Going Public in a Rollup
Poof! Rub the magic lamp and a bunch of small private companies suddenly become a big public company. What do family business owners have to gain, and lose, in the new rollup IPOs?
In 1996, Troy L. Fraser was running the company his father started in their backyard while Troy was still a teenager, and he was running it well. Fraser Industries Inc. of Big Spring, Texas, posted $50 million in revenues that year. The company, which makes and recycles pallets—the wooden platforms used to ship heavy machinery and supplies—was a market leader in the Southwestern United States. It was at the end of a three-year growth spurt during which it had opened nine new plants.
Growing much larger wouldn’t be easy, however, because the pallet industry is highly fragmented and controlled by regional companies generally smaller than Fraser. To achieve significant new growth, the company would have to break out of its region—a move that could cost a lot of money before ever returning a dime. And Fraser was much too small to consider a serious public stock offering to raise capital.
Since March of this year, all that has changed. Troy Fraser is now part of the senior management team at PalEx Inc., a publicly owned pallet maker with annual revenues of more than $100 million that operates in nine states, blanketing the southern half of the country from Virginia to California.
Troy Fraser, and his family company, were part of a rollup IPO, a method of taking small companies public that is gaining in popularity because it involves little upfront cost for owners and can yield considerable rewards. The idea is to “roll up” a number of small companies in a similar line of business and turn them into one medium-sized, or even large, public company.
“It’s called a ‘poof’ transaction because one day these are all separate privately owned companies, and then the next day they are all one public company. Poof! Just like that,” says Howard Ross, a managing partner for Arthur Andersen in Philadelphia, which has put together several rollups. Ross is one of the pied pipers of the rollup IPO movement, which he says started about three years ago.
While a rollup can be an ideal path for some family companies, particularly those already considering an eventual sale, they have their downside. Owners will no longer have full control of how their companies run. They may have significant management responsibility, but they will inevitably have to answer to someone else, probably an outsider whom they have known only a short time, or a board.
Being a public company, moreover, means opening the books to a degree that may be discomfiting for some. And a rollup inevitably produces a company with a different culture and set of standards than any of the individual companies that make it up. If you’re not prepared to adapt to these changes, then it might be best to avoid the idea.
Nevertheless, there are tremendous benefits for owners who wish to get some of their equity out of their business and have a role in steering the fortunes of a larger, stronger enterprise. By selling some of the ownership in his pallet company, Troy Fraser pocketed just under $1 million and received another 1.4 million shares of PalEx stock (which opened at $7.50 but was soon selling for more than $10). Best of all, he never had to leave his family business. “What had been Fraser Industries is now the western region of PalEx,” says Fraser, who is now chief development officer for PalEx. His brother Steve is operations director for the western region.
What is a rollup?
“A rollup is the rapid aggregation of businesses in an industry sector to achieve immediate critical mass,” Ross explains. But really understanding what a rollup is requires a look at a couple of them.
Let’s return to PalEx first. Fraser Industries’ revenues were roughly equal to those of Ridge Pallets Inc. of Bartow, Florida, a company that covered the Southeastern states. “We knew the management at Ridge real well through our industry organization [the National Wooden Pallet and Container Association, or NWPCA], where we had served on the board of directors,” says Fraser, 47, who is also a state senator in Texas. “We were considered the two industry leaders,” and teaming up made a lot of sense, Fraser adds.
A third company was also rolled up to make what is now PalEx. With just $4.3 million in 1996 revenues, Interstate Pallet Co. of Richmond, Virginia, was much smaller than its two partners. Interstate’s founding president, Stephen Sykes, was also a former president of the NWPCA and is considered the industry expert on waste disposal. Fraser explains, “Waste is a major part of our expenses. As much as 10 percent of the product we’re working with becomes waste. And Steve Sykes has been real good at turning that waste into a profit center.” That skill was something the managers at Fraser and Ridge realized they wanted.
So together, Fraser, Ridge, and Interstate became one company, completing a public offering that raised $24 million in mid-March. The companies were different, but they worked with the same product and complemented one another well. The hope is that they have turned three good companies into one even better company.
