Serial Acquirer Event Redeye - Part I

Introduction to the serial acquirer model + Lifco pitch

On March 6th, 2024 Redeye hosted its annual serial acquirer event. At Redeye, they provide content which is of insanely high quality. In this post, we’re going to summarize the serial acquirer model and the Lifco pitch.

Introduction to the serial acquirer model

Christian Binder, analyst at Redeye, compiled an interesting presentation on why serial acquirers tend to be good businesses and stock investments. There’s a long runway for reinvesting cash flows into new businesses and expanding their reach in adjacent markets (consider Lifco expanding outside of the pretty TAM constraint “Dental” area).

Oftentimes, people think of the multiple arbitrage (trading at >20x EV/EBITA and acquiring at 7x EV/EBITA) explaining why serial acquirers have done so well over the past decade (and in some cases even decades). This shouldn’t be your primary focus to start (or stay) investing (invested) in a successful serial acquirer; it’s rather a consequence of the market rewarding your capital allocation strategy. Remember valuations are driven by reinvestment rate, return on capital and the consistency of applying a rational capital allocation playbook. Most importantly, multiples in the private smaller-sized M&A space have remained relatively stable over many years, as we highlighted in our previous article.

Higher multiples paid for larger serial acquirers reflect the increased investor appetite for their compounding potential, especially during the tough years following the pandemic. The world’s best serial acquirers managed to improve margins (for both the existing businesses as well as incoming acquisitions) and go after lucrative deals (margin accretion, better organic growth potential) while maintaining a healthy financial position.  

2022 saw a drop in M&A deal volume, from very high levels in 2021. Higher interest rates, sellers becoming more hesitant to selling their company (waiting for better times)… In 2023, thanks to better working capital management and some stabilization in the economic outlook, cash flows allowed for more acquisition-hunting (especially true for the larger conglomerates with a long list of potential targets).  

As we look at the serial acquirer space – and we’ve highlighted this already in a previous post – industrial acq machines tend to see net working capital outflows when they experience organic revenue growth. However, given that organic growth is typically a lot less capital-intensive than growth through M&A, enhancing ROIC on growth CAPEX (to target organic revenue growth coupled with margin expansion being the icing on the cake) and being less reliant on M&A is likely to keep their stock market valuation multiples stabler.

Software serial acquirers such as Constellation Software, Sygnity (pretty remarkable cash management for that ones, kudos to its team) et al are on the other side of the spectrum with no real cash outflows to grow organically (depending on how R&D accounting is being implemented). No surprise we’d expect their performance to be stabler (better risk-adjusted expected returns) over the next couple of years.

As Christian rightfully pointed out, you have to make a clear distinction between niche acquirers (sector-agnostic) that target strong individual subsidiaries with top-notch margins, differentiated product offering, organic growth potential, and roll-ups that typically go after companies with narrower moats.

Likewise, it would be foolish to say: well, this smaller-sized roll-up strategy will produce returns equal to Lifco’s, but really it’s not an apples-to-apples comparison. Moreover, we believe Lifco’s larger scale won’t inhibit it from compounding NOPAT at a decent clip, on the contrary, its quality has gotten better over time as evidenced by the organic EBITA performance and the results post-acq. We’d expect its performance to weather the next storm better.

We should never become complacent about a trackrecord (especially when it's been achieved over a period that’s been generally favorable to many serial acquirers), assessing the quality of recent acquisitions, the management focus and financial position are critical to identifying good risk-reward investments going forward. Especially now that we’ve started to lap the huge price increases, which have allowed for margin expansion and strong top-line growth, paying more attention to the underlying growth potential is crucial.  

Lifco Pitch by CEO Per Waldemarson

Focus on the Numbers

A no-nonsense quote to start with: “We’ve just learned that numbers are more important than story-telling.” This is in fact what we love about Lifco (and most of our other “Compounding Tortoise” positions): cutting to the chase, highlighting the main financial metrics that matter most, not very fancy presentations to boast how the great the management has been performing as of late, brief earnings calls (in Lifco’s case typically 25 minutes including Q&A). And then business as usual and returning back to the core task of a management team: being great stewards of shareholder capital.

Looking at Lifco’s divisions, Per Waldemarson said: “It leads to two things: it provides opportunities to expand into adjacent markets where we already are, while at the same time being open-minded about completely new areas. It’s always a matter of choice. We’d love to buy many dental business (with good margins, when the valuation is right). But: we’re not forced to do that.” Many of Lifco’s competitors that operate solely in the Dental area have to continuously source deals in that area, even during times when it’s not convenient (higher multiples, lower-quality pipeline of potential targets).

