In May 2015 Bill Ackman, a hedge-fund manager, spoke at the Ira Sohn conference, a charity do at which Wall Street investors bat around ideas. Ackman tried to rehabilitate an old concept, that of “platform” companies, which grow by continually buying others, finding their targets in the unloved and musty corners of the economy. Roll-ups, as they used to be known, were all the rage in the mid-1990s, before a series of blow-ups brought them into disrepute. Ackman highlighted two firms that he said were modern masters of the strategy. Their fortunes have diverged widely since his speech, confirming that roll-ups are an enduring enigma.
One of Ackman’s exemplars was Valeant, which buys up obscure drugs. It is now reeling, after accusations in October of creative accounting (which it rejected). The other was Jarden, which owns a motley collection of brands, straddling baseball, angling, and plastic cutlery, that seems barmy until you realize it has delivered shareholders a compound annual return of 28% since 2010. On December 14 Jarden said it would be taken over for a tidy premium by Newell Rubbermaid, which makes pens and household goods. The combined firm will be worth $23 billion. From a mouse a decade ago, an elephant has grown.
As Potter Stewart, a Supreme Court justice, once said of pornography, roll-ups are hard to define, but you know them when you see them. Plenty of big firms have dealmaking in their blood: think of Vodafone, a British mobile-telecoms operator, or Pfizer, a drugmaker. Some investment vehicles repeatedly buy whole companies. Berkshire Hathaway, Warren Buffett’s outfit, or Blackstone, a private-equity fund, are examples. And many industrial firms continually make “bolt-on acquisitions” to gain new expertise or to gain market share in a particular product. Honeywell, an industrial conglomerate, aims to spend $10 billion on such acquisitions over the next five years.
Roll-ups combine elements of all these approaches. Frequent dealmaking is an explicit objective. The cumulative size of these deals will ideally dwarf the roll-up’s original value. They aim to integrate what they buy, to gain the benefits of shared overheads. Their targets are usually in similar industries. A roll-up is presented to investors not as a diversified investment fund, to be measured by such yardsticks as its net asset value, but as a unitary business, whose performance should be judged by its profits and cashflow.
Defined in this way, roll-ups in America today have an aggregate value of perhaps $100 billion. Some famous firms began as roll-ups and graduated to become giant multinationals. John Malone’s Liberty, a media empire with a market value of $65 billion, started out buying tiny cable-TV networks in rural America in the 1970s. AB InBev, a Belgian brewer which is buying its British rival, SABMiller, is arguably the greatest roll-up in history. It began with the marriage of two midsized Brazilian brewers in 1999 and has carried on buying beer brands faster than its customers neck pints. If the SAB deal goes through it will have wheeled and dealed its way to being the world’s 13th-most-valuable firm.
In the 1970s and 1980s corporate swashbucklers such as Sir James Goldsmith created conglomerates through a succession of audacious takeover bids. But roll-ups came of age in the 1990s. Between 1994 and 1998, 90-odd such firms floated in America, using the funds raised from outside investors to buy other businesses. They ventured into the corners of the economy where Wall Street did not deign to tread: hairdressing, funeral homes, vending machines, buses, video-rental stores, and dustbin-emptying were all fertile territory for deals. This made sense on one level: fragmented industries were consolidated, and economies of scale achieved.
But the 1990s also demonstrated the dark side of roll-ups. Many played a dangerous game, stoking up investors’ expectations so that their shares traded on high valuations. By using those highly rated shares (or debt) to buy the lowly rated stock of small firms, they could get an immediate boost to earnings per share, giving the illusion of growth. The game ended when their shares fell out of favor. Many roll-ups struggled with the sheer complexity of executing and then integrating a dizzying number of acquisitions.
Some were caught up in allegations of accounting shenanigans and fraud. Waste Management, a waste-disposal firm, was accused by regulators of inflating its profits by $1.7 billion. Its alleged sins included neglecting to depreciate the value of its bin lorries. A study of corporate deals in the 1990s by Keith Brown, Amy Dittmar and Henri Servaes, three scholars, found that, overall, roll-ups lost investors money — but that there was a huge divergence between winners and losers.
So is there any way of discerning between roll-ups? It is surprisingly hard, as the cases of Valeant and Jarden show (see table, above). In some ways Valeant appears to be the superior firm. So far it has achieved faster underlying sales growth, after stripping out the benefit of acquisitions — though its increases in the price of drugs it has bought may provoke a backlash. For every dollar of sales it converts more into cashflow than Jarden — though in part it has done so by buying businesses that are already strongly cash-generating. Both firms have similar leverage and have been similarly acquisitive relative to their size.
The big difference is the number of acquisitions and the price that they have paid for them. Jarden has been selective and disciplined on price, whereas Valeant has been frantic and sloppy. It helps that Jarden is in simple industries, whereas Valeant is in pharmaceuticals, a complex business.
Jarden’s co-founder, Martin Franklin, clearly believes in the formula. Though he is selling his biggest roll-up, he has started others, including Platform Specialty Products, which operates in the chemicals industry. There will always be a steady supply of targets for roll-ups. Big firms are always rethinking their strategies and shedding subsidiaries. Many industries are fragmented—think of the plethora of technology startups that may one day need a bigger home, or America’s shale-energy industry, in which thousands of embattled, smallish firms need shelter from the storm. There are always entrepreneurs willing to sniff around underneath capitalism’s carpet for bargains—and who love the thrill of the next deal.
© The Economist Newspaper Limited, London (December 19, 2015).