M&A Explained Part 4: Buy-To-Build Strategy & Vertical Integration

Welcome back to the final episode of a 4-part miniseries on mergers and acquisitions with Stephen, our Director of Corporate Finance here at AmplifyMe. And today we're going to talk about a couple of different things related to M&A, the buy and build type of strategies. So we're going to talk about RSK acquiring DWD. You might not have heard of those, but Stephen will explain. And then I'll talk a little Hotel Chocolat as well to, um, just throw in the mix given it's almost Christmas. I'm sure they'll be making a little extra boost over that period. Then we'll talk about buying back core assets. There's big headlines this week about McDonald's and China and a big private equity name. And then we'll talk about vertical integrations as well. So Stephen, firstly, how are you?

I'm pretty good, thank you, Ant. Uh, I'm looking forward to this final part. We've been through 3 episodes now talking about why companies buy other companies, and I've been trying my best to fit some textbook knowledge around deals that have happened in the last week. So sometimes I've had to scrape through the smaller deals. Again, RSK acquiring DWD probably didn't hit the top of your, your deal feed, but it's certainly a really interesting one. And, and obviously, you know, it's always good to talk about Mars and McDonald's and all of the all of the fatty stuff.

Yeah, so, so maybe to kick things off then, I mean, who are RSK and who are DWD?

Yeah, so RSK, it's a, it's an environmental consulting services business. It doesn't sound particularly interesting, but what I want to really highlight, it's called RSK Group, and the group part is quite important. Because RSK has built its company through acquisition. Just going to land a couple of stats and think about this. RSK in 2022 alone completed 36 acquisitions. 36. Think about integration. Think about standardization. Think about the cost of acquisition. These are obviously small acquisitions. We're not talking division-style acquisition. But 36 is still a big number, right? And overall, if you look on their website and look at RSK Group's businesses, there's over 170 separate businesses that sit below RSK Group. Now, these businesses all operate in the same kinds of spaces, the environmental, energy and power, buildings, infrastructure, consultancy type space. But they all offer slightly different things to slightly different clients. So the acquisi— the announcement of the acquisition of DWD, which is a UK-based company of property advisors, valuation experts, and planning consultants. Now, this is just part of RSK Group's buy and build strategy. And a buy and build strategy is a relatively common, uh, use of acquisitions, reason for acquisitions. And that's basically, instead of growing organically, which is growing without acquisition, growing slowly, you grow— you have a specific strategy to grow inorganically by making multiple, multiple, multiple acquisitions every single year, and then creating a company as the sum of all of the acquisitions and all of the separate entities and all of the separate groups that sit below that master group, which in this case is RSK Group. So buy and build strategies are certainly something that we need to be aware of when we're thinking about reasons for acquisitions.

So, so a company with that type of strategy, would they have a slightly different makeup in terms of the advisory side internally in order to just keep costs efficient rather than going through the full service kind of process with a bank, for example?

Yeah, it's a really good question. I was actually looking at the management team of RSK trying to figure out whether they have a head of corporate finance or whatever it might be. And in their senior management team, they have 3 job titles that I would suggest are pretty much focused on buying and integrating. Now they may have an M&A advisor on retainer for some of the bigger deals, they probably have an accountant that's got really, really good experience in integrating M&A deals, but they would definitely have a corporate structure where the senior management of RSK Group are exceptionally good at finding, acquiring, and integrating these companies. And when I say integrating, by the way, these companies probably still operate, you know, they've got 170 separate businesses. These companies probably operate relatively autonomously but will benefit from centralized procurement, will benefit potentially from centralized marketing. There might be some, yeah, cost synergies, something that we spoke about in previous episodes. There might be some cost synergies, you know, it's better to be part of a bigger group because you benefit from all of these different things. And that's the reason why you do a buy and build strategy.

