Time Stamps
00:00 Intro
01:00 Introduction to Acquisition-driven Compounders
02:08 Segmentation of Acquirers
03:16 The Specialists
04:21 The Generalists
07:59 Characteristics of Programmatic Acquirers
09:15 The Story of Financial Targets
11:03 Scaling M&A
16:33 Risk Reduction Through Expanding Root Systems
17:46 Decentralization
23:31 Becoming the Preferred Buyer
25:56 It’s All About Durable Growth
26:53 Ownership Structures and Succession Planning
28:38 Does Organic Growth Matter?
30:10 Business Systems
32:09 Capital Allocation and Cash flows
40:57 A Closer Look at Nordic M&A and Deal Characteristics
43:11 Acquisition multiples
45:10 Valuation and Pricing
48:08 Potential Risk & Red Flags
50:05 Field Research Insights
Introduction to Acquisition-driven Compounders
 Serial acquirers, also known as acquisition-driven compounders, strategically purchase small, profitable businesses, often family-owned, to foster growth and enhance shareholder value. These businesses generally have strong cash flows with limited opportunities for further investment. Once part of the larger company, they continue to generate substantial cash, enabling the parent company to reinvest and achieve higher returns over time. These companies maintain a lean central management and operate with a decentralized structure, allowing acquired businesses to retain their customer relationships and day-to-day decision-making, thus preserving their entrepreneurial spirit. The main role of the corporate headquarters is focused on financial oversight and capital allocation.
Segmentation of Acquirers
 Serial acquirers can seem complicated at first. It might look like a good idea to merge these businesses together to save costs and boost sales. However, the most successful ones keep their purchased companies independent and decentralized, allowing them to operate on their own and maintain their unique business cultures.
 The book "Billion Dollar Lessons" discusses how trying to combine different companies often fails. It suggests that a company should either keep its acquisitions independent or integrate them completely, but not try to do both. The main lesson is that forcing companies to work together as one doesn't usually work as planned, and keeping the entrepreneurial spirit alive is crucial.
 In simple terms, when looking at serial acquirers, it helps to think of them as either specialists focused on one area or generalists that cover many areas.
 The Specialists
 In the specialist category, companies often focus on specific industry areas and typically try to integrate their acquisitions closely, aiming to cut costs and achieve larger scales. However, these companies tend to buy other companies too quickly, push for aggressive growth, and use a lot of debt. This rapid pace is often a response to the limited growth opportunities in their specific markets.
 Specialists that operate globally, make decisions locally, and focus on understanding their customers are preferred, especially those in large, diverse markets. These companies look for synergies but do not force them. Companies that grow through their own earnings, rather than relying heavily on financial strategies, are also favored. These qualities can help avoid some of the common problems seen with specialists who focus too narrowly.
 The Generalists
 The generalist category in business allows for more flexibility. These companies often focus on multiple industry areas, which may have recurring characteristics or be completely unrelated. This approach broadens their potential for growth and allows them to build expertise like specialists. From the outside, it may look like they specialize in certain niches, but they are not confined to any specific sector and continuously adapt by learning from one industry and applying insights to another.
 For example, companies like Lifco segment their operations into categories like "System Solutions," which serves as a catch-all for varied businesses not fitting into their other specific categories like Dental and Demolition & Tools. This flexible segmentation helps them manage diverse operations without strict boundaries, focusing more on finding and investing in promising businesses that offer strong returns.
These companies often share best practices across their networks, improving aspects like pricing and working capital management, which supports organic growth—an important factor for overall success. They emphasize value pricing strategies over traditional cost-plus models, and encourage testing and innovation within a safe framework, boosting confidence and maintaining an entrepreneurial spirit.
However, the level of decentralization varies among companies. Some practice a decentralized approach at a broader platform level while still extracting synergies specific to each platform, adapting to the unique dynamics of each business unit. Successful companies typically allow decisions to originate from the ground up rather than imposing them from the top down.
This dynamic approach to growth shows that while companies may start focused on a single niche, they can evolve into generalists over time, continually adjusting and expanding into new, profitable areas based on learned experiences and market demands.
