Great questions! EBITDA multiples vary by industry and within an industry by a company's size. This strategy is attractive because the market generally rewards scale with a higher valuation. More specifically, the market is generally willing to pay a higher multiple of EBITDA to acquire a larger business. This means that the sponsor (i.e., private equity firm or independent sponsor) behind the roll-up is likely to benefit from multiple arbitrage at exit. There are additional benefits to roll-ups including economies of scale and cross-selling, but multiple arbitrage is one of the strongest value drivers. You can read more about it here: www.asimplemodel.com/insights/private-equity-roll-up
In the long run though the arbitrage would collapse if the public market found out you are just issuing stock at a high multiple to buy a at a low multiple with no value add; eventually the two multiples would converge hence getting rid of the arbitrage. To keep a roll up going long term you need to add operational efficiencies to do a 1+1 = 3 model.
When a roll up works, the financial gain can be exceptional. That said, there are many poorly executed roll ups. Some studies even suggest that the majority fail to create value, and I think we are going to see many exposed at higher rates (no longer benefiting from persistently rising multiples year over year). Bain's most recent Global PE Report is a great read on this subject. We will also be posting more related articles on the Insights page if you have an interest. Most recent: www.asimplemodel.com/insights/private-equity-roll-up-industry-considerations
Fascinating. Isn’t an EBITDA multiple based on industry? Would this only be possible for companies that are looking to vertically integrate?
Great questions! EBITDA multiples vary by industry and within an industry by a company's size. This strategy is attractive because the market generally rewards scale with a higher valuation. More specifically, the market is generally willing to pay a higher multiple of EBITDA to acquire a larger business. This means that the sponsor (i.e., private equity firm or independent sponsor) behind the roll-up is likely to benefit from multiple arbitrage at exit.
There are additional benefits to roll-ups including economies of scale and cross-selling, but multiple arbitrage is one of the strongest value drivers. You can read more about it here: www.asimplemodel.com/insights/private-equity-roll-up
In the long run though the arbitrage would collapse if the public market found out you are just issuing stock at a high multiple to buy a at a low multiple with no value add; eventually the two multiples would converge hence getting rid of the arbitrage.
To keep a roll up going long term you need to add operational efficiencies to do a 1+1 = 3 model.
When a roll up works, the financial gain can be exceptional. That said, there are many poorly executed roll ups. Some studies even suggest that the majority fail to create value, and I think we are going to see many exposed at higher rates (no longer benefiting from persistently rising multiples year over year). Bain's most recent Global PE Report is a great read on this subject. We will also be posting more related articles on the Insights page if you have an interest. Most recent: www.asimplemodel.com/insights/private-equity-roll-up-industry-considerations