We have one target: to improve profits every year. Lifco has so far only failed twice. The recession of 2008-2009 hurt its “Demolition & Tools” area, but fortunately there was still the steady as she goes Dental business. To increase profits, Lifco has a very strong focus on margins: focusing on differentiated products, ditching your low-margin customers. Growing margins has to be done through increased internal efficiencies and by becoming more niche as there are little or no synergies to be captured.

Quality First

When asked about how the current profitability is likely to be sustained, Waldemarson stated: “Assuming Lifco was one company, it probably wouldn’t be sustainable, but Lifco consists of more than 200 entities.” This reminds us of Constellation Software being on the lookout for good acquisitions in what are oftentimes TAM constraint markets. Being small, having a dominant position in a tiny market that doesn’t attract much competition but still enjoying consistent cash streams: that’s how endless cash flow compounding potential for the mothership is born.

Lifco isn’t giving up on quality and isn’t targeting cheap acquisitions that would require a substantial turnaround (most turnarounds simply don’t turn). This stringent mentality led to positive mix effects on the EBITA front. Still, initially, when Lifco very rarely completed an acquisition, the standalone business was in a turn-around state: managers were being replaced, profit margins needed to go up.

Today, Lifco is at a point where the margin profile is so great that setting the bar too high could prevent it from doing new great deals (i.e. not buying a business with 20% EBITA margins is likely to make you end up with higher excess cash flows that can not be redeployed into M&A).

To make an acquisition-driven growth strategy work, you have to be disciplined and make you sure your financial position is able to digest M&A activity and – from to time – temporarily elevated cash outflows related to working capital. Waldemarson has a new favorite tool to track: the free cash flow per share (which isn’t defined in accordance with our definition of substracting lease liability repayments from the traditional FCF calculation, after all, leases represent a portion of the capital intensity of a business).

Taking a long-term view here, you’d better not pay too much attention to quarterly figures as there can be business seasonality, one-offs (supply chain constraints). Free cash flow per share is a very relevant metric over a decade-long horizon.

Organic Growth and M&A - Both Are Equally Important Levers

Jumping to the growth strategy, Lifco has been firing on two growth cylinders. In terms of organic growth, the economic environment has been very friendly to many. As we pointed out, management integrity plays a key role in sustaining the compounding flywheel and we think it’s fair to say that this attribute is even more crucial in the serial acquirer field. Organic growth provides a clue as to how serious the management team is about making each individual subsidiary more resilient. Again, it will matter more during challenging periods. Return on Capital Employed is a crucial metric to grow organically while still having leftover cash to buy new companies. Staying rational on the multiple you pay for acquisitions is important.

Lately, there’s been a lot of chatter around the lower multiples paid for acquisitions by Lifco. Lifco takes a long-term view on a subsidiary’s historical earnings growth, and over the past couple of years, many of them have seen incredible margin expansion. As such, comparing last year’s EBITA to the price paid for a company (based on the last five years’ EBITA) leads to a seemingly low multiple. It just highlights the margin of safety built into Lifco’s M&A strategy: buying good companies but not at astronomical prices that are based on what could potentially be peak margins.

Focus on profitability and cash flow, that’s how you’ll get rewarded as a Lifco manager. Not through making acquisitions: anyone can buy a company. And whilst, back in 2019 some believed Lifco was a rather slow-moving serial acquirer (a Tortoise acquirer), growing at 10-12% in EBITA through acquisitions has been the right pace to make sure the organization was internally well-prepared to handle the growing stream of absolute EBITA growth.

Although Lifco is very much into decentralization, taking care of recruitment of key management personnel and developing a strong culture is a must to create a safety net. In order to become a chair person, Waldemarson believes you have to have experience as a CEO, as being equipped with certain managerial kills is a plus. As always, there are exceptions to the rule.

Always a Challenge to Find Good Deals

On the topic of what comes next, Waldemarson honestly replied: “We don’t know what comes next and it’s always a challenge to find and buy good companies.” Every day, Lifco gets new opportunities. Looking at the number of companies they’ve contacted over the past years, some would call that a huge pipeline but still, it’s a question mark whether Lifco will be able to ultimately buy them.

This was part one. If you liked it, please share it with your network and/or leave a comment below.

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