What do the industries of waste management, movie rentals, and cars have in common? A man named H. Wayne Huizenga. In 1968, Huizenga’s company had a single garbage truck. By 1983, he had turned his company, Waste Management, into the largest waste removal company in the United States. Huizenga then went on to create Blockbuster, the largest movie rental business in the nation. Then, Huizenga changed industries again and went on to build AutoNation, the nation’s largest automotive retailer. Huizenga didn’t build these businesses from the ground up; rather, he participated in hundreds upon hundreds of acquisitions in order to consolidate these industries into one dominant firm. This strategy, which led to great success in Huizenga’s case, is known as a roll-up merger. While Huizenga was not the first to use a roll-up merger strategy, his success made him the strategy’s historical poster child.
When a roll-up is successful, it can dramatically improve a company’s future trajectory. Because of this, roll-up mergers have become a prevalent strategy across many different industries. These transactions attract a lot of attention from investors. In some cases, roll-ups help create stronger, more profitable companies that can successfully go public later. In other cases, IPOs have been used to finance roll-up transactions. In addition, some public companies have used similar acquisition strategies to develop or maintain their dominant market position. In order to understand what makes this strategy so popular among investors, and to understand the factors that play into its success, this article will describe the definition and process that roll-ups follow, examine roll-up IPOs and their significance, and detail several of the benefits and drawbacks of roll-up mergers. By understanding this strategy, business leaders will be better able to assess whether a roll-up is appropriate for their business.
Roll-Up Merger Strategy
A roll-up merger is generally defined as the strategy of acquiring a large number of smaller businesses, either at the same time or over a period of time, in order to create one larger firm. There are several different motives for roll-up mergers that depend on the strategy of the parent company. For example, a roll-up could be used to increase market share within a company’s current market, or to build revenues across new, related markets. This could be done by acquiring companies that are already established in certain products, services, or geographies. Another reason to implement a roll-up strategy is to expand the current scope of a company’s operations. For instance, roll-ups are often used to expand across new and related products. Another motive for a roll-up strategy could be the need to consolidate talent across companies within an industry. If some companies are better at sales and others at operations, a roll up could give the acquiring company the industry’s top talent in both areas.
When business leaders are evaluating whether a roll-up will benefit their company, they need to consider long-term strategic benefits of the transaction. In the best-case scenario, both the acquirer and the target will have compatible synergies that make the merger worth more than the sum of its parts. In the worst-case scenario, a roll-up can lead to poor performance and eventually the death or sale of the various acquired companies. A roll-up strategy needs to be carefully examined to determine whether it will actually produce the desired results, even when considering the potential time and resources lost during the integration process.
For example, imagine a software development company that is considering a roll-up in order to bring new software capabilities to its platform. In many cases, this is a great way to get the functionality and features a company needs, without having to develop them internally. However, because of the number of programming languages and styles, piecing together software from multiple entities and doing proper upkeep could end up taking a substantial amount of time and resources, eventually becoming a tangled web of complexity. This could raise the indirect costs of integrating the acquisition so far that the company would have been better off keeping development in-house.1 As this example demonstrates, unless there are cost-cutting opportunities through an acquisition, a merger might not be justified. If there are underlying synergies, such as compatible software and code, then a roll-up merger might be a viable option.
Roll-Up Merger Process
The process of completing a roll-up merger strategy will differ in its details depending on the nature of the industry and motive of the company pursuing a roll-up strategy. However, the general process remains the same. Over time, one company in an industry acquires other smaller companies. This strategy might take place over many years, or happen relatively quickly depending on the nature of the industry.
The most difficult part of a roll-up acquisition strategy is finding the necessary capital to fund the various acquisitions. A company can fund these acquisitions with its own capital, by taking on additional debt, or by obtaining funds from private or public equity. In many cases, a roll-up strategy requires more capital than a company has on hand, so it will need funding from other sources. One of the most common places for roll-ups to find capital is in the private equity market.
