Lumber company A has had a devil of a time negotiating with the Lumberjack Union, but it buys company B so that they can go from five million acres to eight million acres of forest to kill, digest, and turn into scratchpads.
With a highly unionized labor force, both lumberjack companies had only 10% margins, and few resources to invest in technology. Combined, however, with their enormous new scale, it makes financial sense to replace two-thirds of their lumberjacks with robots, a.k.a., the Tree Slayers.
The would-be acquired lumberjack company B knows the math, because they've taken a couple of awesome finance courses on Shmoop, and while as a stand-alone company they might be worth 14x earnings, as they key to unlock the Tree Slayer and a new era of high-margin tree cutting, lumberjack company B will be smart enough to demand a big acquisition premium.
That is, instead of their steady state 14x earnings valuation, they'll ask for and probably get something closer to 20x earnings or more, as the acquisition premium here is warranted in the creation of this new behemoth tree cutting company, which everyone is happy about.
Except the trees. And the squirrels who lived in them. And the birds. And the atmosphere...
Related or Semi-related Video
Finance: What does it mean to "roll up"?1 Views
Finance a la shmoop... what does it mean to roll up? well if you're not thinking
Tootsie now then something clearly went wrong in your childhood but we do not [Person with tootsie rolls in their palm]
judge sorta...well a roll up refers to the practice of a given player
in a given market buying up all of her competitors like let's say you inherited
a nice old-age home teeth optional homes smiling gums are our business [Man appears outside of teethsopital homes building]
yeah that's the name of it it has ten million dollars of revenue each year and
five million of profits and 25 million in cash in its bank account and no debt
nice life well one day the competitive old-age home knocks on your door tells [Old competitor knocks on the door and woman answers]
you they are tired of the grind and the chatter and would like to sell you their
home for ten million dollars well there's is smaller than yours but you
look at the numbers and it appears to be valued at about the same multiple of
profits or earnings as yours is you have the cash and 25 million bucks there you
write the check and blammo now you own two old-age homes so one day you're [Old age home with sold sign outside]
telling the floss salesman who keeps coming by never seeming to get the
message as you point at the business sign yeah and he complains that it's [Man carrying briefcase of cash outside home]
less of a schlep now to get kicked out of both places because you own the
southeastern part of town for old-age homes and then a little light bulb goes [Light bulb appears on inside of brain]
off in your brain there are only seven old-age homes in your entire city if you
owned all of them well you could probably raise prices 10% and get volume
discounts on things like bedpans and denture cleanser and industrial-strength [Old age home items dumped on floor by truck]
prune juice you know trust me I've been there and that prune juice it's powerful
stuff you want to go easy on it there people well your existing business flows
a lot of cash you have still a stockpile of 15 million dollars in the bank and [Money stashed inside a bank vault]
you're generating more of it every day and the two places you have now together
flow about 7 million bucks a year so you started knocking one by one you roll up
all of the competitors in the old age home biz in your city until you have [Snowball falling from a hill]
essentially a local monopoly of old age homes in your little city there yeah you
have rolled up your little industry and our queen of the old age homes hopefully
someday there will be a place for you and well wherever that is let's just
hope it has an ample supply of toothpaste [Toothpaste boxes on a store shelf]
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