Summary
In the specialist sector, caution is advised with centralized rollups focused on narrow industry areas. Instead, the preference is for global specialists that use decentralized decision-making and operate in large, diverse markets. In the generalist sector, the favored approach includes decentralized companies with expertise across various themes or a sector-neutral strategy. These companies often follow an industrial approach and grow through self-funding.
Capital decisions tend to be centralized, but daily operations are decentralized, with individual units initiating lead generation and smaller acquisitions. Synergies are not forced, supporting a hands-off approach that values entrepreneurial spirit and autonomy, believing these elements collectively outweigh the potential losses from not pushing cost efficiencies.
Ultimately, the best companies, both generalists and specialists, operate with principles similar to those of successful long-term investors, providing a diversified and growth-oriented approach to managing their operations.
Characteristics of Programmatic Acquirers
To manage acquisitions effectively, companies use a streamlined M&A process. This process starts by identifying potential targets based on certain criteria, including whether the transaction fits the company's culture and structure. A dedicated team then thoroughly evaluates these potential acquisitions.
This strategy avoids extensive structured acquisition processes unless exclusivity is guaranteed due to the significant investment of time and resources required. Moreover, the focus is on building a deeper understanding and relationship with the acquired company and its team through collaborative strategic planning and sometimes shared ownership.
Research shows that while acquisitions are generally a costly growth strategy, companies that specialize in frequent, smaller acquisitions—known as programmatic acquirers—tend to achieve better results. These acquirers demonstrate higher revenue growth and return on invested capital compared to larger, transformative deals. They also exhibit higher insider ownership, signaling strong confidence in their business approach.
The Story of Financial Targets
Companies aiming for sustainable growth and financial independence set specific financial targets. Such ambitious targets are crucial in driving a company's performance, and once established, they significantly influence the company's strategic direction.
In practice, companies adjust their activities to focus more on areas that exceed these target returns and less on those that fall below. This strategy, although straightforward, can have a profound impact over time, especially for larger organizations.
Research on financial targets shows a variety of approaches, namely:
- Some companies, especially those with a longer presence on the stock market, incorporate dividends into their financial targets.
- Leverage is commonly set as a financial target.
- Only a few companies express sales and profit growth on a "per share" basis, while others avoid issuing additional shares.
- Newly listed roll-ups often set financial goals in absolute numbers.
- Some companies measure returns down to specific operational levels, such as return on working capital.
Effective financial targets should align with a company's capital allocation priorities and reflect its overall market narrative. They should be clear, attainable, and adaptable to changing business environments and economic cycles. Unrealistic targets may lead to negative reactions from the market and internal dissatisfaction, undermining management's strategies. Thus, targets should be set carefully to avoid undue risk and dilution of value.
Scaling M&A
In a 2021 article, the former CEO of Addlife discussed the company's approach to growth through acquisitions. At that time, the company comprised over 70 companies and had developed a theoretical rmodel to potentially manage up to 343 companies. This model was based on a hierarchical structure where each management level could effectively oversee seven entities, ranging from business areas to individual units, each managing seven companies.
This structured approach was designed to ensure that the company could scale effectively while maintaining close oversight and development of each acquired company. It emphasized the importance of having sufficient human and financial resources to manage a growing portfolio, highlighting the necessity of integrating and developing a large number of companies successfully. The model reflected a theoretical maximum capacity, acknowledging the practical challenges of managing such a complex organization.
How Big Can an Acquisition-Driven Compounder Become?
As CSI grows, managing its many business units becomes more complex. Currently, CSI has about 125 units in 50 industries, adding more each year. Recent studies show that smaller units are more effective, not related to their size. This suggests the best strategy is to keep units small for better performance. The challenge is to find the right balance in managing these groups without overcomplicating or oversimplifying the structure.
When are they running out of companies to buy?
People often ask about the growth potential for companies that expand through acquisitions. Companies with a generalist approach can choose from a vast pool of potential targets across various industries. This large pool is often underestimated by the market. For instance, major Swedish firms like Lifco, Indutrade, Addtech, and Lagercrantz have made 175 acquisitions outside the Nordics in a decade, which is only a small part of the available opportunities. These companies have successfully used their home market experience to expand globally while maintaining a disciplined approach to mergers and acquisitions. This strategy needs careful monitoring by shareholders.
