Buy-and-build has its attractions, particularly in a business environment where organic growth might be hard to find. Yet, it is a strategy that, in the words of Evelyn Waugh’s obsequious foreign editor in Scoop, works “up to a point”. Which is to say that market share can clearly be bought but, as the field of play narrows and the obvious low-hanging fruit gets snapped up, suitable targets become harder to find and the strategy runs the risk of falling apart.
Like our wardrobe, it does not make these companies bad buys – it just means that you need to understand where they are along this path and whether to trust the management hammering the thing together.
AIM contains current examples of buy-and-build companies in the process of finding this out. One I liked previously is Keyword Studios (LON:KWS), a leading developer in the gaming world.
What attracted me was that it was working in an attractive industry that was growing at around 7% pa. In other words, it was a rising tide. Yet even a rising tide comes with its own issues.
Keyword is an outsourcer (games companies come to it to help them develop and build video games) and for a company of that type, regardless of the success it was having in scooping up some smaller rivals, the valuation was toppy.
Having bought in for under £2 in 2015, I finally sold out last year when the price reached over £15. The share price fell during the general AIM sell-off in the last quarter of last year, down to around £10 before rebounding again this year to £17. This price action suggests others still see the logic of the company’s strategy but I
think the investment case is a harder sell today than it was.
There are other buy-and- build companies out there that provide clearer evidence, perhaps, of what happens when the strategy runs out of road.
One is Restore plc (LON:RST), a document management company that was, admittedly, operating in one of the most fragmented of sectors.
I say this because having pursued its strategy for several years, there is now every sign that it has helped contribute to the hollowing out of the middle ground.
In other words, in hoovering up the competitively priced mid-sized competition, where Restore had pricing power, the company has found its acquisitions now coming at much higher multiples.
Buy-and-builds can also be more problematic from a competition standpoint. This can be seen with Restore where last summer’s buyout of the UK element of TNT was referred to the Competition and Markets Authority.
The decision went in favour of the deal but with the top three operators now controlling 65% of the document storage sector, further large-scale acquisitions are over.
Another issue is valuations; for buy-and-build to work, the multiple has to be within a certain range.
I prefer any company I am invested in to be acquiring at between three and five-times EBITDA (at a push seven times) and before fabled cost savings are taken into account. However, this is often a hard measure to stick to for managers pursuing buy-and-build who, almost inevitably, will start citing ‘strategic’ as a key reason for an acquisition, often with the kicker of a promise of lower multiples post-synergies.
Both statements are often an indicator of that dreaded phrase “financial engineering”.
This is not necessarily the reason to be wary of Restore, but there are other signs that the company might be experiencing acquisition indigestion.
The final issue is a slowing market. The introduction of GDPR and increasing use of digitisation over physical storage are crimping demand.
This means that the market generally might have gone ex-growth and at a time when the sector now has a bar-bell characteristic whereby companies are either too small or too big to be acquired.
It is also notable that the original management has also bailed out.
An attractive opportunity
A more attractive opportunity in a very different sector is Xpediator plc (LON:XPD).
The company works in a far less developed and very much fragmented sector – freight management and forwarding.
It has a low-ish p/e ratio of around 10x and boasts a yield of 3.2x. The latest results show it achieving a balance between organic and deal- led growth with the two most recent buyouts delivering strong growth post-acquisition.
Xpediator is still at an attractive stage in its own construction phrase and as such it may be a good time to be picking up the screwdriver and hammer.
Stephen English is investment director at wealth managers Blankstone Sington.
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