Buy and build: a smart strategy for disruptive times – Ed Fazakerley

The increasing prevalence of buy and build strategies in private equity was clear before COVID-19 struck. Rising competition for larger businesses, especially in white-hot growth industries, has steadily pushed up valuations over the last decade.

But if fierce bidding for more-established companies sparked the trend, the immense capacity for value creation in mid-sized businesses with latent potential to scale through acquisition has catalysed it.

The pandemic is proving both a severe challenge for many industries, while simultaneously accelerating the growth of others; largely due to macro shifts in the way we live and work which were in train pre-2020 but have been embedded during it.

There is a place for considered buy and build strategies in both scenarios.

The most impacted industries will be markedly reshaped by the pandemic. The imminent arrival of vaccines will provide welcome relief for businesses in sectors which have suffered the most in 2020; with retail, leisure and travel the three most obvious. The net result is that while these industries should return to some sort of normality next year, and may even benefit from pent-up demand, the brands and operators within them are likely to change. This return to normality will also sadly come too late for some businesses which have fared the worst during this challenging time.

This flux will lead to consolidation, and present opportunities for well-thought-out buy and build strategies, enabling ambitious management teams to transform distressed assets into valuable bolt-ons.

Palatine backed Hallmark Hotels and, specifically, we backed its management team; led by Arnold Schnegg and James Hawksworth who wanted to build a boutique hotel chain.
Both Arnold and James had first-hand experience of buy and build in the sector when they had previously worked for Paramount Hotels. They wanted to replicate the model of acquiring underperforming hotels which required refurbishment. They created an eight-strong national chain that was successfully sold to Topland.

If that can be achieved in the years following the last major recession, there is nothing to stop entrepreneurial management teams with the right backing finding diamonds in the rough in industries recovering from coronavirus next year.

For those sectors which have been turbocharged by demand for a digitally and tech driven way of living and working mandated by 2020, buy and build can be even more effective.

One of the attractions for entrepreneurs working in these sectors, and their investors, is the speed at which businesses based on software or digital platforms can grow. The reasons are myriad but include a diminished requirement to invest in physical workspaces and infrastructure; fewer regulatory barriers; and a near frictionless ability to reach customers around the world.

These favourable factors do, however, mean that competition to capture market share is fierce. First movers are rewarded, and the cost of inaction is often irrelevance within an equally short timeframe. COVID-19 has expanded existing digital industries. Agile businesses have designed and launched new online services within months. Developing these new offerings organically can undoubtedly work – but it leaves businesses open to being beaten to launch by a competitor in marketplaces which are regularly winner takes all.

Strategically bolting on the additional capacity or capability required is a far shrewder and dependable approach. If success leaves clues then look no further than the US tech giants Alphabet, Amazon, Apple, Facebook and Microsoft. In 2020 they have been on an acquisition spree, snapping up more complementary businesses than at any time in the last five years.

It’s an approach we use effectively with our tech portfolio businesses, Acora, which offers IT support and cloud solutions, and Cyberfort, a full-service cybersecurity business. Both are reaping the rewards of buy and build.

Palatine supported the creation of Cyberfort Group following an investment into the Bunker in 2017. As an ultra-secure IT service provider with a 20-year pedigree the Bunker was an ideal platform business. Since then, we have driven a buy and build strategy to develop four divisions, enabling the group to capitalise on cross-selling opportunities. Several targeted bolt-on acquisitions including Agenci (GDPR compliance and regulatory consultancy), Arcturus (world-class cyber penetration testing), and Auriga (public sector and reputation specialists) have enabled Cyberfort to develop a comprehensive market-leading proposition in a fraction of the time it would have taken to do so organically. The group now enjoys a healthy share of the mid-market in fintech, health and the public sector.

The fundamental principles of buy and build are the same regardless of industry. A thorough understanding of market dynamics is vital. As a rule, a fragmented market is ripe for consolidation. There also needs to be a ready supply of bolt-on businesses with the right attributes to diversify and enhance the platform business. We always look for outstanding management teams, but when considering whether a buy and build strategy is appropriate, we like to back individuals with experience of the approach.

Successful integration is where acquisitive growth aspirations stand or fall. Buying new businesses and continuing to operate them as separate entities is not buy and build. A failure to properly integrate businesses into a complementary group to unlock synergies and economies of scale, is where many poorly executed strategies fail.
Over the last decade, Palatine has completed more than 170 buy and buy and build bolt-ons for our portfolio companies.

Successfully implemented, buy and build can be one of the most effective approaches to value creation; it is a smart strategy in disruptive times.