European Market Opportunities
Serial Acquirers have access to the expansive global market of small and medium-sized enterprises (SMEs), which are not limited by market size, sector, or geography. SMEs, particularly independent ones owned by families or founders, make up 99.8% of all businesses in Europe, totaling 23.5 million. Each year, about 15,000 of these companies are sold to various buyers, including the type of compounders we invest in. This substantial and diverse market forms the backbone of the economy, providing a broad and dynamic field for potential acquisitions.
Italy: Italy, known for its strong manufacturing sector, has many family-owned businesses established during the economic boom of the 1950s and 1960s. Regulations often favor small businesses, but generational transitions can challenge competitiveness, sometimes leading to sales. The importance of local relationships is critical for acquisitions.
Germany: Germany has 2.4 million SMEs, with around 95% being family-owned, often with a diverse family shareholder structure. This creates both challenges and opportunities for acquirers.
UK: The UK remains one of the most active M&A markets in Europe, driven by private equity and increasingly attractive to acquisition-driven compounders. Despite challenges, M&A activity is robust, particularly in the small company segment. Notable transactions include multiple acquisitions by Constellation Software and Swedish Lagercrantz’s purchase of a fire door supplier.
Summary
Acquisition-driven compounders excel in the SME market by leveraging local teams to identify and secure valuable acquisitions. Investing in these companies offers long-term growth opportunities and high returns on capital, essential for achieving significant long-term stock returns. Our companies maintain discipline in securing deals at favorable multiples, ensuring sustained high returns on capital and creating substantial value for long-term shareholders.
Risk Reduction Through Expanding Root Systems
Focusing solely on visible success—like rapid growth from a single product or market—can overshadow potential vulnerabilities. This is risky, akin to a tree relying on a few shallow roots.
Serial acquirers exemplify the value of diversification. By spreading investments across various areas, these companies protect themselves against significant downturns, similar to how a tree with widespread roots gathers more resources and maintains stability.
Teledyne, under Henry Singleton’s leadership, demonstrated how a decentralized approach could smooth out risks associated with economic fluctuations and market dependencies. This strategy not only sustained high returns but also offered lessons on building resilience through diversity.
In essence, the success of both nature and business relies on a broad and sturdy foundation, which guards against unexpected challenges and supports continued growth.
Decentralization
Trust-Based Business Models
Leaders who decentralize their business, empower local managers to make decisions close to the action. This not only boosts motivation and customer relations but also reduces bureaucratic drag, making organizations agile and responsive.
Decentralization allows subsidiaries a high degree of autonomy, leading to better long-term returns. Trust in these leaders is crucial, as investors often rely on the judgment and capabilities of the people running these companies.
Does Cooperation Pay Off?
Yes, cooperation does pay off, as evidenced in Robert Axelrod's "The Evolution of Cooperation." This book discusses the effectiveness of the "tit-for-tat" strategy, where initial cooperation and reciprocal actions lead to mutual benefits over time, analogous to relationships in business.
In business, decentralization plays a crucial role in fostering cooperation. When head offices grant autonomy to subsidiaries, it creates a culture of trust and mutual respect. This approach allows subsidiaries to feel empowered, responding with decisions that benefit not only themselves but also the entire organization and shareholders. This mutual cooperation is beneficial for long-term success and stability.
Leaders like Johan Steene of Teqnion emphasize the importance of creating relationships and sharing knowledge among CEOs to foster a collaborative environment. This not only enhances business operations but also cultivates a strong community within the company.
The decentralized business model is not about micromanagement but about providing support and fostering independence, which in turn drives substantial shareholder value. Companies that adopt this model, like Heico under Larry Mendelson's leadership, demonstrate significant returns and resilience, proving that a trust-based, decentralized approach is a sustainable strategy for growth and success.
Decentralization and Customer Focus
Decentralization is crucial for companies, particularly when integrating acquisitions into a larger structure. This approach allows companies to maintain entrepreneurial agility, tailoring solutions closely to customer needs and enhancing specialty performance.