Yeah, and that's a perfect kind of segue into the confectionery giant Mars announcing in the last week that they're going to buy Hotel Chocolat for £534 million. Um, the shares, uh, in the chocolatier actually jumped. I didn't even realize they were listed, to be honest. Uh, they jumped 160%. I just had a look. Actually on their chart, and I was interested, like, I haven't really heard a lot since the announcement. Um, given that they're a smaller company, the share price, what you typically see from a trading perspective is there's just not a lot of activity in that, in that company in terms of buying and selling. It's not like with Apple. You could be, you could come in and, well, an Apple share trades at, let's say, $300. You know, Joe down the street might buy 5 shares You could even come in and buy 5,000 shares of Apple and it probably wouldn't even blink an eye. But you go to someone like Hotel Chocolat, they go in and the shares explode because there's just not a lot of buying and selling day to day. So I looked at it, they jumped, they're currently trading around £3.66 at the moment. And I was like, when you look at it on a 6-month chart, you're like, Wow, that's impressive. It's like doubled from where it was at the beginning of the year. But then I was like, I always do this, you've got to look in context of like, what's the lifetime performance of this company? And you look back and you go to like late 2021 when they were trading at over £5. So they were a lot higher than even after the pop. And the interesting thing there is the share price declined quite dramatically through the beginning and middle of 2022. And if you remember what happened in 2022 is interest rates started to go up for the first time, and they didn't just start to go up, they went up sharply. And kind of fitting that macro environment into this story, what happened was Hotel Chocolat were trying to aggressively borrow to build and expand overseas at the exact time then the interest rates were starting to explode. And whilst they were trying to build out their operations in the US and Japan, these inflationary pressures requiring higher interest rates, weakening consumer sentiment and therefore demand for these types of products, chocolates, meant that their business just got slammed, basically. So they lost a heck of a lot of money, uh, and their share price was very suppressed ahead of this deal. So they got it wrong, essentially, the timing, um, definitely. So they were founded in 2004. They swung to a loss in the year to July, falling from a pre-tax profit of around £22 million. Their last was a loss of a million. So they've gone from like making £20 million pre-tax profit to losing money. So one of the things here, and I guess this is kind of a little bit like you were saying at the end of that last deal, which I wanted to kind of ask you about, is this more, as you say, buy and build, or is this more economies of scale, which I think was our first episode, which was Mars, on the other hand, is an absolute giant. And what are the benefits of teaming up with someone like Mars? Like you said, you can use marketing departments, you can use global supply chains, for example, commercial relationships, all these different things. You know, if you think about Mars, they exist in North America, they exist in all over around the world. It's just a matter of deploying the product into an already well-oiled machine. So that definitely makes sense, I think, from, from that side. And then from Mars's side, why would Mars want this, I guess? Um, and from what I was reading, it was more about an opportunity, as I said, a, a good price, um, given the fairly precarious situation they found themselves in to move into higher value premium chocolate categories. So just expanding their, their product offering, I guess.

Yeah, so yeah, you've read— you've mentioned a couple of interesting things there. I think the first thing that's really interesting is when looking at valuations on deals, we're going back into kind of M&A 101 here. When looking at valuations of deals, one of the ways that you can obviously put a value on a deal is by looking at a company's market cap and then applying a premium. Uh, and in this case, the premium was massive. You say 150%, something like that. But it's really important not just to look at the last 6 months or 12 months. You've really got to look at the steady state of that particular share price. And often what we do when we're looking at whether the— whether there's a premium or what the valuation should be is we will take the highest share price from the last 52 weeks or something like that instead of the stable share price from the last week before. Because you never know what will happen, what happens in the short term. It's better to look at the long term. But just in terms of looking at the rationale for Mars, just going to quote Andrew Clark, who's the global president of Mars's snacking division. He says that Hotel Chocolat fills a gap in our portfolio. So they do not have a premium brand. You know, they do not have a Lindt or an equivalent. Their stock and trade is, from a snacking perspective, M&M's and Mars and Snickers and Twix and things like that. So firstly, this is just filling a premiumization gap in their portfolio. Yeah, which, which makes total sense. I wouldn't call this a buy and build. I'd just call this a, a strategic acquisition. And I think the second thing to mention with regards to Hotel Chocolat is they are pretty well known for their sustainability credentials. They give 10% of their pre-tax profit back to farmers in cocoa-growing regions. They say that they pay more than any other chocolate company and, and things like that. And you must have seen the increase in, in, in chocolate, like Tony's Chocolonely. I don't know if you've come across chocolate. You know, that's now front and center of every confectionery aisle. That's only been the case for the last couple of years. And if I'm Mars and I'm seeing Tony's Chocolonely, which are a benefit corporation, a B corporation, and are growing incredibly quickly from a relatively low base, I'm going to be thinking, all right, I need to get in on the sustainability push. Because when I think about— when the average consumer thinks about Mars or thinks about Snickers or thinks about Twix, they probably don't go, oh gosh, that's sustainable, that's ethical. But when they think about Tony's Chocolonely and to an extent Hotel Chocolat, they think, all right, you know, well, that's pretty ethical. I'm pretty happy to be buying that. So there's a couple of really good strategic reasons why Uh, why Mars is doing this deal.

