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Investors beware: ‘Roll-ups’ don’t always work

The salespeople (also known as stock brokers) for the upcoming Steadfast initial public offering (IPO) are quick to compare Steadfast to Austbrokers (ASX: AUB). It’s certainly a reasonable comparison to draw given Austbrokers is also in the insurance broking industry. For the salespeople, Austbrokers makes the perfect comparison as it allows them to point to the magnificent 360% return Austbrokers has provided investors with since its listing in 2006.

Don’t ask the barber if you need a haircut!

As Warren Buffett would say “don’t ask the barber if you need a haircut.” The barber will of course say “yes!” Likewise if you ask a stock broker if you should buy the IPO he or she is flogging… well, you get the picture.

So while some may choose to compare Steadfast to Austbrokers, the fact that Steadfast is being formed via the purchase of over 40 individual insurance brokers makes comparison with other ‘roll-ups’ quite reasonable as well.

As the chart below shows, there are plenty of examples where the ‘roll-up’ model has meant anything but great returns for investors. Examples include accountancy business WHK Group (ASX: WHG), medical general practice giant Primary Health Care (ASX: PRY) and don’t forget the mother of them all, ABC Learning Centres.

tmchart2

Source: Google Finance

Foolish takeaway

There are of course a number of examples of successful companies that have been created through a roll-up acquisition strategy, so an investment needs to be determined on a case-by-case basis. History does show however that many listed roll-ups enjoy a few initial ‘honeymoon’ years as a company expands revenues and profits at a speedy pace; then as the original vendors head for the exits, the company inevitably hits a speed bump.

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Motley Fool contributor Tim McArthur owns shares in Primary Health Care.

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