Additionally, decentralization supports the rapid pace of acquisitions by granting autonomy to each business unit, avoiding the pitfalls of micromanagement that can stifle the integration of new companies. A decentralized model is essential for managing multiple acquisitions effectively without overwhelming central management.
Leaders like Ulf Lililus of Momentum Group emphasize leading through inquiry rather than directives, promoting a decentralized leadership style that fosters independent decision-making within teams.
In the context of acquisition-driven compounders, the decentralized structure is advantageous even for niche businesses with limited growth prospects. These businesses may not attract as much attention in the market, leading to lower acquisition costs and less competition. This scenario allows compounders to efficiently reinvest cash flows into other valuable niche companies, leveraging the benefits of diversification and stable cash flow.
Ultimately, the success of decentralized businesses, especially those operating in niche markets, depends on maintaining strong customer relationships and a flexible, autonomous corporate culture. This approach not only supports robust business operations but also empowers subsidiary leaders to cultivate their unique cultures, contributing to the overall strength and cohesion of the parent company.
Swedish Legacy of Decentralization
Sweden's success in fostering acquisition-driven companies is linked to its rich industrial history and innovative corporate governance. Key factors include:
1. Historical Pioneers: Companies like Sandvik and Atlas Copco began expanding internationally through acquisitions early on, supported by financially robust families like the Wallenbergs.
2. Decentralization: Influenced by Jan Wallander at Handelsbanken in the 1970s, Sweden adopted a decentralized governance model. This approach reduces central management's routine burdens, enhances local accountability, and promotes strategic focus.
3. Business Environment: Sweden's landscape of small to medium-sized, often family-owned companies, is conducive to decentralized, acquisition-driven models.
4. Transparency and Trust: High transparency in business operations and public access to financial data foster trust and reduce acquisition risks.
These elements have established Sweden as a leader in innovative corporate practices, reflected in its strong global rankings in business ease, innovation, and development.
Becoming the Preferred Buyer
A crucial aspect for serial acquirers is not simply offering the highest price, as this approach can be unsustainable and detrimental to long-term value creation. Instead, acquisition-driven compounders establish themselves as the preferred buyers by cultivating a reputation for trust and stability over decades. This reputation makes them attractive to sellers, often family-owned niche companies, looking for a permanent home for their business that respects their legacy, values, and culture.
Serial acquirers are disciplined in their financial offers, focusing more on sharing visions and creating aligned incentive structures with the companies they acquire. This approach typically outshines the more substantial, less disciplined bids in the eyes of sellers who value the continuity of their company’s ethos and the well-being of their employees.
Successful acquisition strategies also involve understanding the unique needs of sellers, such as a desire for a smooth process and assurances about the future of their company. These needs often take precedence over the sheer monetary value of the offer. Serial acquirers often avoid competitive bidding wars, instead securing deals through established relationships and early engagements, sometimes cultivated over years.
Furthermore, by positioning themselves as a stable and enduring home, these compounders hold an advantage over private equity firms, which often focus on cost-cutting and short-term gains. The ability to maintain a familial and business culture is a crucial selling point that distinguishes these buyers in the market.
Lastly, while leveraging internal deal sourcing and maintaining long-term relationships are essential, serial acquirers also benefit from using corporate brokers to expand their reach and knowledge in new markets, ensuring a robust pipeline of potential acquisitions. This strategic positioning helps to sustain their status as the preferred buyer, enabling ongoing growth and long-term partnerships.
It’s All About Durable Growth
A study by Boston Consulting Group and Morgan Stanley on S&P 500 companies from 1990-2009 found that in the short term, stock prices are mainly driven by changes in valuation multiples. In the mid-term, sales growth and profit margins become more important. Over the long term, growth in sales is the key factor for stock performance, along with profit margins, explaining most of the price movements. There's also a strong link between total shareholder returns from 2007 to 2023 and earnings growth. Essentially, consistent earnings growth, especially when it reflects free cash flow, is crucial for long-term stock price increases.