If a company does decide to use funding from a private equity company to pursue a roll-up acquisition strategy, it should find a private equity company that specializes in this type of merger. Roll-up transactions are different than other private equity financing deals because they often require more capital and result in more experience with the difficulties of integrating multiple companies. A private equity company with experience in roll-ups will be able to help a company avoid many of the common mistakes that are made throughout the acquisition and integration process. In some cases, one private equity firm won’t be able, or want, to finance the strategy alone. In these cases, many acquisition-focused companies will need to use debt or other equity financing to fund at least a portion of the acquisition. When this is the case, the parent company will need to be prepared financially to pay interest on the debt incurred to fund the acquisitions. For more information about debt structuring, see our articles on Startup Debt Covenants and Debt Restructuring For Pre-IPO Companies.
In addition to the general process of generating the necessary capital, companies should be careful to integrate the acquisitions properly. The exact way that a company chooses to integrate its acquisition will depend on the industry, size of the acquisition, and nature of the acquirer’s strategy. Integration is a difficult process, which can be approached a number of different ways. For instance, the pace of integration can make a big difference in its success. In some cases, it may be possible and appropriate to approach integration quickly. In other cases, many acquisitions may be better off if they are integrated slowly and are largely allowed to continue functioning as an independent business unit. Another consideration is how to keep employees and leaders motivated. In many roll-up situations, a large number of employees may need to be let go. In other cases, keeping key employees will be imperative to a successful integration. Overall, the integration process needs to be approached strategically, and companies would be wise to think through the long-term implications of each decision they make as they go through the integration process.
Many of the factors that will play into the success of a roll-up merger are similar to those of a regular merger or acquisition. For more information about how to approach mergers and acquisitions, see our article titled M&A: Buy Side Vs. Sell Side.
Because of the amount of capital needed to finance a roll-up strategy, many private company roll-ups in the past have turned to the IPO market to finance the acquisition deals. In these cases, the roll-up of several private companies and the IPO happen at the same time, so this is referred to as a roll-up IPO. Because the companies merge and become one company at the same time on the day of the IPO, some have even referred to some instances of roll-up IPOs as a “poof IPO.”2 Roll-up IPOs are often done with the goal of the new merged firm becoming a major player in the industry.
In order to complete a roll-up IPO, the company will need to comply with the regulations of the Securities and Exchange Commission (SEC) regarding roll-up transactions. These requirements can be found in the Form S-13 and Form S-4.4 These requirements specify how the company should file specific information about the roll-up transaction.
Roll-up IPOs were primarily popular in the late 1990s, with dozens of roll-up IPOs happening during several of those years.5 This strategy has not been prevalent in recent years, however. Some have speculated that this is because of the abundance of available capital in the private equity market. Because capital is so abundant in the private equity space, roll-up IPOs are less relevant in the current market than other types of IPOs that are being used to pursue acquisitions, such as special purpose acquisition companies (SPACs). For more information on these types of IPOs, see our article about SPACs.
In the early 1990s, the electrical contracting industry was highly fragmented in the United States, with tens of thousands of small operating businesses. In 1997, John Colson brought four electrical contractors together to prepare for a roll-up IPO. On the day of the IPO, the four original companies, PAR, Potelco, Union Power, and Trans Tech, combined to form one larger company—Quanta Services. Quanta Services went public in 1998, raising approximately $45 million (USD). Of the IPO proceeds, $21 million were used to fund the cash portion of the acquisitions of the four original companies.6
Since their IPO, Quanta Services has acquired over 200 additional companies as they continue to consolidate the electrical contractor and utilities space. The company now operates in industries such as electrical, pipeline, and communications.7
Pros and Cons of a Roll-Up Merger
Roll-up mergers have been pursued in a variety of industries over the years. Many of these roll-ups have had great success, while others have ended in bankruptcy. In order to understand what makes certain roll-up mergers successful, leaders need to understand the potential benefits of this strategy as well as the drawbacks that have caused many roll-ups to fail.
Pros of a Roll-up Merger
Roll-up mergers have been and continue to be pursued in many industries. The fact that these types of transactions have remained prevalent indicates they have the ability to generate positive returns for investors. The continued interest of investors and private equity groups is likely due to the many potential benefits a successful roll-up merger can bring. Several of the potential benefits are detailed below.
