Is it just me or do rollups appear to be popping up all over the ASX?

Some well-known rollups include G8 Education Ltd (ASX: GEM) Greencross Limited (ASX: GXL) and Regis Healthcare Ltd (ASX: REG)

For those unaware a rollup business is essentially a strategy to acquire and merge numerous small businesses in the same marketplace.

The key to success of the rollup strategy is the ability to reduce costs by merging many of the small businesses’ common activities such as payroll or purchasing. You may remember this from your high school economics, economists refer to this type of cost reduction as “economies of scale”.

For anyone considering investing in an IPO (Initial public offering) of a rollup company the key is deciding whether the benefits or cost savings are as substantial as the prospectus sets out.

Let’s take a look at three rollup stories.

G8 Education

Perhaps the one company that has borne the brunt of investor scepticism more than any other is G8 Education following on from the collapse of ABC learning. Much of the doubt surrounding GEM has centred on its high levels of debt. For any rollup strategy debt will play an integral part. The key is therefore the ability to service any debt. With childcare notorious as a low-margin business the success of GEM’s strategy relies heavily on its ability to acquire profitable childcare centres for reasonable prices and to maintain as near as possible full occupancy in the centres it currently owns. So far the management team has been able to do just that.

Greencross Limited

As we all know pets are fast becoming more and more like family members particularly with couples choosing to have children later in life. Greencross has tapped into this theme with its rollup of vet and pet care stores. So far Greencross has delivered on its promises. One particular highlight has been the remarkable growth in like-for-like sales it has and continues to achieve from its pet care stores. Currently running at over 5.5%, many mainstream retailers would kill for such numbers.

Regis Healthcare Ltd

It is no surprise to learn a number of companies have moved into the aged-care space with Australians living longer. When a patient enters an age-care facility they have the choice of how they wish to pay for their care. Payment can be via lump-sum payment, called a ‘refundable accommodation deposit’ (RAD) or a ‘daily accommodation payment’ (DAP), or a combination of both. The RAD is like an interest free loan to the healthcare provider. Not many industries have access to such a cheap form of funding and this in part makes age care an interesting proposition for investors. With aged care highly reliant on government funding it is susceptible to any changes in government policy. This was highlighted by the recent federal budget with changes in funding for patients requiring higher levels of care.

Foolish takeaway 

Rollups should not be feared but investors should enter any investment with their eyes wide open. IPOs based on rollup strategies boasting high cost savings need to be viewed with a level of sceptism. When in doubt over where to invest I always lean to the investment with the greatest margins. The reason being that a greater margin provides a larger buffer if conditions unexpectedly change.

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Motley Fool contributor Alan Edmunds owns shares of Greencross Limited and G8 Education Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.