Ownership Structures and Succession Planning
The Value of Succession Planning
Succession planning is crucial in investment strategy, focusing on the role of the CEO as a cultural leader. Companies with "forever-CEOs" like founders or long-standing leaders often create significant value due to their deep connection with the company's ethos. However, this approach risks instability if the CEO departs unexpectedly. Companies that recruit CEOs internally tend to maintain strategic consistency and cultural integrity, offering a smooth transition and predictable shareholder outcomes. External CEO recruitment can bring fresh perspectives but may lead to strategic shifts. Overall, long-term value for shareholders is best supported by CEOs who embody the company's culture and have a strong alignment with its long-term goals.
Regarding ownership structures, companies with significant insider ownership often perform better, reflecting a long-term view in their management and strategic decisions. High insider ownership aligns management's interests with long-term shareholder value, unlike purely institutional ownership, which may focus more on short-term gains. Insider ownership ensures accountability and a generational perspective, especially when insiders are involved in governance. However, this can be a risk if governance is weak and insiders prioritize personal gains over the company's broader interests. Thus, assessing governance mechanisms is essential when investing in companies with high insider ownership.
Does Organic Growth Matter?
Organic growth is vital for acquisition-driven compounders because it demonstrates their ability to enhance the value and development of acquired companies. This growth indicates that the new ownership can successfully integrate and improve these businesses, particularly in a decentralized structure where responsibility is pushed close to customers, fostering a dynamic, growth-oriented environment. CEOs like Niklas Stenberg of Addtech and Bo Annvik of Indutrade emphasize that organic growth proves credibility, competitiveness, and value delivery to customers. It also prevents stagnation, making the company more attractive for new talent.
Organic growth contributes to profitability and reduces reliance on continuous acquisitions, balancing strategic risk. This approach has shown that companies like Lagercrantz and OEM, with different focuses on organic versus acquisitive growth, can achieve varied success rates and market perceptions. Consistent organic growth, combined with a balanced and prudent acquisition strategy, leads to superior long-term shareholder returns, as evidenced by companies like Lagercrantz. The stability and increase of margins, whether through acquisitions or organic growth, are rewarded by the market, demonstrating the importance of maintaining and enhancing value in acquired businesses.
Business Systems
The "Superinvestors of Bergman & Bevingsville" mirrors the principles of Warren Buffett's "Superinvestors of Graham-and-Doddsville," emphasizing value investing and operational efficiency. Bergman & Beving, established by Arvid Bergman and Fritz Beving, became known for its decentralized approach and self-financed growth. Starting as a technical trading company, it evolved through strategic acquisitions, like the significant one of Johan Lagercrantz in 1967. The company's growth strategy was marked by a focus on niche markets and value addition, navigating changes and challenges in the EU market and competition.
Significant leadership changes, like Anders Börjesson's tenure and the introduction of the Profit/WC (P/WC) metric, played a crucial role in shaping the company's philosophy. This metric, which gauges returns on working capital, has been foundational in guiding the company's operations and acquisitions, aiming for a self-sustaining business model. The emphasis on P/WC encouraged operational efficiencies and optimal asset utilization, contributing to organic growth and profitability.
The company's history includes periods of experimentation, such as the shift to centralization, which ultimately reverted due to inefficiencies. Bergman & Beving's split into entities like Addtech and Lagercrantz marked significant strategic diversification, each focusing on distinct market segments but united by core principles like the P/WC metric and the Focus Model, which sets performance benchmarks and prioritizes operational strategies.
Overall, Bergman & Beving's journey showcases the importance of adhering to core principles, optimizing operational efficiency, and maintaining a strategic focus on value creation and self-financing growth, all contributing to long-term shareholder value.
Capital Allocation and Cash flows
Capital allocation is the strategic use of company cash to maximize long-term shareholder value. This involves investing in opportunities with returns higher than the cost of capital and wisely managing expenditures like mergers, growth initiatives, dividends, or debt repayment. Effective capital allocation is crucial for competitive advantage and optimal resource use, avoiding poor investments and maximizing opportunities.
 Leaders must understand their company's value and adopt a structured, individualized approach to capital allocation, rather than imitating others. Examples from William Thorndike's "The Outsiders" and Mark Leonard's letters show that skilled capital allocation can significantly outperform the market and peers.
