This year is all about the roll-ups. No, not those fruity snacks you used to find in your lunchbox; roll-ups are the aggregation of smaller companies into larger firms, creating a potentially compelling path for equity value.
Right now, all eyes are on Thrasio, the fastest company to reach unicorn status, and its cadre of competitors, such as Heyday, Branded and Perch, all vying to become the modern model of consumer packaged goods (CPG) companies.
Making things even more interesting, famed investor and operator Keith Rabois recently announced that he too is working on a roll-up concept called OpenStore with Atomic co-founder Jack Abraham.
Like any investment firm, to be successful, a roll-up should have a thesis or two providing it with a cohesive strategy across its portfolio.
Thrasio has been reaping the benefits of the e-commerce market’s Cambrian explosion in 2020, in which over $1 billion of capital was invested in firms on a mission to acquire independent Amazon sellers and brands.
This catalyst can be attributed to a few key factors, the first and most notable being the pandemic accelerating spending on Amazon and e-commerce more broadly. Next is the low cost of capital, a reflection of interest rates making markets flush with cash; this has made it easier to raise both equity and debt capital.
The third is the emerging and quantifiable proofs of concept: Thrasio is one of several raising hundreds of millions of dollars, and Anker, a primarily Amazon-native brand, went public. Both stories have provided further validation that a meaningful brand can be built on top of Amazon’s marketplace.
Still, the interest in creating value through e-commerce brands is particularly striking. Just a year ago, digitally native brands had fallen out of favor with venture capitalists after so many failed to create venture-scale returns. So what’s the roll-up hype about?
Roll-ups are another flavor of investing
Roll-ups aren’t a new concept; they’ve existed for a while. In the offline world, roll-ups often achieve much greater exit multiples, known as “multiple arbitrage,” so it’s no surprise that the trend is making its way online.
Historically, though, roll-ups haven’t been all that successful; HBR notes that more than two-thirds of roll-ups fail to create value for investors. While roll-ups are often effective at building larger companies, they don’t always increase profits or operating cash flows.
Acquirers, i.e., those rolling up smaller companies, need to uncover new operating approaches for their acquired companies to increase equity value, and the only way to increase equity value is to increase operating cash flow. There are four ways to do this: reducing overhead costs, reducing operating costs without sacrificing price or volume, increasing pricing without sacrificing volume or increasing volume without increasing unit costs.
E-commerce could present a new and different opportunity, or at least that’s what investors and smart money are betting on. Let’s explore how this new wave of roll-ups is approaching both growth and value creation.
Channel your enthusiasm: Why every roll-up needs a thesis
Like any investment firm, to be successful, a roll-up should have a thesis or two providing it with a cohesive strategy across its portfolio. There are a few that are trending in this particular wave.
The first is the primary distribution channel upon which a company grows. Evaluating companies with a common distribution channel can be helpful for creating economies of scale, focusing marketing and growth resources in a specific channel versus diluting resources across several.
On the downside, these companies become reliant on this distribution strategy and any changes could create vulnerabilities for their portfolio companies. As a study, let’s take a look at how two companies take different approaches:
Thrasio is exclusively Amazon-focused and relies heavily on it for distribution. This focus has made Thrasio an expert in its ecosystem, creating a flywheel. It’s been watching trends and ratings long enough to spot good burgeoning products and pinpoint how to add value. This risk, of course, is that Thrasio is too dependent upon Amazon, and any changes to the Amazon algorithm could compromise performance. What’s more, the proliferation of fake goods on the Amazon platform could present a risk to their portfolio’s performance, though for the time being Thrasio is only interested in branded products.
Moonshot Brands is a newcomer to the space, focused on omnichannel brands that have both a presence on Amazon and sell directly to consumers (DTC). This approach makes its portfolio less susceptible to changes or vulnerabilities in one channel, but may be more difficult to scale because it requires a broader set of customer acquisition expertise; selling DTC often means utilizing Google and Facebook as primary acquisition channels.
The challenge here, especially in iOS-dominant marketplaces, is navigating system updates (like the upcoming iOS 14) that threaten targeting and analytics. It’s also interesting to note that Moonshot builds its brands instead of buying them.
Next up for consideration is the customer audience or category of focus. In the examples above, the aggregators are diversified across customer segments and categories. Others, however, take a different approach.
Grove Collaborative started in one vertical, household goods, and then expanded into adjacent verticals with aligned brand values and customer personas. While it’s not a roll-up in the strictest sense, it sells products from brands it does not own, builds its own brands in-house, and occasionally acquires brands to join its native portfolio. Grove Collaborative presents an interesting case in that it focuses on natural, environmentally friendly goods, inviting a number of core processes that are scalable and replicable across multiple categories.
Again, this is far from a new idea — CPG retailers have been doing this for decades. Some traditional CPGs take a horizontal approach, acquiring brands around a common customer such as LVMH (luxury consumer) or Unilever (middle-income American household); other CPGs go deep in a category. For example, L’Oreal owns mass brands such as Maybelline and Garnier, luxury brands such as Lancôme and Yves Saint Laurent, and professional brands such as Kerastase. Note that each category is big enough globally to accommodate several multibillion dollar companies.
What’s the optimal approach? It’s TBD
While companies have different investment theses and ways of constructing their portfolios, there’s no proven way to win. Risks abound.
With the surge of invested capital, cash becomes a commodity and multiples on every deal increase. When these acquisitions get competitive, it becomes even more important that there are exit and liquidity opportunities on the other side for the roll-up. Deal-makers will find businesses that really aren’t worth more than their cash flow. While these e-commerce entrepreneurs will enjoy inflated value and quick wins, it won’t last forever.
While growth in these categories may look easy as companies build their initial brands, it can also be difficult to sustain. After the first several tens of thousands of fans, finding those incremental million customers can be difficult. It may also involve channels not core to the roll-up’s thesis — do these Amazon-native firms decide to build expertise in traditional DTC acquisition? It’s very difficult to hedge these risks because they are long-term investments by nature, and the whims and trends of the market cannot be easily predicted.
To stand out in an increasingly crowded market, aggregators need to create tangible value in marketing, supply chain and logistics, and/or research and development. This enables them to appeal to consumers, attract companies considering a sale, strengthen their unit economics, and continue to innovate and beat out the competition.
When roll-ups do add value to their portfolio companies, how do they realize the value they’ve created? Do they sell them at a certain point? OpenStore says it’s not planning to flip companies, yet exit paths are unclear.
The space is heating up, flamed by huge market opportunities and the promise of enough market capitalization potential to house many multibillion dollar companies in the space. It’s now a race to build a firm with the right portfolio construction and management strategies in an unprecedented way. Gone are the traditional private equity investors, now replaced by a blend of finance executives and e-commerce operators who are fluent in digital growth strategies.
The e-commerce boom, as validated by Thrasio, has created new opportunities for technology to innovate in these areas. But we’re still in the early innings of this game, and key risks remain unaddressed. Hundreds of millions of dollars of capital raised does not equal success. Many will fail, and success, like anything, comes down to execution. It’s a capital-intensive process, and as the cost of capital increases, the pressure will increase to deliver returns.
Winning here will mean creating value in meaningful ways that haven’t been achieved before. And whoever wins will create a lasting effect on the e-commerce landscape in the years and decades to come.