Hardly a week goes by without a major merger that shakes up an industry. Sometimes the deal is surrounded by startling numbers, as with the recently approved plan by the Boeing Co. to buy McDonnell Douglas–a $14 billion merger, the 10th largest in American history, which would create the world’s largest aerospace company.
In another realm, there is a quieter way that companies grow: acquiring one tiny enterprise at a time. Although they lack drama, these deals can add up to an impressive growth story for a company, and to a lucrative opportunity for investors.
These “rollup” companies, as they are known, are often begun by venture capital firms, which pick managers and provide initial financing.
“Then we methodically go out and buy and build,” said Bruce Rauner, a principal at Golder, Thoma, Cressey, Rauner, a Chicago venture capital and buyout firm that has financed more than 55 consolidation deals in 17 years. Once a company reaches critical mass, it is taken public, though the venture capitalists may retain a position in it.
But investors in rollups should be wary, especially of gobble-em-up outfits.
“I want companies with a real strategy, not just a consolidator that is trying to build revenue by buying companies cheaply,” said Richard Dowd, a corporate-finance partner at Ernst & Young. Acquirers without plans, known as “poof companies,” are often appropriately discounted in the market, Dowd said.
One rollup company that has a plan is Corestaff, which provides temporary employees to light industry and to the field of information technology.
By making acquisitions to establish a nationwide presence, Corestaff is exploiting a trend among big businesses to reduce the number of temporary personnel agencies they employ, said Dale Dutile, an analyst with MFS Investment Management, which owns shares of Corestaff in its MFS Growth Opportunity fund.
Corestaff, whose shares closed earlier this week at $30.9375, trades at 28.9 times its estimated earnings per share. But analysts expect that the company, whose acquisitions helped raise its revenues from $345 million in 1995 to $596 million last year, will benefit from the great need for information-technology workers, who generate about 47 percent of Corestaff’s business.
“There is a huge demand for information-technology professionals, which is far outstripping the supply,” Rauner said.
Another sign of a smart rollup is the cross-marketing of products to newly acquired clients, said Pat Boroian, a partner in Sprout Group, the venture capital division of Donaldson, Lufkin & Jenrette.
Lason Holdings, a company that helps businesses manage their paperwork, fits this profile, said Robert Gardiner, portfolio manager of the Wasatch Micro-Cap fund. Lason has three lines of business. One converts documents to a microfilm or digital format. Another does high-volume, quick-turnaround printing. A third distributes collection letters, proxy statements and other papers.
When Lason acquires a company, that firm’s customers may be buying only one of those services. In part by selling them other services, too, Lason has achieved an internal growth rate of about 20 percent in the last year. That is double the combined growth rate in its three markets, which are themselves growing fast because of the trend toward farming out work that companies once performed themselves.
Lason is the product of 15 purchases in the last 2 1/2 years; its revenue jumped from $46 million in 1995 to $70 million in 1996.
Although Lason’s stock is trading at $24.75, or 30 times estimated 1997 earnings, acquisitions can add at least $25 million a year more to revenue, he said, and internal growth will add even more.
“It is a pretty open-ended growth story,” Gardiner said.
Other companies use rollups to broaden their product offerings. Consider Cable Design Technologies, a maker of video, audio and computer cable, as well as cable for alarms and factories.
“Cable Design Technologies has been picking off new segments of the marketplace and folding them into their existing product line,” said Robert Atchison, a portfolio manager at the Harvard Management Co., which invests the endowment of Harvard University. “They can say to the distributor they sell to, `Before we had products that were 25 percent of your sales, and now we can provide you with 50 percent.’ “
And Cable Design is in a high-growth business. Many companies will continue to need new cables as they upgrade their networks with faster equipment, said Mark Regan, a portfolio manager at MFS Investment Management, and demand for telephone cable is up because many consumers are installing second lines for Internet access.
Even with a recent runup in Cable Design’s stock, it is still inexpensive. At $33.875, it is trading at 17.7 times its estimated earnings per share for 1997, even though it has an estimated annual earnings growth rate of about 25 percent, Atchison said. Many investors believe a stock is a good buy if its multiple is substantially less than its expected percentage growth in earnings.
Cost-cutting is a key advantage behind the rollup strategy at American Medserve, which fills and delivers prescriptions to institutions, mainly nursing homes.
By buying up local pharmacies and getting more institutional clients, American Medserve can put more deliveries on the same route, said Bryan Cressey, who is chairman of American Medserve and whose venture-capital firm has a 38 percent stake in the company.
Like Cable Design Technologies, American Medserve, which closed earlier this week at $17.875, or 29.6 times estimated 1997 earnings, is in a fast-growing sector. The institutional pharmacy business is growing 10 to 15 percent annually because of the aging of the population and because of medical advances, said Linda Miller, portfolio manager of the John Hancock Global Rx fund.
But it is an aggressive acquisition plan that will put American Medserve ahead of the pack, Miller said. From 1995 to 1996, revenues rose from $27 million to $82 million, and so far this year the company has made six acquisitions, adding $28 million to annual revenue. Miller says that pace will continue in 1998.
Such tiny bites will not make big headlines, of course. But for investors in American Medserve and other rollup companies, they may yield big profits.
