Small Business Roll-ups – A Generational Opportunity
As the Baby Boomers continue their mass retirement wave, have you thought about what will happen to the myriad small businesses they own?
We may be heading towards an era that sees increasing dominance of big box stores and chains, but that doesn’t mean there isn’t a great opportunity in finding a way to invest in successful small businesses.
Many of these companies are facing an uncertain future as their owners prepare for retirement, with an aging workforce and not enough children (or at least not enough willing ones) to take them on. We all have anecdotal evidence of this: a soon-to-retire business owner, who sent their kids through college, now has nobody to take over/buy their business, made successful over years of blood, sweat and tears, and which is also likely tied to their retirement plan.
There is an oversupply of these companies up for sale and an undersupply of people who want to buy them. The reasons vary, but it often come down to the fact that these types of businesses are not even on the radar as investments, taking a back seat to everything from tech stocks to other popular market offerings.
Why? They are boring, making boring things. But they make money and are ready to go. From an investment perspective, it’s a textbook example of a mispriced asset class, yet one big challenge remains: how do you invest?
Roll-ups are one way
Rollups are a great example of risk-reward. They are often controversial among investors, and for good reason. The industry is rife with examples of how they do not work, creating a mirage of value during the acquisition phase only to fail spectacularly shortly after.
Valeant Pharmaceuticals was one very well-known example, having completely imploded not long after everyone was saying how brilliant it was. And in the smallcap space, the list of rollups gone wrong is long.
However, at the same time the list of successes is noteworthy. One of the most well-known in Canada was the Boyd Group Income Fund. They rolled up autobody shops across the country into an investible asset, leading to amazing returns of over 50 times for investors in a decade.
Atlas Engineered Products (AEP), which we invest in, follows a similar roll-up approach. They focus on acquiring, integrating and upgrading well-established companies in Canada’s truss, wall panels, and engineered wood products industry. They have delivered great returns over the last year and look set to continue this trend.
There’s also Park Lawn Corporation (PLC), which has pulled off a similar feat with funeral, cremation and cemetery providers, making them the largest in Canada and the fastest-growing in North America.
Another is Terravest Industries (TVK), which acquires industrial companies. While not quite rolling up a sector, they buy related businesses—heating products, gas storage, transportation, and more.
We expect more of these types of companies to emerge in the years ahead, if nothing else for the simple fact that the numbers don’t lie.
The math checks out
In our day-to-day experiences, we are seeing small companies valued at incredible discounts, with banks that are very willing to step in.
As a rough example, we are seeing situations where banks are willing to finance up to 80% of small companies with strong cashflow.
It makes perfect sense in this market, where increasing interest rates and cyclical factors have reminded many that just 1 in 10 startups break even. Why wouldn’t you buy something that’s making buckets of cash instead?
This could mark the beginning of a potentially long bull market for roll-up investments that capitalize on this emerging opportunity.
Of course, there are key factors you should look out for. We published an article back in 2018 called the Art of the Roll-up, laying out key factors to consider when looking for a good roll-up company. These still stand and include looking for a company that targets a fragmented industry, boring businesses, industries with succession challenges, and more.
And as always, we recommend starting by researching industries you know—getting an understanding of what the trends are and where the opportunities may lie.
A generational opportunity
Overall, we believe this could end up being a generational opportunity, as cash-rich and cash flowing small businesses have little choice but to sell for a great price.
While roll-ups are the obvious way to invest, as they have the capital and ability to buy multiple mom and pop companies, vacuum up an industry, and present it to you as a ticker on the TSX, more opportunities may emerge as the business case grows. But don’t let the risk of roll-ups dissuade you; follow the investment advice we have constantly laid out and you will be able to separate the good from the bad.
We are on the hunt for such opportunities now and encourage you to reach out to us if you know of any opportunities, whether it’s a business looking to sell, a trend you are seeing, or an approach we may have missed.
If you need more convincing, the evidence is out there. Just walk down the street, go into a small business, buy one of those boring services or products you need but don’t think about, and then notice that these businesses are everywhere—and they are on sale.