 Investing in companies requires understanding how well their management uses resources to create shareholder value. This skill, known as capital allocation, significantly affects long-term returns.
 For example, Company A and Company B both earn $100. Company A invests its earnings at a 10% return, suitable for a Price-to-Earnings (P/E) ratio of 10. However, Company B's better management invests at a 14% return, justifying a higher P/E of 20 and doubling its value compared to Company A.
 In another case, the two companies both get a 20% return on investment but have different opportunities to reinvest. Company A, in a limited market, can reinvest only 35% of its capital, leading to a P/E of 15. Company B, with more diverse markets, can reinvest 75% at the same rate, warranting a P/E of 30.
 These examples show that a company's value depends not just on earnings but also on how effectively its management can reinvest and grow those earnings over time.
 Acquisition-driven compounders often distribute dividends instead of reinvesting all their cash flow because this strategy aligns with the long-term vision of their owners, who value steady, strong cash flow and prefer to build their companies gradually without selling shares. These companies are often capital-light and risk-averse, allowing them to pay dividends from a strong financial position. This approach also imposes a discipline on management to make selective, high-return investments due to the limited available capital, which can lead to more prudent investment decisions. While the ideal might be to reinvest all profits for maximum growth, the best of these companies show that they can still achieve significant growth, around 15-20% annually, while paying dividends. This balance allows them to grow steadily and maintain flexibility in capital allocation, adapting to both opportunities and challenges in scaling their operations and M&A activities.
 Henry Singleton, co-founder and CEO of Teledyne, led the company to remarkable success through excellent capital allocation and a decentralized business model. He skillfully used Teledyne's stock for strategic acquisitions and buybacks, enhancing shareholder value significantly. By managing over 130 individual profit centers with minimal central interference, Singleton empowered local managers, fostering a high-performance culture. This approach allowed rapid identification and reward of top-performing units. Singleton's focus on trusting and investing in capable people, combined with a competitive and fun work environment, drove Teledyne's annual returns far above the industry average. His leadership principles and strategies provide valuable lessons for investors and managers today.
Capital Allocation Through GFC
Acquisition-focused Nordic companies have demonstrated resilience during economic downturns by consistently reinvesting a significant portion of their free cash flow into mergers and acquisitions. This approach is supported by robust balance sheets and careful risk management, enabling them to continue acquisitions even in challenging economic times.
During the 2008-2010 financial crisis, these companies allocated a substantial part of their operating cash to fund mergers, acquisitions, and dividends. Many benefited from releasing net working capital when sales declined, which boosted their cash flow and allowed them to maintain dividends and mergers and acquisitions activities.
In 2009, all these companies saw positive net working capital movements, helping to compensate for declines in funds from operations. This sustained cash flows and merger activities even as organic growth slowed.
Recently, there's been a shift with more companies releasing net working capital, improving operating cash flow, reducing debt, and creating opportunities for more mergers and acquisitions. These companies are also capital-efficient, with low capital expenditure levels, allowing more funds to be allocated to value-adding mergers and acquisitions.
Overall, these companies exhibit a strong capability to maintain growth and financial health during downturns by leveraging net working capital releases to keep robust cash flows and continue their acquisition-driven growth strategies.
The Value of a Strong Balance Sheet
During economic downturns, such as the Great Financial Crisis, companies with higher leverage experienced more significant share price declines and slower recoveries. For instance, Bergman & Beving, with high leverage due to aggressive M&A strategies, saw a 76% drop in share price.
From 2001 to 2007, Bergman & Beving (then BB Tools) pursued a rapid expansion through acquisitions, often investing more than their cash flow allowed. This strategy initially boosted their market favor, but excessive debt and a shift from decentralization to centralization led to a significant loss in shareholder value, especially during the 2008/2009 downturn. In contrast, Addtech's disciplined approach to M&A and balance sheet management resulted in long-term outperformance.
The experience of these companies highlights the importance of a disciplined M&A strategy, high returns on capital, and prudent risk and capital management for long-term success.