While the former executives at Ridge and Fraser are on the senior team at PalEx, the company is run by an outsider, Vance K. Maultsby Jr., a former partner with Ernst & Young in Dallas. But a family business culture has survived it all; both Fraser and Sykes have brought their children into the business.
Who are the promoters?
While consolidators and aggregators have been buying companies and taking them public for their own profit for years, a rollup IPO is more of a partnering arrangement brokered by a promoter. The owners of the companies agree on the financial details and receive significant shares in the new firm as well as cash from the offering.
The promoter is typically one of two types of people. He can be a financial professional who recognizes an opportunity in an industry and gets financing to try to put together a deal. The promoter may or may not want to run the eventual public company, but if he doesn’t, then an outside management team is likely to be brought in. Another type of promoter is the owner of a company in the industry being considered for a rollup. This person knows the business and the players well, and wants to consolidate with other companies to create a larger entity. He probably wants to run it, but may bring in outside managers. In both cases, managers from the rollup up companies will usually be welcome to stay, but their role and level of influence will depend on how much they can demonstrate their worth to their partners, and how flexible they are when the deal is implemented.
The payoff, if the merger reaches the stage of a public offering, can be bountiful. Sam W. Humphreys, head of Main Street Capital Partners, a merchant banking firm, brought the PalEx companies together and took them public. Main Street committed up to $1.2 million to pay the expenses of the transaction, and in return, received 10 percent of the shares of the public offering. The firm’s stock is now worth a total of about $10 million at the current market price, and Humphreys is now the non-executive chairman of the company.
TeleSpectrum Worldwide Inc., a rollup of six telemarketing and telephone fulfillment companies that went public on Aug. 8, 1996, was an even more complex package. The deal was spearheaded by CRW Financial, whose chairman and CEO is J. Brian O’Neill. O’Neill recruited nine other investors who together put up $2.1 million to cover the upfront costs of the IPO. Between them, they ended up dividing 1.4 million shares in the new company.
The TeleSpectrum rollup involved a broad range of different-sized companies along the East Coast, ranging from one with 1995 revenues of $31.9 million, to four companies like NBG Services Inc. with revenues around $12 million, to another with annual sales under $7 million. Four were primarily telemarketers that were not family operated. The other two—a firm providing direct-mail and fulfillment services and another that does market research—were run by families.
The experience of Bill Rhatigan, chief executive of NBG in Cambridge, Massachusetts, demonstrates how a small company is suddenly transformed by a rollup. In 1995, NBG racked up revenues of $12.8 million from its telemarketing centers in Massachusetts and Arizona. In 1996, those revenues shot up to $22 million, but by the end of that year Rhatigan was no longer a CEO. Instead he was president of operations for TeleSpectrum, which has facilities across the country and revenues of roughly $120 million.
The companies in the TeleSpectrum group needed a strong sense of cohesion before going public. “I was responsible for the integration of all the telemarketing companies, which were four of the six companies originally involved,” Rhatigan says. It was a new challenge for Rhatigan, and one he enjoyed. “When we went into the financial markets, it became clear that we would be better off if we were more fully integrated,” he says. This included commitments that management would stay on, at least through the transition stages. “Anyone who wanted to stay on had the opportunity to do so, in significant roles,” he says. But, he adds, only two of the six former chief executives actually have stayed.
The top management team at TeleSpectrum includes three executives who had not worked for any of the companies in the rollup, including one of the investors, Michael Boyd, co-founder of QVC, the television shopping network. Bringing in outside management is common in large rollups, and, obviously, can dilute the influence of the former majority owners. But when the TeleSpectrum rollup was completed, Rhatigan says he and the other owners of NBG received $30 million for the company, half in cash and half in TeleSpectrum stock. “We knew we wanted to sell someday,” Rhatigan says, “but we didn’t envision getting out by going public.”
Perhaps the biggest advantage of a rollup is that it allows small companies to become much larger very quickly, taking advantage of several benefits.
“It addresses some very specific issues about how you create an attractive company,” says Seth J. Lehr, managing director of Legg Mason Wood Walker, a regional investment banking firm in Philadelphia that has been active in rollups. Chief among these is giving a company the chance to raise money needed for growth.
