In our first webinar of the year, we dug deeper into the emerging trend of add-on acquisitions within private equity.
Sam Glasswell, our CEO and founder, was joined by two speakers: Richa Aggarwal, Partner, Private Equity Value Creation at PwC, and Yale Kwon, Partner, Private Equity Value Acceleration & Transformation at AlixPartners.
They covered a range of topics during the hour-long discussion, including:
- Changes and consistencies in why investors opt for add-on deals as a strategy.
- The different approaches to merging portfolio companies with add-ons.
- What rising carve-out activity could mean for add-on acquisitions.
- How this space will continue to evolve in the future and how high interest rates play into this.
Click here to watch the full webinar.
What are the main drivers behind the rise in add-on acquisitions?
From 49.6% in 2013, the proportion of add-on deals in private equity soared to 76% by 2023, according to Pitchbook data. In investing, some things never change, says Aggarwal, so many of the initial driving factors for their uptake are still relevant.
However, what’s driving their trajectory in more recent years is a combination of factors, including:
1. Organic growth is languishing
“This lack of great platform assets, especially in the TMT sector, or like some of the core sectors that we are seeing, is further [fuelling] the focus on add-ons… the deal teams and the portfolio companies are finding these as a means to continue their growth trajectory… and they definitely bring some operational cost savings as well.” – Richa Aggarwal
2. Circumventing challenging dynamics
“If you look at the higher interest rate now, and it's hard to borrow money at this point, and when I speak to a lot of people, they've been really shifting their portfolio strategies… They start to think, ‘Okay, financial creation [is] not gonna be a viable option anymore’.” – Yale Kwon
3. Shifting strategy models
“[Another reason] is the shift from LBO models to growth equity models. There are not many funds out there who can buy the entire company… add-on equity is a perfect opportunity to buy a very small subset of the asset.” – Yale Kwon
Historically, M&A has always been hard when it comes to integrating two companies. Is this becoming easier now?
It’s not becoming easier, Aggarwal said, but there’s now perhaps more of a focus on both merging the teams and ensuring that value is being realised.
Aggarwal added that there’s a need to understand the level of integration that’s needed. “If you are looking at an add-on for more product platform capabilities, that's a different level of integration versus a geographic expansion or a pure-play market expansion.”
Kwon agrees that companies should look at different strategies depending on the type of deal and outlined three options:
- Full integration: the companies are fully merged in every aspect, from the back office to branding.
- Semi-integration: certain teams stay independent, while others are merged.
- Standalone: two independent entities are maintained but synergies are still fostered between them.
How can private equity companies best support their portfolio companies to find assets that have the best synergies?
“You kind of want to create a co-working SWAT team, in a way, for a short period of time,” said Kwon, who recommended bringing together the portfolio company and the deal team. The deal team will obviously be the best at sourcing the right company, but the executives from the portfolio firm can also be looked to as a source of industry expertise.
However, with carve-out activity on the rise, another opportunity emerges for private equity firms to support their portfolio companies. “What are the capabilities that you want to bring on that are no longer valuable to some other companies?,” Aggarwal asked, rhetorically.
By keeping an eye out on both public and sponsor-to-sponsor deals, private equity firms can explore new, compatible capabilities for their portfolio companies that have lost their value elsewhere.
How do you expect add-on deals to evolve over the next couple of years?
For the reasons already listed here, and the fact that many portfolio companies are trying to build bigger capabilities, Aggarwal expects to continue to see add-on deals flourishing. This will create something of an upward cycle.
“So getting value out of these assets will show to deal teams and the management company, they can truly make [add-on deals] an integral part of their growth strategy.” Richa Aggarwal
Kwon added a slightly different perspective, and turned the conversation to the huge amounts of redundancies seen at the beginning of the pandemic and at present. However, he believes that the current rounds of job losses are indicative of something more positive.
“It's not because of weak financial performance, not because of uncertainties. We feel that this is more based on the rebalancing act for them to prepare for the growth in the coming years,” Kwon explained. When interest rates eventually go down, he added, companies will have much easier access to capital, meaning they can fund their future visions.
Catch the recording of the webinar here to get more insights and hear expert responses to audience questions. Here's a sneak peak of the Q&A session:
"While the post-acquisition challenges vary on a case-to-case basis, how big of a challenge is the first step in the process - discovery phase? Plenty of companies that have a lot of synergy with your portfolio companies but don't get discovered at the right time, especially in an era where every fund gets a very similar list of opportunities. "
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