Economies of Scale
One of the benefits of a roll-up merger is that it can help a company achieve the benefits of economies of scale. This means that the larger the company gets, the more efficiently it can operate. As a company grows, it is able to spread its fixed costs over larger volumes of production. In addition, with more experience and greater scale, a company is also able to lower its variable and marginal costs per unit. In other words, each new unit or service provided will be more efficient, bringing costs down. By lowering costs in this manner, a company’s profitability increases. Lower costs could also allow a firm to outcompete its competitors by charging lower prices or using profits to stay ahead in terms of product or business development. Because economies of scale can present such important strategic benefits, many roll-up mergers take place in fragmented industries where other companies have not yet achieved economies of scale. A roll-up strategy is more attractive in these cases because a company can be the first major player in a historically weak industry.
Cross selling is another benefit of a roll-up merger strategy. Cross selling refers to the ability of a firm to sell its product or services to additional customers, or to sell additional products to existing customers. By acquiring several firms in the same industry, a company can either sell new products to its existing customers or sell its existing products to the newly-acquired customers. In this way, a company can effectively increase its size and scale without needing to expand into these markets on its own.
Market Power and Influence
As a roll-up company makes additional acquisitions, it significantly increases its market share. Once a company has established itself as a dominant player in a market, it will have more influence over that market. As market power increases, companies have the opportunity to use that market power to make higher profits which will continue to drive future growth. In this way, a consolidated company with market power can provide greater value to shareholders than the individual smaller companies ever could have provided separately.
With market power, companies can exert greater influence in several different areas. For example, a national grocery store chain is better equipped to reach favorable agreements with suppliers than is a small, single-location grocer. Market power can also give a company more influence over buyers as well. Larger businesses may have more influence on buyers and can demand higher prices or sell in higher volumes than could a smaller business. Another upside of scale and market power is the ability to obtain financing. Banks are more likely to provide capital and favorable terms to large, well-established companies than to smaller, riskier businesses.
Improving Financial Results
In many cases, mergers have the potential to improve the acquiring company’s financial ratios. For example, if the acquiring company purchases a company with a higher price to earnings ratio, this can improve the acquiring company’s price to earnings ratio. However, as detailed in the drawbacks section below, temporary improvement of financial ratios is not solid logic for a merger. Rather, a roll-up strategy should take a long-term approach. If a merger takes place because of legitimate synergies between the companies, then the merger will better the financial results of both companies in the short run and the long run.
Another way many companies use roll-ups to improve financial results is through multiple arbitrage. Multiple arbitrage is a term that is used in a different ways depending on its context. In the case of roll-up mergers, multiple arbitrage refers to the ability of an acquiring company to increase its valuation, or the valuation of the acquired company, without changing anything about the company other than the reflected financial results. In the case of roll-up mergers, the collection of multiple smaller companies can add significant value to the parent company, without needing to change anything within the acquired companies. For instance, imagine an industry with one large and many small players. If a large, reputable firm acquires a much smaller firm, then analysts might see the smaller firm more favorably and give it a higher valuation than it had before the acquisition, even though nothing about the firm has actually changed. In turn, this would increase the value of the parent company.
One example of a company that has successfully followed a roll-up strategy over an extended period of time is Constellation Software. The following is the description of the company from its website.
Constellation Software is an international provider of market-leading software and services to a number of industries, both in the public and private sectors. Our mission is to acquire, manage and build market-leading software businesses that develop specialized, mission-critical software solutions to address the specific needs of our particular industries.
Constellation Software has made a large number of acquisitions in a number of different industries over the years. They have six different operating groups within the company that manage operations in over 100 different markets. Most of the acquisitions made by Constellation Software are relatively small, and they each fall into distinct categories within the industries that the groups are interested in having as a part of their business. Because of its focus on making acquisitions that are a good fit, the company has seen remarkable success. Since closing at a price of $18.30 CAD on the day of its IPO in 2006, the company has reached share prices of over $1,700 CAD in 2021.
Cons of a Roll-Up Merger
While a roll-up merger strategy has a variety of potential benefits, it also has a number of significant difficulties and drawbacks. An article in the Harvard Business Review (HBR) reported that more than two-thirds of roll-ups failed to create any value for investors.8 By this metric, less than one in three of these mergers result in success. The failure rate is so large that the HBR article actually lists roll-ups “of any kind” as one of several strategies that are most likely to lead to business failure. While there are a variety of drawbacks, some of the most impactful include the difficulty of integrating existing businesses, the necessity for certain market conditions, and the allure of illusory financial progress.