Assa Abloy, initially spun off from Securitas in 1994, experienced rapid growth through aggressive acquisitions, buying around 60 companies and spending over SEK 20 billion on mergers and acquisitions. This strategy, fueled by high leverage and significant equity issuance, led to a staggering 3,300% increase in share price up to 2001. However, from 2001 to 2012, the company shifted its focus to consolidating its acquisitions and strengthening its financials, which resulted in stable but unchanging share prices despite a solid Total Shareholder Return of 100%. This period included a major purchase of Yale's lock division for GBP 675 million. After 2012, Assa Abloy resumed growth at a more measured pace, using 50-60% of its cash flow for further acquisitions, which improved its valuation and aligned it with other large industrial companies. The overall journey of Assa Abloy demonstrates the importance of balancing aggressive growth with prudent risk management. Despite the challenges, the company has achieved a remarkable Total Shareholder Return of 25,000% since its inception, underscoring the effectiveness of a balanced approach to capital allocation and growth.
A Closer Look at Nordic M&A and Deal Characteristics
Research indicates that from 2020 to 2021, more companies used issuing new shares as payment in M&A. This means the total value and the percentage of deals using shares increased. Newly listed or strategy-changing companies often use this method for rapid growth. However, established companies like Addtech, Addnode, Indutrade, Lagercrantz, and Lifco avoid using shares to prevent diluting current shareholder value. They prefer to use cash flow and debt for growth, ensuring high returns on investments.
Using debt comes with risks. Excessive debt limits a company's flexibility in economic downturns and can lead to selling assets at low prices. High debt can also result in lower stock prices in bad economic times, making issuing shares costly. Too much debt can lead to negative views from investors and higher costs of capital, destroying shareholder value.
Issuing new shares for M&A has its pros and cons. The advantages include raising significant capital with minimal impact on current shareholders, aligning seller interests with the company, attracting respected investors to increase the company's value, and providing a quick way to finance acquisitions. The disadvantages include destroying shareholder value when shares are undervalued, sellers preferring cash in uncertain markets, potential selling pressure when lock-up periods end, and previous sellers feeling cheated if share prices drop, affecting company performance.
Studies show the market prefers cash deals over stock deals, as they indicate the buyer's confidence in the deal's value.
David Barber, former CEO and Chairman of Halma PLC argued against issuing more shares if a company is successful and growing. His view is that owners of a successful company should not dilute their ownership by sharing it with others, reflecting a long-term view over a short-term approach to success.
Acquisition multiples
Acquisition multiples are generally capped at 7-8 times earnings. Private companies reliant on limited sources—like a single person, a few suppliers, or a handful of large customers—should be purchased at a 30% to 50% discount, often resulting in 5x earnings multiples. Successful companies maintain discipline in their acquisition pricing to maximize shareholder value over time.
Indutrade, since its IPO in 2005, has achieved a remarkable total shareholder return of 4,300% through a strategy of disciplined and effective acquisitions. The company's sales grew from SEK 3.8 billion to SEK 31.2 billion, and EBITA from SEK 333 million to SEK 4.7 billion, with a consistent increase in EBITA margin from 9% to 20%. Their approach involves maintaining low leverage, with net debt/EBITDA never exceeding 2.5x, and strong cash conversion, enabling continuous acquisitions even during challenging times like the 2009 financial crisis. Indutrade has managed to increase both the number and size of its acquisitions over time without compromising on its strategy of purchasing companies with sales under SEK 250 million. Overall, their success is underpinned by a focus on organic growth in acquired companies, scaling acquisitions intelligently, and maintaining strong financial discipline, all supported by stable leadership and a long-term ownership perspective.
Valuation and Pricing
Investing in great businesses for the long term often means holding stocks that may seem expensive in the short term but are undervalued over many years due to compounding earnings. The key focus should be on long-term reinvestment opportunities rather than short-term multiples.
The appropriate price-to-earnings (P/E) ratio for a stock depends on the company's profit reinvestment and its return on equity (ROE) over time. For instance, companies that reinvest 80% of their profits at a 20% ROE are often undervalued by the market if they sustain this performance.
A unique investment opportunity lies in companies expected to slow down after a few years but continue growing rapidly for much longer. These companies might seem expensive initially but are appealing to long-term value investors if they exceed growth expectations.
