A new analysis by The Boston Consulting Group reveals that, between 2010-2015, 39% of the total deals made by private equity firms in the Middle East were executed based on a buy-and-build' strategy - for the purposes of expanding a business across borders or to extend it along the value chain
DUBAI — Today, buy-and-build deals - in which a private equity firm buys a company and then builds on that "platform" through add-on acquisitions - can both accelerate revenue growth and drive margin expansion by realizing synergies. Furthermore, buy-and-build strategies can create market expectations of continued growth and margin improvements in portfolio companies, which can translate into higher exit valuations.
To gain a better understanding of the increasing importance of buy-and-build deals as a means of operational improvement, The Boston Consulting Group, collaborated with HHL Leipzig Graduate School of Management in Germany to analyze 2,372 deals - spanning Western Europe, the UK, and other regions - exited from 1998 through 2012. The results - which are detailed in a report titled The Power of Buy and Build - reveal that the share of private equity deals that include add-on acquisitions climbed from 20% of all deals in 2000 to 53% in 2012. The average number of add-on acquisitions per deal grew from 1.3 in 2000 to 2.7 in 2012.
There's one simple reason for the surge in buy-and-build deals: they outperform standalone private equity deals, generating an average IRR of 31.6% from entry to exit, compared with an IRR of 23.1% for standalone deals. The study also sheds light on the fact that buy-and-build deals have become private equity firms' value creation strategy of choice.
And in the context of the Middle East, this rings especially true. Recent BCG data shows that, in the Middle East, most local private equity firms are acquiring companies to carve out a powerful growth story, as they need proof that they can generate value at exit and returns for their investors.
"According to our research, it was established that, between 2010-2015, 39% of the total deals made by private equity firms in the Middle East were executed based on a buy-and-build strategy - to either expand a business across borders or develop it along the value chain," said Markus Massi, Partner and Managing Director and Head of BCG 's Middle East Principal Investors and Private Equity Practice in the Middle East. "The result? Middle East buy-and-build deals have created value worth an average of $100 million in just five years."
Buy-and-build deals are not the only way to generate superior performance, but they have become one of the favored means of realizing operational improvements and furthering a credible narrative about future growth and margin expansion. Value in buy-and-build deals often results from traditional synergy levers - such as scale effects in procurement and in selling, general, and administrative expenses - and from improved sales force effectiveness and pricing.
When Buy and Build Works Best
BCG's analysis of buy-and-build deals exited from 1998 to 2012 found that the approach is most successful when the portfolio company is small- or medium-sized; has a private equity sponsor with operational and acquisition experience; offers an operationally efficient and scalable platform; is in a low-growth, low-profitability, highly-fragmented industry; does only one or two add-on acquisitions; targets adds-on in its core industry; and uses acquisitions to expand internationally.
In the Middle East, from 2010 to 2015, a total of 47% of private equity firms' buy-and-build deals were aimed at creating value by expanding the business across geographical borders. The remaining 53% were designed to create value by forging synergies across the value chain; this means acquiring companies operating in the same industry but at different levels of the value chain.
In addition, almost a quarter (23%) of buy-and-build deals made by Middle East private equity firms are intended to both expand a business internationally or extend it across the value chain.
"A buy-and-build strategy is especially effective when used to internationalize the acquirer's business," added Ihab Khalil, Partner and Managing Director and expert in private equity. "The international expansion of a formerly domestic company in the Middle East creates opportunities for cross-selling and economies of scale, as well as multiple expansion if the business improvements raise investors' expectations of results that aren't yet borne out by financial performance. That is precisely why Middle East private equity companies - most of whom are covering one or two countries - are ideally suited to adopt buy-and-build strategies."
While it is true that local private equity companies in the region are less experienced in operational improvement - compared to their international and larger peers - they are starting to absorb the skills needed to learn how to extract value from operations.
"Still, to capture the opportunity that buy and build presents, private equity firms in the region must raise their game in all phases of their businesses," concluded Massi. "It's the only way to create value in all markets and in all stages of the economic cycle."
Founded in 1898, HHL Leipzig Graduate School of Management was the first business school in Germany. Currently, HHL is one of the country’s leading graduate schools, offering a variety of academic executive programs for different graduate degrees, including MSc, MBA, and PhD. The Center for Corporate Transactions, headed by Prof. Dr. Bernhard Schwetzler, is HHL’s major research unit in the field of mergers and acquisitions. It is designed to bring together scientists of HHL and its research partners working in the areas of corporate finance, accounting, law, and game theory to analyze and discuss problems in corporate transactions. For more information, please visit www.hhl.de/finance.
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