Hmm. Nice. Yeah, it's really interesting actually when you break it down like that. All right, well, look, let's move on. And so after we've kind of filled our boots with Snickers and Mars bars, let's get a McDonald's. What's going on at McDonald's?

Yeah, so this is the story. This is a really interesting one, and I think we, we did a LinkedIn post about this earlier this week. This is McDonald's buying back Carlyle, the private equity firm's minority stake in its China unit. Yeah, so let's, let's try and unpack this a little bit. We'll go back to the beginning. So McDonald's, 95% of McDonald's stores are franchises. So McDonald's is the franchisor, and individual companies, individuals, individual owners are franchisees. They pay McDonald's a franchise fee in order to benefit from the McDonald's logo and the products and the processes and things like that. And to be a McDonald's franchisee is incredibly expensive. It's one of the most expensive franchises you can possibly buy.

Just a question, do you have any idea— because I always go to McDonald's and I, and without fail, I will always ask myself, I'll look around and I'll go, It's just bonkers in here how busy it is. And I always think to myself, I've gone in the wrong profession. Like, I should have just been— I should have just owned a chain of McDonald's. Like, what's the average profit that one of those— I'd love to know, as a franchisee, what type of money can you make out of per store, for example?

Well, so a franchise— so, so I don't know the specifics, but I know that a franchise license in the UK, depending on the area, franchise license might be anything from $1 million to $2.5 million to franchise McDonald's. Yeah, to buy the franchise for a particular store on the outskirts of wherever it might be. But as you say, it's always so busy. Just, just as an aside, an average franchise license for Subway is about a tenth of that, right?

That's why there's so many Subways then.

Exactly, exactly. You can pick up a Subway franchise for under $100 grand. Um, but McDonald's, because it has got this amazing, amazing brand reputation, consistency of products— it's a franchise, but you are going to get 99.9% similar products wherever you go. It's quite an amazing business. And obviously, from McDonald's perspective, it's a great business because I can expand without having to put up the capital to lease the properties, to retrofit the buildings, Etcetera, etcetera. So the franchise model was very, very popular. Now, the reason why I say this is because when McDonald's back in 1992 decided to enter China, it didn't and couldn't franchise. It operated through a joint venture where on the ground, the subsidiary or the JV company were the operator and owner of all of the McDonald's branches, McDonald's restaurants in China. And that was necessary in 1992 due to the regulatory situation. Now fast forward to 2017, and McDonald's was under quite a lot of pressure, actually. There was an activist investor saying that they need to focus more on their franchise business. They need to trim down their number of stores. It's a difficult— there was a lot of difficulty managing the relationship with the China JV partner. They wanted to free up some capital. So in 2017, they sold 80% of their operations in China, their subsidiary in China that runs all of the businesses. Remember, it's not a franchise. And that 80% got bought by CITIC Consortium. Is a Chinese conglomerate and private equity investor, and Carlyle, who bought 28%. So Carlyle, the massive US private equity firm that's got quite a big presence in Asia, ended up owning 28% of McDonald's China business. And that left McDonald's with just 20% of the China business. Now fast forward again 5 or 6 years to today. That sell-off of 80%, McDonald's has started to reconsider. They bought back the 28% from Carlyle, and the reason behind it is because they want to take more control of their fastest growing area in the world. So the number of stores in China, the number of restaurants in China, has increased from about 2,000 in 2017 to about 6,500 today, and they're going to try and increase it again to 10,000. So rationale for deals. All right, we're back in 2017. I needed to free up some capital. I needed to shed some pretty stodgy assets. 2023, wait a second, this thing is growing and I actually want a bigger piece of this. Karlisle is up for selling, so let's regain and take back control of an area that we now want to get involved in.

When you were putting out those numbers of stores, I was like, okay, 10,000 restaurants by 2028. I was like, okay, I wonder how many restaurants there are in the UK. So what do you reckon? I just had a quick look. How many McDonald's are there in the UK?

All right, this is McKinsey consultancy question time.

Yeah, okay. So I'd like you to, Mr. Barnett, I'd like you to walk me through your process, please.

Okay. All right. So my process. So there are 40,000. I know that there are 40,000 franchised restaurants. McDonald's have 45,000, 40,000 franchised restaurants around the world. Right. I would say that the US is its biggest market. I reckon 20,000 of those 40,000 are going to be in the US. Now, the US has got 350 million people. The UK's got 65. So let's cut that down by a sixth. So let's say 3,000 restaurants. And then maybe because the US just loves McDonald's and we don't like McDonald's quite as much, let's go 2,500. No, 2,000. How close am I? Yeah.