Mergers and acquisitions are notoriously difficult to execute successfully. Often companies have very different cultures, values, and processes. Additionally, existing leadership is often key to the acquired company’s success, but may have a difficult time integrating within the new, merged company. When leaders stay, they may hinder a company from implementing the needed changes in a timely manner. However, in many small businesses, leaders play a critical role in holding things together. If a leader leaves, then productivity and morale may fall substantially. In addition to the difficulty with transitioning leadership, personnel across the board might have a difficult time integrating. In order to keep the company together and avoid losing talent, the new merged company will need to find ways to deal with these problems. In the end, so many things need to go right for an acquisition to truly add long-term value that many companies might not be able to see success with this strategy.
Ill-Suited Industry Attributes
Many of the benefits described above require certain industry attributes and market conditions for a roll-up merger to be successful. For example, to experience economies of scale, an industry needs to have the space in its general cost structure to lower overall costs. Put another way, mergers do not automatically create economies of scale. In some industries, scale doesn’t necessarily lower cost substantially, meaning that a larger company will have no real advantage over a smaller company. In these cases, smaller businesses are already operating so efficiently that a merger won’t provide any additional cost savings.
In addition to economies of scale, buyer attributes can play a role in whether a roll-up strategy is able to be successful. For example, in many industries, buyers may actually be less likely to favor national brands, instead favoring small businesses that are better able to cater to individual and local needs. For example, private music lessons are more often taken through a local teacher than they are through a national chain of professionally hired teachers. This industry would be difficult to consolidate, and consolidation would likely make service more expensive and wouldn’t necessarily increase the number of students. Other factors can also play into the success of a roll-up merger. If suppliers are still relatively more powerful, they may keep costs high and prevent scale-related cost savings. A roll-up firm may also have a difficult time finding a competitive edge against smaller rivals. Because of these various factors, a roll-up needs to take place in an industry where consolidation will give the combined larger company a competitive advantage that outweighs the potential difficulties it will face.
Another important potential drawback of mergers is that they can create the illusion of financial success without improving the underlying business. For example, a roll-up merger could improve a company’s price to earnings ratio. After an acquisition, the merged firms combine their earnings, raising the level of earnings for the merged company. If the acquiring company has a lower price to earnings ratio to begin with, then by merging with the higher price to earnings firm, the price to earnings ratio of the acquiring company may go up after the merger, at least initially. However, a higher price to earnings ratio, which is normally a good sign, doesn’t necessarily reflect the true economics of the merger. Instead, the higher price to earnings ratio may be obscuring the fact that the merged company isn’t actually making more money, at least not yet. In fact, these changes in financial ratios often hide the fact that a merger isn’t based on synergies that will allow both companies to operate more efficiently. And once the market realizes that the synergies aren’t there, the favorable price to earnings ratio of the combined company can come crashing down.
For a company to pursue a roll-up strategy, it will need a large amount of capital to complete all the various acquisitions. While some companies have used IPOs or private equity to pursue these strategies, often some level of debt or financial leverage is used as well. With each acquisition, more debt may be incurred, which means a company needs to be able to service those debts. If an acquisition goes poorly, or the quality of the acquisition is poor, then the roll-up company may also face a lower credit rating. A lower credit rating will lead to worse terms for future debt financing. These worse terms will in turn continue to increase the cost of servicing debt. Increased debt servicing costs can then further reduce credit ratings. Because this process is circular, it can quickly become self-reinforcing and snowball out of control. When this happens, debt financing becomes a quick road to bankruptcy.
In the cases where a company chooses to use equity instead of debt financing, other burdens will appear. These include loss of ownership and control of the company and future decisions. For more information about the positives and negatives of losing control, see our article about Founder Control.
One famous example of a failed roll-up is Loewen Group. Loewen Group was a “death services” company that owned cemeteries and funeral homes. Over the course of several years, the company acquired hundreds of funeral homes and cemeteries. However, industry attributes, legal battles, and competitive pressures all led to the eventual failure of the firm. While the firm was able to see some benefit from economies of scale, there were several other problems that eventually led to the company’s downfall. These factors included nature of the industry, loss of focus, lawsuits, and loss of investor confidence.
