Four Reasons Acquisitions Make Good Business Sense

Consolidation is significantly changing the landscape of the collision industry. But it is not just the collision industry that is consolidating rapidly. Throughout the entire automotive aftermarket there are examples of consolidating industries. Paint distribution, first consolidated in the late ‘80s and early ‘90s is undergoing a second round of consolidation. LKQ and aftermarket parts distribution, consolidated once already by LKQ is in the very early stages of a second round of significant consolidation. Aftermarket mechanical parts distribution already dominated by behemoths such as NAPA (Genuine Parts Co.), O’Reilly and AutoZone, and are seeing continued consolidation activity. Even automotive retail and new car dealership industry, once a paragon of the family-held small business, is undergoing consolidation at the hands of AutoNation, Sonic, and Warrant Buffett’s Berkshire Hathaway Automotive Group. It begs the question, why is consolidation such a popular business strategy?

New Clients, More Revenues

One of the most often cited reasons for considering an acquisition of another company is to rapidly acquire new clients. Strategically acquiring another business can give the purchaser immediate access to significant additional revenues and new sources of referral accounts. Often acquisitions involve entering new geographies as well. The benefit of acquiring an existing company in a new region is that the purchaser also acquires the brand and reputation of the business and can bypass months or even years of marketing building a brand presence. Of course this can be a double edged sword if appropriate due diligence is not completed to thoroughly assess the customer and vendor relationships of the business. But buying a business often provides a purchaser with a cash flow positive business from day one rather than months of negative cash flow building a business over time. Building a business may be cheaper in the long run but buying a business can generate immediate cash flow.

Improved Margins through Scale

Scale is a business term that describes a company’s ability to increase overall profitability by reducing the overall input costs for products and services by spreading fixed costs across a wider base of sales. Every business has certain overhead expenses that are relatively fixed and do not vary as the business grows, or do not grow at the same rate as revenues. In the collision industry, at the corporate level, examples of these costs would be regional management expenses, IT and computing expenses, and other corporate management and administrative expenses like HR, marketing, finance, and legal functions. At the individual location level, fixed costs include plant and equipment (i.e. frame racks, paint booths, computer systems, tooling, fixtures, etc.) and other facility specific expenses like general liability insurance, security and maintenance, and rent or leases.

Building scale also allows a business to leverage companywide efficiencies and leverage buying power. For example, a larger company is able to negotiate purchase contracts at more favorable terms than smaller companies, further lowering costs and improving margins. Scale also allows a company to reinvest at a level that many smaller companies will find difficult to match. Take the projected investment in upgrading a facility to handle aluminum repairs. A company with one million dollars in annual revenue may find it inefficient to reinvest 1.0% of revenues into capex improvements as the total dollar amount would not cover the investment required to upgrade an individual facility. However, a company with $100 million in sales may find a 1.0% investment a manageable and worthwhile endeavor that yields benefits across multiple locations.

Customer and Vendor Consolidation

In many industries, consolidation often happens in reaction to consolidation in other parts of the market. Consolidation throughout the supply chain is logical. As customers become larger they require companies that can provide services that match their level. Companies that are able to grow alongside a consolidating customer base can position themselves to become both vendors of choice and acquirers of choice in a fragmented industry.

This situation is currently unfolding in the collision industry worldwide. In many countries the primary payer, the insurance payer, is heavily consolidated. While the role of the insurance payer in the industry continues to be hotly debated in various industry circles, the influence insurance carriers have on the overall industry is undeniable. In the U.S. the top ten automotive insurance companies account for over 70% of all polices. The top five companies account for over 50% and cumulatively wrote $100 billion in policies in 2014. These institutions actively seek out vendors to partner with that are able provide services that match their size and scope as a general matter of business efficiency.

Many of the large consolidators in the collision industry continue to grow in order to provide comprehensive nationwide services to their largest insurance customers. In order to remain competitive and leverage the benefits of scale, parts and paint vendors selling into the collision industry also consolidate alongside their customers. Consolidation in the insurance industry contributes to consolidation in the collision industry which contributes to new rounds of additional consolidation in the parts and paint distribution industry.

Private Equity

If you are looking to supercharge your business, bringing on a private equity partner may be for you. But if you are looking to attract a private equity partner to help with growth you first must demonstrate you are capable of executing an inorganic growth strategy in a fragmented industry. Private equity is a type of investor that invests in private rather than publicly held firms (we discussed the role of private equity in the industry in depth in this article). Private equity firms often are attracted to industries which they are able to make platform investments, or investments in companies that are designed to consolidate a fragmented market. Private equity investments in Caliber, ABRA, and Service King are all examples of platform investments.

The appeal of consolidation strategies to private equity investors has to do with the way these investors generate returns for their limited partners. Private equity firms view the value of a business based upon the cumulative cash flows the business can generate over time. Because investments tend to be highly leveraged (i.e. a lot of debt is used to finance the acquisition) the ability to rapidly increase cash flows is a key driver in the investment thesis of many platform acquisitions. But the success of the private equity model is undeniable, and business owners looking to take some money off the table while still taking part in the continued growth of their company may find partnership with private equity firms a very attractive business strategy. Of course, for private equity investors, the benefits of scale, increased client and geographic diversity, and the ability to become the vendor and acquirer of choice also are strong motivators to grow firms rapidly.

Conclusion

Growing through acquisitions is often good business sense. Growing organically by building from the ground up can take months if not years and rapidly drain cash flow. Growing inorganically via acquisition allows an owner to realize often immediate positive cash flow as well as build a more diversified and profitable company. Growth via acquisition makes a company more attractive to larger companies that are also growing, as well as to outside investors looking to invest in the platform of a growing company.

If you are interested in discussing acquisitions in more depth please reach out to me via my contact page. I find the transformation in the industry fascinating. I also just like to talk to real humans in an industry I am passionate about. I keep all communication confidential.

If you found this article useful, please sign up for weekly email updates at supp-co.com or by entering your email address in the form below. About once a week I send out a newsletter designed to help people grow their company, help people sell their company, and help people increase the value of their company using the tools of corporate finance. It would be great to have you as a regular reader. I do not share your information with outside parties or marketers. Best of all, if you tire of me (which I hope you will not), you can easily and automatically unsubscribe from notifications at any time through the unsubscribe link attached to every update email.

Until next week!

Increase the value of your business. Sign up and get my weekly notes straight to your inbox. I keep your email private and do not share your info. Easily unsubscribe at any time.