So it's all about the process, everyone. Whenever you get this question, it's about the process, not the end. Answer. The answer is 1,270.

I'm not that far off.

I'm not that far off. To be fair, I liked it. I liked your method.

I'll advance through to the next round. Thank you very much. Yeah, it's kind of crazy. And therefore, yeah, as you say, 10,000 is a chunky number. And this is one thing that I want to say, not necessarily on the acquisition rationale, but I'm just going to take this from a Carlyle perspective very quickly. Now Carlyle, uh, they bought into the McDonald's operations in China in 2017. It's an enterprise value at a deal value of $2.1 billion. That's what the value of this company was. And now it's expected that they're going to sell their 28, uh, 28% at a deal value, at an enterprise value of $6.4 billion. Now with leverage, with debt, it is expected that Carlyle from 2017 to 2023 are going to make 6 times their money, 6 times their original investment on McDonald's operations, holding it for 6 years and selling it. That's not a bad piece of business from the, from the, from the Asian Carlyle team.

Oh, so someone like Carlyle, they're US-based, is that right? So US PE firm. So how much deal activity would be Asia-Pac for someone like a Carlisle?

I mean, it depends what year you talk about. I mean, so the private equity firms went massive, went very long on Asia over the last kind of 10 to 15 years. But I don't know if you've been reading the headlines about bored bankers in Hong Kong, uh, desperate for a deal, twiddling their thumbs. So there's massive retreat across, across China from a, from a private equity perspective and from an M&A perspective as well. So this might actually just be a strategic move from Carlyle to, to get out of certain positions that they've got in Asia due to, again, just the macroeconomic climate, increased difficulty of doing business in Hong Kong and China, and maybe a repivot back towards the US, which is going gangbusters from an economic perspective.

Cool.

All right.

Well, look, last one, vertical integrations and this Broadcom VMware deal.

Yeah, I want to talk about this deal for a couple of reasons. The first, because it's massive. It's a deal that was announced back in, I think, May 2022, a long time ago, $61 billion. So Broadcom, I'm going to call it a chipmaker. It's a hardware, ostensibly a hardware business that services basically the infrastructure of computing and the infrastructure of data, and VMware, which is the software layer that goes on top of the hardware. So again, translating the data that you're getting out of these, of these data centers and things like that and turning it into something that's actionable. I want to talk about this deal because one, it's massive. Two, it's extremely boring. You know, I cannot find a way to make Broadcom or VMware sound remotely sexy.

Can we not throw in AI somewhere in there?

I'm sure I'm actually looking at their website at the moment and I'm sure AI is probably mentioned. But look, I— it is, it is how what they do does power a lot of the artificial intelligence world. It's not an interesting business. It's picks and shovels, it's infrastructure, it's hard stuff. But just as a kind of note to any would-be founder who's listening, my gosh, these infrastructure businesses are insanely valuable. $61 billion for VMware is a fair reflection, and the, and the multiples are, are pretty high. But if you think about these infrastructure businesses, they're called infrastructure, and that's because they are necessary for a whole industry. So they are sticky revenue streams. Just imagine taking Broadcom out of a particular process. It's going to be almost impossible. So these are brilliant companies to found, even if they're not the most attractive, sexy, exciting companies that you really want to talk to people about at a dinner party. But also, this acquisition is a great example of vertical integration. So vertical integration classically is taking margin from different parts of a supply chain. Oil and gas companies are vertically integrated because they own the exploration, the extraction, the transportation, the refining, and the selling. So they take margin, they take profit margin at each stage, and they also make themselves more defensible because they know what's coming through the pipes, that they know what's coming through the supply chain. And if you think about that from a technology perspective, if Broadcom is the hardware, to use a very simplistic rendering of this story, if Broadcom is the hardware, they have just bought the software layer. So if I'm— and they are becoming vertically integrated. So if I'm a client that really wants access to data centers, but also wants access to the software that allows me to understand my usage and optimize and things like that, I can now go to Broadcom plus VMware and get it as a bundle. And suddenly Broadcom's owning the margin from both the hardware and the software and being able to bundle in a kind of revenue synergy environment. So it's a really lovely example of vertical integration, which is a brilliant textbook case of why one company acquires another.

So is that why it was awaiting regulatory approval for the reason you just described?

