Eat or get eaten: growing enterprise value through niche sector consolidation

Ever since John Rockefeller bought up rival refineries — both big and small — to build Standard Oil into the behemoth it became, horizontal integration has been the most commonly used corporate expansion strategy.

These days, major industry sector mergers and acquisitions are exponentially more complex than they used to be, requiring many thousands of man-hours to deal with contractual and legislative details, not to mention technological considerations that didn’t even exist 10 years ago. It has reached the point where it is impossible to predict whether or not the acquisitions will ever succeed in creating synergies required to add to the total enterprise value.

Nevertheless, beneath the radar of government antitrust watchdogs, public and private companies operating in fragmented and niche industries are pursuing profitable growth strategies through acquiring competitors and upstream/downstream operators. These smaller deals require far less work and carry fewer risks for experienced players.

While it might seem risky to purchase several businesses within the same sector — the phrase ‘don’t put all your eggs in one basket’ comes to mind — more often than not the opposite is true. There are multiple benefits to pursuing this single-sector consolidation strategy.

These include removing competition through acquiring rival companies, opening up new export markets, consolidating costs and placing your enterprise in a better position to cope with changing rules and regulations whenever they arise within a given sector.

A particularly strong motivating factor for the stakeholders of many organisations operating in fragmented industries is the attractiveness of the potential exit value of having a larger organisation. In general, the exit multiple of a company in any sector will increase exponentially in relation to its NP up to a point that is defined by the market capitalisation of major industry operators.

Here, we will look at a few examples of companies that have successfully grown by focusing almost exclusively on making the right acquisitions within niche sectors at just the right time.


The rat race
Let’s first look at the remarkable turnaround achieved by multinational pest control firm Rentokil Initial. At the height of the last recession back in 2008, and after issuing a profits warning that sent investors scuttling for cover, Rentokil’s board and shareholders thought the business was struggling primarily due to problems with the management team and their bonus scheme structure.

Rentokil fired then chief executive Doug Flynn and chairman Brian McGowan, and elected to bring in a trio of managers responsible for a dramatic turnaround at Imperial Chemical Industries (ICI).

The new trio comprised John McAdam as chairman, Alan Crown as chief executive and Andy Ransom as executive director. They were each promised bonuses of £31.5 million, as well as heavily-incentivised share schemes, if they could pull off the same feat achieved at ICI.

As well as a programme of ongoing restructuring and a renewed focus on organic growth, the business announced in 2015 that it was extremely keen to increase its share in the global pest control market. After all, the industry as a whole is thought to be worth around £10 billion a year.

Fast forward to 2016 and still under the trio’s leadership, Rentokil has achieved double-digit growth in revenues during the first three months of 2016. It has achieved this growth primarily through niche horizontal acquisitions. The company has bought up 12 British businesses within its sector — nine in the pest control and three in hygiene. These businesses had a combined annual revenue of £13 million at the time of purchase, instantly boosting the company’s bottom line.

As a result of its aggressive acquisition strategy, overall company revenues have jumped 11.8 per cent to £468.1 million during the first quarter of 2016 alone. Within the company’s pest control division revenues have increased by 6.4 per cent, with the hygiene arm growing 2.3 per cent.

In the US, the pest control multinational’s strategy has been even more successful, due mainly to the successful acquisition of fellow pest control company Sheritech last year. This purchase, costing a FTSE-250 record of £276 million, has helped drive North American revenues up by an impressive 54 per cent.

Going with the flow
Fragmented markets often represent fantastic opportunities for niche consolidation strategies. A good example of this comes from the recent market activity of Lancashire-based hydraulic, pneumatic and industrial solutions company Flowtech Fluidpower.

Despite operating within a wider industrial sector that has been struggling in recent years, Flowtech has employed an acquisitions strategy to deliver some remarkable numbers. It recently posted a sales increase of 19 per cent to £44.9 million in 2015 and an adjusted pre-tax profit of £6.7 million — a 59 per cent rise compared to the previous year’s figures.

The fluid power solutions firm has achieved these numbers primarily through selective, earning-enhancing acquisitions within its own sector, of which it is now the current market leader. In 2015, for example, it acquired Nelson Hydraulics, which brought with it revenue of £6.7 million, as well as further cost and efficiency savings.

Furthermore, analysts predict that the recent Q1 acquisitions of niche sector rivals Hydravalve and Indequip will see Flowtech’s pre-tax profits jump to £8.1 million off the back of increased revenues of £54.7 million in 2016. These are some very positive numbers, to say the least.

Seeking financial advice
The financial adviser sector has seen a raft of consolidations in the last few months. A great example of this comes from Succession, which recently made its fifth acquisition this year (making 22 overall) within its own niche sector, while simultaneously announcing that it plans to acquire 50 firms by the end of 2017, with at least another ten this year alone.

However, what makes these acquisitions different from the ones covered above is that they are all driven by acquiring the ability to cope with the ever-increasing burdens presented by regulation and compliance. Additionally, these recurring income sources also help to cover baseline costs.

Another example involves 1825, the financial planning division of Standard Life, which, since forming in early 2015, has already agreed deals with Almary Green, Munro Partnership and Baigre Davis — collectively worth £1.6 billion in assets under advice. The reason given for the move was to scale up the business in order to meet demand created by the changing pensions landscape.

Reaching for the stars
In the world of software, and especially the burgeoning Internet of Things (IoT) market, things are even more cut-throat. Multinationals are buying up fledgling start-ups almost daily. The global giants would far rather acquire niche expertise and market opportunities through aggressive acquisition strategies than build them up from scratch, which isn’t often practical in an industry that moves incredibly quickly. It is not just the technology sector where niche acquisitions are being made primarily to gain access to external knowledge resources.

Smaller companies are also pursuing niche sector acquisition strategies. One of the more unusual ones involves Canadian tech darling Constellation Software, which has acquired around 250 businesses since going public in the mid-2000s.

Furthermore, its strategy involves leaving the acquired businesses to their own devices, even if they directly compete with other businesses under the Constellation umbrella. While this is not a strategy we would recommend, it is certainly working for Constellation — its Q1 revenues for 2016 grew 15 per cent to $487 million (£337 million) compared to $423 million (£292 million) in Q1 2015.


What we have seen here is a variety of acquisition strategies employed within niche sectors. The reasons for such acquisitions may vary, but they are all working out very well for the buyers. Buying other companies within a niche sector helps to reduce costs, bring in additional revenue and cope with changing industry rules.

Rentokil Initial and the companies within the financial advisory sector identified weaknesses and made purchases to address them. For Rentokil, it looks like the management team and the bonus structure were the key weaknesses. For companies in the financial advisory sector, it was the ever-changing pensions rules and regulations that prompted a niche sector consolidation strategy.

Lastly, we have seen that acquisitions within the rapidly-changing technology sector enable companies to quickly bring in time-consuming expertise, increase their product differentiation and boost overall revenue.

Whether we define ‘niche’ as a subsidiary market with special needs or a market that is too insignificant for sector leaders to worry about, in time most niche areas ultimately become mainstream.

Every sector will eventually be dominated by just a handful of companies taking a share of at least 70 per cent of the market. The many deals along this path steadily increase in value, with business owners extracting commensurately higher proceeds. Therefore, if your goal is to be attractive to the biggest fish, you will need to feed first!

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