The roofing world is back in force in Dallas for the 2023 International Roofing Expo, and private equity investors are on the prowl looking for opportunities to make high returns.
Among the crowds moseying around the Kay Bailey Hutchison Convention Center this week — roofing contractors, salespeople and other industry types — are some who may not know much about the roofing trade other than it seems lucrative and they want in on the action.
“We’re coming here with the intent to learn as much as possible and want to further develop our understanding of the key stakeholders across the industry,” said Raj Das of Alpine Investors, a private equity firm based in San Francisco.
This IRE will be the second roofing event Das and his business partner, Zach Grech, have attended in the past six months, familiarizing themselves with the marketplace after finding success in the HVAC marketplace.
“To be a value-add partner, you have to put in the work to actually learning as much as you can about the industry, the problems facing it, and what companies are doing to address those problems,” Das said. “We think conferences like this and Best of Success are some of the best ways to learn as much and as quickly as possible.”
Since last fall, RC has reported on more than a dozen announced mergers or acquisitions among roofing companies primarily driven by private investment. And many of those companies have been perennial names on RC’s Top 100 list. Grech said the scope and pace of trade-based acquisitions are picking up; it shouldn’t surprise anyone that reliably performing companies, regardless of the industry, would be targeted for acquisition.
“Our goal is to partner with and build best-in-class companies that become the employer of choice in the industry, partner of choice for founders/owners, and contractor of choice for customers,” he said. “The only way to do that is by partnering with the best companies and operators in the space who have similar goals and values.”
How it Works
Part of the buzz circulating on the show floor this year is people asking why investors are particularly interested in roofing — and why now? Analysts and industry insiders say the roofing trade provides the right ingredients for a fantastic recipe — the secret sauce — that private equity loves for acquiring companies through a "roll-up process." Roofing checks all the boxes: a stable industry that enjoys long-term growth, is large, fragmented, and profitable.
When private equity managers find these characteristics within an industry and can strategically leverage creative financial packages for longer-term investors, comfortable with a five-to-seven- year return on investment, the resulting financial gains for investors is often quite lucrative.
The real allure, some analysts point out, is roofing's fragmentation; it is a crucial differentiator from other industries. The largest 15 roofing companies nationwide represent less than 5% of U.S. industry sales. Contrarily, in most established industries, more than 50% of any given market is controlled by only 10% of companies within that sector.
Attractive creative financial packaging is also a significant driver of interest in the roofing industry. To understand how private equity creates value, reviewing some investment basics is important.
Overall Investment Basics. The primary driver of investment is the risk versus reward trade-off: The higher the risk, the higher the return on investments to justify that risk. For example, most shareholders in companies with revenues under $50 million expect a minimal return of 15% or more to offset higher risk. Conversely, bond investors, also called debt investors, typically expect 4-7% returns due to the relatively low-risk bonds present.
Business Owner Investment Basics. Entrepreneurs often hate long-term debt. The attitude is, “If I don’t have to borrow, why would I?” After paying themselves enough to support their lifestyle, owners reinvest profits into the company; reinvestment shows on the balance sheet as “retained earnings.” Also, owners aggressively use accelerated depreciation to reduce their tax burden. As a result of depreciation, asset values on balance sheets are often lower than the actual market value.
Private Equity Investment Basics. Unlike business owners, private equity investors love debt. Debt is cheap because it is relatively lower risk. Debt solutions are completed much faster and with less effort than selling shares and are ideal for a business model based on quick and opportunistic acquisitions. Debt increases cash available to make acquisitions and pay salaries. More debt means sharing profits with fewer investors.
Company Value Basics. In general, bigger means more valuable. That’s because outside investors perceive the bigger the company, the lower the risk and the greater the opportunity. Investors pay a premium for one larger company that consolidates individual smaller companies. Simply put, a smaller company increases in value immediately after a larger company acquires it.
Business Acquisition Basics. Most acquisitions use a formula based on a multiple of something called EBITDA, which stands for Earnings Before Interest and Taxes with Debt Added back. EBITDA reflects the amount of cash a business generates from operations. As you’ve likely heard, “cash is king.” Larger size and lower risk increase the multiple; therefore, private equity creates value with an acquisition almost immediately.
Why it Works
Given these basics, here is the essence of how private equity uses creative financial packaging plus strategic leverage to create value for investors and themselves.
1. EBITDA Multiple Equals Immediate Value
Example: Private equity acquires five individual roofing companies generating $20 million in revenues, 15% EBITDA, acquired at a multiple of five and net worth that is 35% of sales. Consolidated, the company now has $100 million in revenues, $15 million EBITDA, a balance sheet net worth of $35 million and acquired for $75 million. Due to scale, the consolidated business value is now eight times EBITDA and, therefore, $120 million in market value versus the $75 million paid for acquisition; value creation is $45 million! Investors are ecstatic and ask private equity to “find me more opportunities to invest!”
2. Restructure Investment on the Balance Sheet
Using the above example: Adding the individual acquired balance sheet net worth is $35 million, or 35% of sales. Private equity might suck out $25 million in cash by replacing the net worth with debt when consolidated into a single balance sheet. By extracting $25 million in cash, private equity firms cover 33% of the cash needed for the $75 million in total acquisition costs.
3. Revalue Assets, Financed with Loans
Owners depreciate assets aggressively to avoid tax burden. As a result, the actual value of the assets is often significantly more than reflected on the balance sheet. When private equity acquires a company, investors restate the assets on their consolidated balance sheet to a much higher fair market value and borrow against those assets to generate even more cash.
4. Increase Profits by Leveraging Consolidated Resources
Private equity reduces expenses by combining operating services:
- One HR department
- One IT team and software platform
- One finance and accounting group
Many also share large, expensive equipment across divisions and can shift crews to where business opportunity exists.
5. Increase Opportunities by Leveraging Relationships
A consolidated business can increase market share by expanding service to existing clients in a wider geographic region it now serves. Also, thanks to substantially increased resource capabilities, the consolidated business can bid on opportunities that an individual, less capitalized company couldn’t otherwise consider. Investments in business development are more cost-effective. Also, Private Equity accesses their trusted relationships that influence roofing installation and service decisions.
While focused on learning about the roofing industry on the show floor, investors are also taking a broad approach to the overall experience. That includes looking out for those top-tier roofing contractors and starting conversations that could lead to cultivating business opportunities.
Grech said an industry-wide event like the IRE offers investors a way to evaluate what they can add to roofing’s evolution.
“We’re looking forward to learning more about the problems facing the industry — for contractors, distributors, manufacturers, and other stakeholders — and the innovative things groups are doing to address those issues,” Grech explained. “Our overall approach is to find ways to help scale these innovative solutions, hopefully, in turn benefitting everyone involved.”