Yeah, it's a really good point. It was announced in May 2022 and it's just been completed this week. In fact, if you look at the VMware website, it says VMware by Broadcom. So it's actually happened now. Often we talk about deals that have been announced but haven't yet happened, but this has finally happened. But yes, it was a huge regulatory holdup. I think Japan, the US, the UK, and the EU, and China had to opine and had to clear the deal. And actually, I think it was China that said, look, all right, we will allow this deal as long as VMware's server software— stay with me— as long as VMware's server software stays interoperable with Broadcom's competitors' hardware. So it's basically saying, look, you can own VMware, but VMware still needs to be available on top of other hardware solutions. So you can't just corner off a whole market yourself. Now, I don't know whether there's a time limit on that. I don't know whether that's, you know, 5 years or 10 years and then maybe it can properly consolidate. But again, yes, vertical integration is potentially quite monopolistic. Or at least potentially quite anti-competitive. So yeah, definitely worth a really good case study, much like the Microsoft and Activision case study that we spend a lot of time talking about.

Okay, before we wrap up, you did have a note about a quick update on something we spoke about a few episodes back earlier in the miniseries about the Telegraph Media Group. So anything going on there that we should be aware of?

So remind us, so Telegraph, as it just as a very quick reminder, they were, they are now owned by Lloyds Banking Group because the Barclay brothers couldn't pay, couldn't service the debt that they took out as part of their ownership of the Telegraph. And now Lloyds Banking Group don't want to own the Telegraph and they put the company up for sale. You know, again, Telegraph, UK broadsheet newspaper. Spectator, which is also a UK political magazine. When we spoke about this a few weeks ago, we were naming a bunch of different— remind me, who, who did we think could be up for this?

There was one, one person that I think would be interesting because there's been a few other developments, is Ken Griffin, who's the founder and CEO of the most profitable hedge fund in history, Citadel. And what's interesting there is that Obviously we were talking about soft power and influence and the media and these finance people getting involved. He's also— he must have been— he must have got the, the textbook from the Saudi Fund about utilizing sports, because I think he's also sniffing around the Miami Dolphins or something like that, the football team. Um, so he's, he's looking to branch out At a time when that company's making record profits, you would think he would be all focused on business, and yet he's focused more on being a— capturing a dominant voice in the media and then also in the sports arena as well. But yeah, yeah, absolutely.

Well, and, and a very— I know that we don't really deal in book recommendations on this podcast, but there's a very, very good book that's just been, uh, that's just been, uh, put out by I think it's Robert Copeland, which is called The Fund, which is all about Ray Dalio and Bridgewater. And, and quite similar in, in the sense that Dalio has become bigger than the firm and has tried to, you know, is, is— it hasn't really cared about the investment operations for the last 20 or 30 years and is, is busy pumping his principles and, and being a kind of bigwig on the, on the Davos stage.

So he sounds like the world's World's Worst Boss. Some of the stories that have come out of that book, you're like, wow, honestly, read, read this book.

Um, I, I read it last week and it's just, yeah, it's, it is an exposé into the world's, yeah, as you say, the world's worst boss and a complete narcissist. And, and yeah, definitely read it. Anyway, but let's go back to Telegram. So the reason why I just wanted to give you a quick update is because The, the front runner to buy the Telegraph is the Abu Dhabi Sovereign Wealth Fund. So Redbird IMI, which is a fund, an investment fund owned by Abu Dhabi and Sheikh Mansour. They said that they're going to support the acquisition and take the debt off of Lloyds' hands. But the issue there is that the UK government's getting involved. They're saying, oh, do we want one of our main broadsheets, one of our main sources of news to millions of people in the UK, to be owned by a foreign government, which is effectively what this is. So this is certainly a story, just, you know, we'll keep, we'll keep updating you. This is a story that's going to run and run, and as soon as the UK government gets, gets its national security clause into a deal this could, this could die. This could end up actually going back into the hands of one of, one of the hedgies that we spoke about, um, or maybe a, a different suitor will be found. Uh, but yeah, just a little update on the Telegraph.

I love that. It's okay if it goes to one of the hedge fund managers because all the politicians are mates with Ken Griffin, correct? Uh, all right, cool. Well, look, that is the conclusion of the 4-part series. So for everyone listening, I hope it's been informative and enjoyable. Don't forget, we are running still through pretty much into Christmas the M&A Finance Accelerator. So it's happening on a pretty much weekly basis up until Christmas on a Thursday. Typically, all you need to do is check out the link in the show notes, click on that, register. We'd love for you to take part. And even though this was a mini-series, we'll be back again. Don't worry. The, the next week, um, to talk about the latest deals that have come out. So thank you, Stephen.

Thanks, Ant.