Learnings from Swedish Serial Acquirers

Thanks to supporters of this publication and the feedback on Twitter, I had the chance to attend the Redeye Serial acquirers themed event in Stockholm. Today, I reflect on what makes them successful.

About a dozen Swedish serial acquirers attended the event and presented their business. Amongst them were Vitec Software, Instalco, Volati, and Lagercrantz.

The event counted Chris Mayer from Woodlock House Family Capital and author of the excellent book 100-Baggers and Portfolio Managers at REQ Capital Oddbjørn Dybvad and Synnøve Gjønnes as panelists. All three have a long experience investing in companies that are frequent acquirers and had interesting insights to share about how they view investing in these types of companies.

I want to take the time to thank Eddie Palmgren and Niklas Sävås, hosts of the Investing by the Books podcast and equity analysts at Redeye, for their invitation.

Why Serial Acquirers?

Most investors tend to shy away from companies that grow through acquisitions. After all, there is a McKinsey study out there that demonstrates that ~80% of acquisitions do not create value some even destroy value. There are many reasons for this phenomenon; overoptimistic synergy expectations, economies of scale that do not materialize, paying too much, ego-driven acquisitions, you name it. This begs the question:

Why even look at these companies if the track record in M&A is so bad?

In this post, I will attempt to answer this question with what I learned from the companies and investors present at the event and my own knowledge about serial acquirers.

Mergers & Acquisitions, a people-driven business

What was clear from all companies attending, is that the way they approach M&A is very different than most public companies. Like students of Constellation Software might have learned, acquiring SMBs takes a lot of time, discipline, and relationship building. The best serial acquirers have often been in talks or had relationships with the seller for years before a deal even is on the table. This is very different than a structured process where brokers and advisors run auctions, with a limited due diligence period and often seeking the highest price possible. This gives experienced serial acquirers two distinct advantages, adverse selection and a deep insight into the people running the business.
By establishing a relationship well in advance of an owner considering selling his business, both parties can feel each other out, get to know each other, and decide if they are the types of people that could do business together. A business owner seeking top dollar and who does not necessarily care what type of buyer he sells to will probably not put in the effort to build a relationship for years. A seller that does will not have the selling price at the top of his list when the time to sell comes around. Conversely, the buyer knows very early what type of character the owner has and has time to get intimately familiar with the business and management team running the business. When the seller feels comfortable discussing a deal, the buyer is on the top of the seller's call list and the odds of a deal being made are much higher than through a traditional process.

Even though serial acquirers do not necessarily have a big advantage on price compared to peers, the deal that both parties find acceptable after building such a relationship is reasonable, even advantageous for both parties. The buyer gets an immediate return on his capital in a business he knows well, the seller knows his life's work will not be ruined and gets a good price for what he has built.

Investors often mention that they get better at evaluating management teams after meeting a lot of them. This is also true for serial acquirers. With many acquisitions every year, constant contact with potential targets, and years of repeating this, good serial acquirers build skill and institutional knowledge in filtering outstanding companies and management teams amongst the average ones. While most companies do a large acquisition every few years, doing M&A becomes a constant part of the job for a manager at a serial acquirer. This is a pattern recognition muscle that gets trained tens, or hundreds of times a year. It becomes part of the DNA for the serial acquirer, often not needing external advisors or due diligence resources due to their extensive M&A experience. This, at least in part, could explain why frequent acquirers are more likely to do well with M&A than the more traditional companies.

Post-acquisition

What a serial acquirer does post-acquisition matters as much if not more than what happens before the acquisition is made. This is also where serial acquirers differ in their approach. Most serial acquirers describe in very similar ways what types of businesses they are looking for, companies with a good track record of profitability with a dominant position in a niche market. So what differentiates all these companies? How do they add value to the companies once acquired? Well, this was a central question at the event. The answers to this question were different but similar at the same time.

