PE roll-ups: Consolidation game

Quadrant Private Equity has acquired three fitness club operators within two months, and apparently it's not finished: further deals are expected over the coming months as the GP seeks to consolidate a fragmented market.

Australia's gym, fitness and health club industry generates approximately A$1.3 billion in revenue each year, according to Ibis World, but only three companies - Fitness First Australia, Ardent Leisure and Anytime Australia - enjoy a double-digit market share. The largest of those, Fitness First, has less than 20%.

Quadrant snapped up Ardent's Goodlife Health Clubs business and then added Jetts Fitness; the two have more than 260 locations between them nationwide. The most recent acquisition is market leader Fitness First, which has 65 clubs. However, this represents a tiny fraction of Australia's 3,500 or so establishments, and if the industry shows signs of saturation as some predict, cost could help force a consolidation agenda.

Roll-ups are an established strategy among Australia's middle market private equity players. For example, it has previously featured in Quadrant's investments in aged care services and it is currently being pursued by Crescent Capital Partners in dentistry (having worked out well in audiology and skin care). Education and business services are cited as other sectors with roll-up friendly characteristics.

The primary objective is to bring consolidation, standardization of services and economies of scale to industries where this is lacking. Centralized procurement that brings down costs, the ability to execute capital expenditure programs that improve technology and systems, wider-reaching marketing and product development efforts, and relieving management strain on service-oriented leadership teams by bringing them into a big tent are all seen as advantages.

In certain cases - such as vocational training in Australia where the government has not or cannot commit sufficient resources to meet demand and greater private sector involvement is encouraged - structural change can be a contributing factor in roll-up strategies.

However, success does not hinge on simply identifying a fragmented industry and making acquisitions. First, there must be a proven formula through which the buyer can strengthen and bring value to its consolidated portfolio of businesses rather than eroding value that is already there. If the aim is to buy cheap and sell at a much higher multiple without making any improvements, the gains will not last.

Second, expansion has to be disciplined; there is no point acquiring businesses if they don't contribute to the overall thesis or if the valuation is so high that the economic sustainability of the strategy is brought into question. Australia has a ready-made horror story in ABC Learning, a listed childcare business that expanded aggressively before collapsing under the weight of its debt.

Practical challenges also come in the form of employee retention. The management of a successful local business needs to be incentivized to keep operating at the same level following an acquisition. A group that makes a string of purchases without putting in place the systems to run them risks seeing a drop in performance that is too widespread to be offset quickly.

There is no single model that fits all roll-ups perfectly and it is possible to contain multiple businesses under an umbrella group - as private equity investors have proved in the restaurant industry - in order to maintain distinct brand identities while realizing some collective advantages. But one question common to all roll-up strategies is whether customers will stay loyal to the business under a new owner.

Gym users in Australia have plenty of choice and various younger players have gained traction by filling a perceived gap in the market, whether it concerns cost, convenience or customer care. Quadrant must avoid diluting the secret sauce.

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• Topics
• Australasia
• Buyouts
• Consumer
• Healthcare
• Australia
• Quadrant Private Equity
• Crescent Capital Partners
• Education