Troy Fraser saw several benefits for his business. Some were not necessarily anticipated, such as the help that the stable management team from Ridge provided to Fraser. “Because of our explosive growth we had a lot of young managers in place,” Fraser says. “The folks at Ridge were real helpful in training those people.”
But the biggest benefits for Fraser came after the cash was divvied up—the economies of scale that increased the companies’ efficiency and market impact. PalEx was able to save money on insurance by self-insuring for some needs and getting better rates for others based on its larger size. Common purchasing has also saved money. “It’s possible to save 3 to 5 percent with these economies of scale,” Fraser says. And then there is the fact that, for the first time, Fraser works for a company that can call on national accounts, since it has facilities near most markets in the country.
In exchange, a rollup partner such as Fraser does have to cede some control and give up any plans to continue ownership of the business in the family. Nevertheless, a rollup IPO almost always allows a family business owner to continue running the company, as a division of the larger firm, and to participate in management of the new company.
The upfront risk
Rollup IPOs are a fairly new phenomenon, and no one has yet compiled numbers on how many have been attempted. At a recent conference on rollups, nine deals were listed. The first one took place in September 1994 when Corporate Express Inc. was created by six suppliers of office products. The combined revenues totaled $637 million at the offering, and Corporate Express now has revenues of nearly $2 billion.
The chances are that numerous other such deals never reached the offering stage. In fact, few that start forming will ever go public. “I’m working now on 12 different deals,” says Howard Ross of Arthur Andersen. “I would predict two or three will actually go public.” In the other cases, the promoter will not be able to bring together the right combination of companies, or the financial community will be pessimistic when promoters try to sell the deal, and the offering will be shelved.
As Lehr of Legg Mason explains, a rolled-up public company “needs to exist for a reason. There needs to be a positive story behind it. If you can demonstrate that what you’re providing your customers is a total solution that is not out there now, then I think you have the right idea.” If not, the rollup may not roll.
One advantage to the businesses in a rollup IPO is that they do not bear any of the initial financial risks; the promoter pays all the upfront costs of putting the deal together. These costs can be steep, totaling $2 million in the TeleSpectrum case. In some instances, as many of five years of audits may be required before a merger gets to the offering stage. Unless the business owners themselves take on the role of promoter, however, they simply agree to participate upon completion of the public offering. They sign a letter of intent and the deal becomes final only on the day the combined company goes public.
If the rolled-up company succeeds in going public, the fees all come out of the proceeds, which means the business owner can figure almost exactly how much he or she will ultimately receive. The fees, by the way, go mostly to lawyers and accountants, and the total of these upfront costs will vary with the number of transactions—for example, the number of audits—required. A professional should be able to estimate the total in advance of the offering.
A seller considering participation in a rollup should treat the deal with as much care and wariness as any other exchange of ownership. And remember that not all rollups are equal. “The fact that a rollup is good for the promoter doesn’t mean it’s good for a family company,” says Ross.
Bill Rhatigan says that his company reviewed and rejected participation in another rollup before saying yes to TeleSpectrum because they didn’t like the way the first deal was being put together. “You have to spend a lot of time understanding not only what the initial process will be, but how it’s all supposed to unfold later,” he says.
Since business sellers who participate in a rollup typically get a lot of stock in the new company, the real measure of the rollup is how well that stock performs in the years after the deal. If one of the companies rolled up starts to lose money, its performance affects everyone, and ultimately the stock price.
Furthermore, many rollups rely on new acquisitions to continue revenue growth. A seller must feel comfortable that the cash will be available for these acquisitions, or that any debt burden the company might take on is not unwieldy.
“But probably the largest factor is that you want to make sure you’re going into business with someone you’re compatible with,” advises Fraser. Howard Ross agrees. “It’s often difficult to integrate the various businesses, and getting them working toward a common goal is tough.” Ross adds that just getting used to being a public company can be hard. “A lot of people do end up leaving because of the huge culture shock.”
Stephen J. Simurda is a business writer in Northampton, Massachusetts, and a frequent contributor to Family Business.