Buy-and-build transactions, in which a private equity firm acquires a company and then builds onto it through add-on acquisitions, generate superior internal rates of return (IRR) to standalone private equity deals, new research shows.
According to The Power of Buy and Build: How private equity firms fuel next-level value creation, a report from Boston Consulting Group in collaboration with HHL Leipzig Graduate School of Management, shows that buy-and-build deals generate an average IRR of 31.6 percent from entry to exit, compared with an IRR of 23.1 percent for standalone deals.
The report analyses 2,372 deals exited from 1998 through 2012 to gain a broad overview of market activity, which it cut down to 121 deals for return analysis. Around 40 percent of those deals included add-on acquisitions, with 90 percent involving companies based in Europe. No US companies were included because of a lack of adequate disclosure, the report noted.
The median fund size among participating firms was $753 million, and the median enterprise value of the deals was $198 million.
The study found that the buy-and-build strategy is becoming increasingly prevalent. The share of private equity deals that include add-on acquisitions climbed from 20 percent of all deals in 2000 to 53 percent in 2012, while the average number of add-on acquisitions per deal grew from 1.3 to 2.7.
According to the report, in the 1980s operational improvement was the source of 18 percent of added value in a firm’s portfolio, while deleveraging contributed 51 percent and multiple expansion contributed 31 percent. The contribution made by operational improvement has grown steadily to reach 48 percent in 2012, while deleveraging shrunk to 13 percent.
The study found that buy-and-build activity increases with the size of the initial platform deal, but the buy-and-build transactions of small platforms – those with an enterprise value of less than $70 million – outperformed those of medium-sized and large platforms.
Small platforms generated an average IRR of 52.4 percent, compared to 20.3 percent for standalone deals, while large platforms – those with an enterprise value of more than $290 million – generated an average IRR of just 12.5 percent, behind the standalone deals at 16.2 percent. Those with an EV of $70-290 million generated an average IRR of 34.6 percent, compared to 30.3 percent for standalone deals.
Although buy and build is most commonly used in primary deals, it is more successful in secondary transactions. Bolt-ons to secondaries generated an average IRR of 36.9 percent, compared to 29.9 percent for primaries and 11.2 percent for standalone secondaries.
The study also revealed that buy-and-build transactions involving cross-border acquisitions outperformed both standalone and domestic acquisitions, and that those add-ons taking the platform company deeper into a specific industry, rather than diversifying, performed better. The industry itself was also an important factor, with those demonstrating particular characteristics such as low industry profitability and high fragmentation performing better.
When it comes to the number of add-ons, fewer is better, with deals including just one or two outperforming both standalone deals and those including more than two acquisitions, with each delivering an average IRR of 35.5 percent, 23.1 percent and 19.9 percent respectively.
At Private Equity International’s European Mid-Market Roundtable in London this month participants agreed that buy-and-build was an increasingly important strategy, particularly in a high entry-price environment.
“[With] the multiples we pay today, the only way to maintain the performance that we want to deliver to our investors is to be able to transform the business and to make sure that at exit the value is completely different. That’s not only by doing a small add-on, it’s doubling, tripling the size of the business,” said Philippe Poletti, head of mid-cap buyout at Ardian.
“In the last five years we made 17 investments and 98 add-ons to those investments. In four years we increased the EBITDA by 70 percent in two-thirds of the portfolio.”
Look out for the full European mid-market roundtable, featuring 3i Group, Ardian, Partners Group, Royal Bank of Scotland and SL Capital Partners in the March issue of Private Equity International.