The death services industry is very different from most other industries. The individuals purchasing these services tend to have very different concerns than they do in their other purchasing decisions. For instance, the family members who are burying a loved one don’t usually have any interest in a large brand name. Rather, they are interested in personal recommendations and small, locally owned funeral homes. In fact, this preference was so strong that many of the funeral homes acquired by Loewen Group kept their new ownership a secret and retained their original names. Another problem with Loewen Group’s acquisition strategy was that they lost focus on what they did best: funeral homes. Investors had been promised a large growth rate, which put pressure on Loewen Group to make more acquisitions. To maintain growth, the company acquired a number of cemeteries, which began taking up a larger portion of the company’s portfolio. Unfortunately, these acquisitions turned out to be less profitable, which hurt the company and caused investors to lose confidence in the company.
In addition to the difficulties in the industry, Loewen Group also faced several large and highly public lawsuits with both private U.S. citizens and the U.S. government. After these lawsuits were launched and after seeing the company turn down a favorable offer from a potential acquirer, investors started to lose confidence in Loewen Group, and share prices fell until the company eventually declared bankruptcy and had to sell over 300 of its holdings to stay afloat.9 After reorganizing, the new company, Alderwoods Group, was eventually acquired by Service Corporation International.
Interestingly, Service Corporation International (SCI), the firm that acquired Loewen Group, is an example of a successful roll-up merger in the same industry. Unlike Loewen Group, SCI has been able to establish business practices that have allowed it to grow and thrive, even in a low growth industry. By finding ways to cut costs and streamline operations appropriately while still focusing on providing best-in-class service, SCI has been able to avoid many of the pitfalls that caused Loewen Group to fail. SCI has also been able to establish successful national brands both in funeral management and cremation, in addition to establishing solid financials by finding ways to “lower expenses, reduce debt and increase cash flow.”10
Because of the dramatic success of some roll-ups, this strategy has continued to stay relevant. In industries where consolidation has made operations more efficient, roll-ups have the potential to make customers and companies better off. However, roll-up mergers are incredibly difficult, and face a number of obstacles that are difficult to overcome. Companies should be careful to recognize and account for these difficulties as they pursue a roll-up strategy. By doing so, a roll-up company gives itself a better chance at achieving the success that it is pursuing.
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Deeb, George. Forbes: “How To Roll-Up Several Companies Into One.” 2 Oct 2018.
Morettini, Phil. PJM Consulting: “When Does a Software Industry Roll Up Make Sense?” Accessed 30 Mar 2021.
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Deeb, George. Entrepreneur.com: “A Secret Tactic for Quick Growth: The Roll-up.” 4 Nov 2016.
Associated Press. Los Angeles Times: “H. Wayne Huizenga, who built his fortune from trash and founded Blockbuster, dies at 80.” 23 Mar 2018.
Trainer, David. New Constructs: “The High-Low Fallacy: Don’t Believe the Merger Hype.” 31 Aug 2012.
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Giddy, Ian. New York University: “The Restructuring of The Loewen Group: Life After Death.” Accessed 30 Mar 2021.
Hempstead, John E. Philadelphia Business Journal: “New player: The roll-up IPO.” 24 Feb 1997.
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Quanta Services: “History.” Accessed 30 Mar 2021.
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- Morettini, Phil. PJM Consulting: “When Does a Software Industry Roll Up Make Sense?” Accessed 30 Mar 2021.
- Greco, Susan. Inc.com: “Poof IPO Goes Up in Smoke.” 15 Oct 1999.
- SEC: “Form S-1.” Accessed 6 Apr 2021.
- SEC: “Form S-4.” Accessed 6 Apr 2021.
- Dittmar, Amy K., Keith C. Brown, and Henri Servaes. “Corporate Governance, Incentives and Industry Consolidations.” SSRN Electronic Journal, Oct 2003. https://doi.org/10.2139/ssrn.379621.
- Quanta Services. 31 Mar 1999. Form 10-K.
- Quanta Services Inc: “History.” Accessed 30 Mar 2021.
- Carroll, Paul and Chunka Mui. Harvard Business Review: “Seven Ways to Fail Big.” Sep 2008.
- Reference for Business: “The Loewen Group Inc. – Company Profile, Information, Business Description, History, Background Information on The Loewen Group Inc.” Accessed 30 Mar 2021.
- Service Corporation International: “History”. Accessed 4 May 2021.