Well, there are Greek salad roll-ups, and taco roll-ups, and roll-up truck bed covers -- but you're probably wondering what roll-ups have to do with investing and companies, right?
If you've ever marveled at a company that appears to be on an acquisition spree, you may be looking at a "roll-up." Roll-ups are companies that grow not by ramping up operations and increasing sales internally, but by acquiring many smaller competitors -- usually in a fragmented industry. This can be a risky business, as each acquisition has its own way of doing things, and each has to be integrated into the roll-up.
Some roll-up companies include our Motley Fool Hidden Gemsnewsletter pick Alderwoods Group
Whereas many diversified firms begin as small companies and grow organically, gradually buying other companies, a classic roll-up has a more unusual modus operandi. The company may not even exist until its founder/promoter finds about five to 15 companies willing to join forces with him or her in exchange for cash and stock. This cash and stock may not materialize until the company goes public (which it quickly does), enticing investors with its rosy projections and plans. In a sense, the roll-up acquires companies on credit.
This process likely continues, with the company issuing more stock as it acquires more companies. Let's say that an acquiree's stock price is valued by the market at about 10 times earnings. If it generates $5 million in annual earnings, the roll-up might buy it for about $50 million in cash and stock. Meanwhile, the roll-up itself might be enjoying a valuation on the stock market of about 20 or 30 times earnings. In this way, the roll-up is immediately recognizing a higher value for its purchase than it paid.
One problem with roll-ups is that they're often run by people more adept at sales and promotion than at running large and growing businesses. Management may have little experience in the industry or with managing full-scale operations of dozens of companies. Integrating the businesses can be extremely difficult.
Not all roll-ups are to be avoided, however, but you should study them closely before jumping in.
Interesting note: This Q&A is adapted from one originally written several years ago. Since then, many of the examples initially cited have either filed for bankruptcy or are trading for pennies, or even for fractions of pennies, per share. The stock market can be a dangerous place if you don't understand what you're investing in.
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