Office Products Co. (USOP), has since created three more--USA Floral Products Inc., a flower distributor; Consolidation Capital; and UniCapital Corp., a consolidator of commercial leasing firms that filed to go public in February. These three were all done in the past year, while Huizenga took 25 years to get to his third.
The man with the most notches on his belt, though, is Steve Harter, chairman of Notre Capital Ventures II, a Houston-based investment bank. Harter has six bronze bulls, awarded by the New York Stock Exchange when a company is listed there, to prove it. He sharpened his skills doing M&A work for Arthur Andersen LLP and, later, analyzing acquisition candidates for Allwaste Inc., a Houston environmental-waste company. After orchestrating the U.S. Delivery roll-up, he completed five more, including some of the most successful yet. Coach USA Inc., a roll-up in the motor coach industry, went public in May 1996 at $14 a share and has more than doubled to a recent close of $38. Another of Harter's creations, Metals USA, is up 60 percent, to a recent high of $16 since its initial offering last July.
Harter also started Comfort Systems USA Inc., which is out to consolidate the air conditioning and heating industry; Physicians Resource Group Inc., a consolidator of ophthalmology practices; and his most recent IPO, Home USA Inc., a consolidator of mobile-home retailers that went public last November.
FEES THAT MATCH THE P/Es
Clearly, the success stories are alluring. But roll-ups have their critics. Among them, oddly enough, are the stronger players, who take aim at less-scrupulous copycats. "There is a tremendous amount of financial alchemy going on," says Harter. What concerns them is that roll-ups can be a house of cards. After the IPO, the roll-up continues to acquire companies, using equity it raised at high P/E ratios to buy smaller private companies that trade at lower multiples. This arbitrage helps maintain the roll-up's high ratio and the acquisition binge; it's a machine that feeds itself.
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