While discipline about the price paid is essential, a high multiple alone is not a reason to sell. Exceptional companies are often worth more than they appear, and it is better to pay a premium for quality than to undervalue a strong business. Durable growth, high returns on capital, and confidence in sustained reinvestment opportunities are crucial.
Ultimately, investing in companies with enduring competitive advantages and steady growth, around 6% annually, is preferable to chasing rapid but uncertain growth. Holding onto these high-quality companies, even at high valuations, is crucial as they continue to generate earnings and are often undervalued by the market.
Since 2017, larger companies that grow through acquisitions have seen increased valuations, particularly in 2021, due to strong performance. Larger companies are valued more than smaller ones because they reinvest more, grow faster, and achieve better returns on their investments.
High EBITA margins help in tough times and support growth but don't fully explain higher valuation multiples. For example, gaming companies with high margins aren't always valued higher due to business predictability and other factors. Overall, larger companies with high EBITA margins tend to have higher valuation multiples, especially since 2020.
Value is created when returns on capital exceed the cost of capital. If growth is zero or returns don’t exceed costs, no value is created. The table below shows how much more investors might pay for companies with different growth rates and returns on capital, assuming a 9.5% cost of capital. If returns match the cost (9.5%), no premium is justified. But if returns are 16% with 5% growth, investors might pay 46% more. At 22% return and 8% growth, a company could be worth three times more than one with no growth.
Growth is highly valuable when returns on capital are high. CEOs of such companies should focus on finding growth opportunities rather than just increasing profitability.
Potential Risk & Red Flags
While these serial acquirers can be impressive, it's crucial to keep an eye out for potential risks. The most successful companies in this space prioritize transparency and long-term value creation, but not all follow this path.
One key area to watch is how a company reports its growth. Be cautious of firms that suddenly stop disclosing their organic growth numbers or start relying heavily on proforma metrics. This could be a sign they're trying to mask underlying issues.
Financial reporting is another critical aspect. Some companies might use aggressive definitions of debt or earnings, or fail to adjust for non-cash items. This can paint a rosier picture than reality warrants.
Pay attention to management behavior too. If you see insiders selling large amounts of stock during capital raises, or CEOs departing shortly after major acquisitions, it might be time to dig deeper.
The pace and pattern of acquisitions can also be telling. While these companies grow through buying others, a flurry of simultaneous deals or frequent announcements of intent before securing funding can indicate a lack of discipline.
Lastly, look at how executives are compensated. If bonuses are tied solely to acquisition volume or revenue growth, it might encourage hasty deals that don't create long-term value.
Remember, the best serial acquirers focus on sustainable growth, maintain high levels of transparency, and align their interests with long-term shareholders. By staying alert to these potential red flags, you can better distinguish the companies likely to deliver lasting value from those taking unnecessary risks.
Field Research Insights
Let's take a closer look at what happens when entrepreneurs sell their businesses to these acquisition-driven companies. After decades of hard work, the decision to sell isn't just about money – it's deeply personal.
Take, for example, one founder who sold his specialty tool business after 20 years. Instead of walking away, he stayed on to run it independently, now benefiting from the larger group's resources and peer network. Another prioritized cultural fit over the highest price, trusting his management team to make the right choice. In a third case, a founder chose a portfolio company over a higher private equity offer, putting his employees' stability first.
These stories reveal a common thread: founders often value cultural alignment and their employees' well-being more than maximizing financial gain. They're looking for buyers who share their values and will preserve their company's legacy.
For investors, this presents an interesting opportunity. Companies that can offer this founder-friendly approach often make attractive buyers and can create significant long-term value. It's not just about the numbers – it's about understanding the human element in these transactions.
When evaluating these serial acquirers, it's crucial to look beyond the financials. How do the acquired companies perform post-acquisition? Are sales, profits, and margins improving? Do CEOs tend to stay on? These factors can provide valuable insights into the acquirer's culture and integration approach.
By digging deeper and talking to those involved – from ex-CEOs to group managers – we can gain a fuller picture of how these acquisition-driven companies operate and create value over time.
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