A company called Seafire (I hadn't heard of it prior to the event), for example, was founded by an ex-Private Equity investor. Their approach is very PE-like, professionalizing management, often replacing or adding to the existing management team, and setting the company up for its next phase of growth. Other serial acquirers were more hands-off, and prefer to let the existing management team run it as they were before. This "never change a winning team" approach requires a lot of trust, a trust which has been built in the relationship-building phase discussed earlier.

Measurement and benchmarking

In Dutch, we have a saying "meten is weten", which translates to measuring is knowing. A pattern that has become quite clear is that successful serial acquirers, through their experience and expertise, set up measurement and tracking systems for all kinds of metrics and internally benchmark companies against each other. Companies often publicly share how every company is doing internally to create a sense of competition and drive continuous improvement.
With this data, the areas where the focus is needed become much clearer. This is an added benefit of being part of a larger group of companies, where a SMB would usually be isolated and have no real idea whether their performance metrics were any good compared to peers. Companies from the Bergman & Beving family, for example, have a religious focus on Profit / Working Capital and profit growth. Getting familiar with how to improve on these metrics is where we get to the next part, talent development.

Talent development

Once again, the importance of people will be the center of this section. Serial acquirers that can develop talent have the opportunity to improve organic growth, profitability, return on capital, and the durability of these metrics. Not only does this work well for shareholders who see increased returns, but it gives employees at the subsidiaries a true sense of purpose and a feeling they can achieve their ambitions as part of the group. If done well, this creates a very strong feedback loop where sellers see their ex-employees and business thrive under the new owner, which is often the very reason they choose them in the first place. Positive references from sellers make new acquisitions easier for the serial acquirer.

Managers of subsidiaries have the opportunity to learn and ask questions like how to improve pricing, inventory turnover, etc. This part is where I think a more specialized serial acquirer, like Vitec Software, Constellation Software, or Addtech has an incredible advantage over more "generalist" serial acquirers. The exact verticals the subsidiaries are active in are different but the fundamentals of being a software company or B2B industrial distributor stay relatively constant.

Although serial acquirers can add a lot of value by properly developing talent at subsidiaries, I would be more inclined to "believe" it when the track record of organic growth, ROIC, etc. of the serial acquirer is long enough to draw conclusions.

Entrepreneurs sharing

An aspect I had not realized was such an added benefit of being part of a group of companies in the sharing of best practices, insights, and experience amongst entrepreneurs/managing directors. Various serial acquirers present at the event independently mentioned how entrepreneurs were often isolated with a tunnel vision of sorts on their own business. Now being part of a community of tens, sometimes hundreds of companies under the same group provides entrepreneurs with a network of like-minded people going through the same things. This sharing amongst group companies can sound trivial at first, but if these learnings marginally improve organic growth and/or profitability in each company, these improvements compound across the entire group over multiple years. The satisfaction that comes from being part of a larger whole is a very human phenomenon that will not shine show up on the P&L statement right away. But at some point, one must wonder how some of these serial acquirers manage to keep organic growth up after years, sometimes decades of owning companies in niches without any exceptional market growth. I think this at least partly explains it.

Centralized vs Decentralized

What fits a serial acquirer best in terms of structure varies and I have seen companies be successful across the entire spectrum. Some companies might benefit from pooling purchasing, while others might simply be able to offer better services with more scale or a broader set of services/products. Generally, I tend to lean more towards the decentralized model. The first reason is quite simple, they don't assume any synergies at the point of acquisition. Unrealistic synergy projections, whether on the revenue side or the cost side, are the main reasons why companies overpay for acquisitions.

Besides the purely financial aspect of decentralization, I find it easier to believe that people are more fulfilled in their job if they have some independence and decision-making ability. When you treat people like adults, they tend to behave like adults. There are countless examples in business, military history, and life where people reward trust and independence with initiative, loyalty, and good judgement if they are given the tools to succeed. From Netflix to maneuver warfare, making decisions closest to the point of action has often delivered outstanding results in terms of speed, adaptability, and morale. This, again, requires a tremendous amount of trust in your people.

