{"id":3391,"date":"2023-09-07T07:49:00","date_gmt":"2023-09-07T07:49:00","guid":{"rendered":"https:\/\/qualitasfunds.com\/investing-in-fragmented-markets-in-the-uk\/"},"modified":"2024-11-08T10:17:38","modified_gmt":"2024-11-08T10:17:38","slug":"investing-in-fragmented-markets-in-the-uk","status":"publish","type":"post","link":"https:\/\/qualitasfunds.com\/en\/investing-in-fragmented-markets-in-the-uk\/","title":{"rendered":"Investing in fragmented markets in the UK"},"content":{"rendered":"\n

In the United Kingdom, small business entrepreneurs tend to be more open to market consolidation compared to their counterparts in other European countries such as Portugal, Spain, or France. This inclination makes it easier to thrive using Buy & Build<\/em> strategies.<\/p>\n\n

Buy & Build<\/em> is a strategy premised on the notion that \u201c1+1=3\u201d It involves acquiring a primary company, referred to as a \u201cplatform,\u201d and expanding its reach by purchasing smaller competitors, known as \u201cadd-ons\u201d<\/em>. For this strategy to succeed, it is essential for the industry to be fragmented with numerous potential add-ons<\/em>, and for small business owners to be willing to join a larger group. Given that the UK economy primarily consists of SMEs, many sectors exhibit this fragmentation. Additionally, due to the market dynamics, there is less competition for the acquisition of SMEs, resulting in lower purchase prices compared to higher market segments.<\/p>\n\n

Buy & Build<\/em> incorporates several key concepts. It is a rapid method for gaining market share and achieving a leadership position. Furthermore, it provides access to new technology, superior labor skills, and economies of scale, enhancing operational efficiency. Beyond these benefits, Buy & Build<\/em> can generate value in a unique manner, even in the absence of clear synergies, through multiple arbitrage.<\/p>\n\n

As mentioned earlier, the lower mid-market offers opportunities to acquire businesses at significant discounts compared to the higher segments. Typically, the smaller the company, the greater the acquisition discount. Therefore, if we acquire a platform at a discount with respect to the immediate higher segment of the market, and subsequently acquire smaller add-ons<\/em> at even lower multiples, not only will be lower the average multiple paid for the aggregate group of companies, but also the platform will naturally grow to become a company classified in the higher segment of the market. As a consequence, the price paid at exit will increase, generating significant value solely from the multiple increase.<\/p>\n\n

To illustrate it clearly, consider this numerical example: In the mid-market<\/em> (companies with an EBITDA of \u20ac20MM or greater), are valued at 10 EV\/EBITDA. In the lower mid-market<\/em>, they are valued at 5x EV\/EBITDA. This implies that a \u20ac20MM EBITDA company is valued at approximately \u20ac200MM (\u20ac20MM * 10x), while a \u20ac10MM EBITDA company is valued at around \u20ac50MM (\u20ac10MM*5x). In other words, larger companies receive higher valuations<\/em>, all else being equal.<\/p>\n\n

Therefore, if we acquire a platform with a \u20ac10MM EBITDA at 5x EV\/EBITDA (\u20ac50MM) and this platform acquires ten \u20ac1MM EBITDA companies al 3x EV\/EBITDA each (\u20ac3MM per company) our total expenditure would be \u20ac80MM (\u20ac50MM rom the platform plus \u20ac30MM from the ten add-ons)<\/em> ). The consolidated entity would then have a \u20ac20MM EBITDA (\u20ac10MM of platform EBITDA and \u20ac1MM of EBITDA for each of the 10 add-on<\/em>) Oddly enough, the \u20ac20MM EBITDA consolidated company will be valued by the market at 10x EV\/EBITDA instead of 5x, because as a larger company it already enters a higher segment of the market where it pays more. This illustrates the market\u2019s valuation dynamics which favors larger companies due to, among other things, that a larger company has better capacity to benefit from economies of scale and greater bargaining power with customers and suppliers.<\/p>\n\n

In our example, the consolidated company could be sold for approximately \u20ac200MM (\u20ac20MM EBITDA * 10x). This translates to a multiplier of 2,5 times the investment (\u20ac200MM sales divided by the \u20ac80MM total platform expenditure, including add-ons<\/em>), without taking into account any synergies or operational improvements. This multiplier could be even higher if additional add-on<\/em> acquisitions are financed via leverage or cash generated by the platform. Operational improvements such as economies of scale, workforce streamlining, or cross-selling<\/em> strategies can further boost EBITDA,<\/em> surpassing the sum of individual parts.<\/p>\n\n

While this strategy holds significant profit potential, it also carries some risks. These include the possibility of not realizing synergies, loss of operational efficiency due to cultural clashes during integration, failure to recover acquisition costs, or inability to sell the consolidated platform at the expected multiple.<\/p>\n\n

Therefore, if considering investing in the UK, a specialized Buy & Build<\/em> fund may be a practical choice. Specialization is crucial, as successful execution is paramount to this strategy, and an experienced team can significantly mitigate execution risks. Additionally, a regional manager well-versed in the market and local regulations can enhance operational efficiency and transaction execution.<\/p>\n\n

Once you have filtered funds based on the above criteria and identified regional funds specializing in Buy & Build<\/em> strategies, it is advisable to compare them based on their track record and the industries in which they plan to execute the strategy. The more tailwinds and fragmentation in the target market, the more favorable the strategy execution and risk mitigation in an adverse scenario.<\/p>\n\n

At Qualitas, our screening<\/em> process has identified several management teams with such strategy. One team in particular caught our attention due to its 18 ayears of experience in the strategy, yielding an average return of more than 4 times the invested capital. Additionally, this team had a well-defined plan for its fund, with five platforms to acquire and an average of three add-ons<\/em> per platform at an advanced stage. These factors significantly reduce the risk associated with investing in a Buy & Build<\/em> strategy.<\/p>\n","protected":false},"excerpt":{"rendered":"

To invest successfully in any geography, it is essential to understand its context thoroughly. This understanding allows to identify long-term trends and select the best managers within a chosen strategy. As previously discussed, strategies benefiting from structural tailwinds significantly reduce investment risk, as inherent momentum not only enhances returns when investments are well executed, but also minimizes risk.<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[82],"tags":[],"class_list":["post-3391","post","type-post","status-publish","format-standard","hentry","category-qualitas-insights-en"],"acf":[],"yoast_head":"\nInvesting in fragmented markets in the UK - Qualitas Funds<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/qualitasfunds.com\/lorem-ipsum-dolor-sit-amet-consectetur-adipiscing-elit-sed-tristique-diam-vitae-consequat-laoreet-5\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Investing in fragmented markets in the UK - Qualitas Funds\" \/>\n<meta property=\"og:description\" content=\"To invest successfully in any geography, it is essential to understand its context thoroughly. 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