Some companies, like Volati and Constellation Software, go even further and are even starting to decentralize capital allocation/ M&A decisions. This is very different than most serial acquirers, where operations are decentralized but capital allocation stays centralized at HQ. I'm curious to see how well this capital allocation model works over the next few years and if other companies follow in their footsteps to be able to scale up M&A activity.

Now that we have some context on how serial acquirers approach M&A and integration post-acquisition, it is time to take a look at the investor perspective.

Investing in serial acquirers

To me, investing in serial acquirers comes down to a few things. Getting a thorough understanding of every subsidiary is an impossible task, especially for the larger ones out there. With so many subsidiaries, a certain level of opaqueness is inevitable. This is where your people-judgment as an investor comes in, much like how the people-judgement skill of the serial acquirer is crucial to their success. Buying a serial acquirer is much more a bet on the management team that is running it than a bet on underlying companies or industry trends.

The best indicator for future behavior is past behavior. Looking at the track record of acquisitions from a ROIC or perspective is a must (deal by deal is possible, but very hard to do). I find the historical organic growth also a very good indicator of the quality of underlying businesses, profit margins, of course, and cash conversion. Serial acquirers that issue lots of shares are a red flag, in my opinion. Issuing shares could be opportunistic, which is fine, but it should definitely not be a habit. Serial acquirers that acquire companies with their organic cash flow significantly reduce the risk of blow-ups.

Fortunately, many Swedish serial acquirers have large insider ownership, significant voting power and tend to actively publish Return on Capital metrics. These are all financial signs I look for in a quality serial acquirer:

• Organic growth >5% per annum

• ROIC >20%

• Low growth in sharecount

• Acquisitions paid with cash

• Reinvestment rate >50%

• Large insider ownership

• Active publication of Return on Capital metrics

• Low net debt

• Track record >10 years (preferably, not a must)

These metrics are not anything groundbreaking and could be applied to other companies, but I find them especially important for serial acquirers. There are many cases of acquisition-driven companies that issued shares to buy businesses in order to increase EPS and do all sorts of accounting shenanigans (Tyco, Waste Management, Valeant). This is simply a multiple arbitrage strategy that falls apart whenever valuations come down or capital markets have trouble.

In addition to these track records, serial acquirers arguably deliver outstanding returns at comparable or lower risk than 'normal businesses'. Constellation Software, Lifco, Addtech, and many of these companies own businesses in a variety of niches, verticals, and areas of the economy. With some of these groups owning more than 100 subsidiaries, the group itself is quite diversified and likely more resilient during difficult periods than companies that have one or two core businesses. I'd encourage you to look at the financial performance of Addtech, Vitec Software, and Indutrade over the past two decades. Spoiler alert, although their profits went down during the 08/09 crises, they never lost money and recovered swiftly after.

Conclusion

Studying serial acquirers is as much a study of people as a study of business or M&A. Making sure the incentives are aligned, the philosophy is consistent, and that the financial performance reflects this is paramount if you want to invest in these companies. There are many companies that will display the characteristics of a serial acquirer, but understanding the DNA of every one of them and your own preferences will determine which ones you find investable. The main message behind this post is that where we investors might be attracted by the financial profile of companies, understanding the human components that drive this and make outstanding financial performance sustainable is what will determine your investment success in these companies. Once you have identified the companies where you trust management and the acquisition strategy, your valuation work can begin and further filtering can be done.

Recommended resources

Redeye Serial Acquirer event

REQ Capital publications

The Book on Serial Acquirers

Exploring Context Studying Serial acquirers

Scott Management Serial Acquirers

Disclaimer: Always do your own research. This is not investment advice and for informational purposes only. Partnership Investing is not a registered investment adviser and may or may not hold securities discussed on this blog.