The Compounding Kings: How Serial Acquirers Turn Small Investments Into Big Returns.

Chris Rolls

Introduction

Unless you are a very well-read investor, you probably won’t be familiar with companies like Constellation Software, whose total shareholder return since their IPO in 2006 has been 38% per annum¹, or Transdigm, whose total shareholder return for nearly 30 years has been 37% pa². It’s also unlikely that you will be familiar with any of the 30-odd companies listed in the appendix whose median total shareholder returns over the last ten years have been 28% pa. These investment returns are truly stellar and, at first glance, appear unrelated. The companies listed sell products as diverse as B2B software, landscaping supplies, spare parts for aircraft, and industrial technology. However, despite the differences in their products and services, they all operate a remarkably similar business model. They are all “Serial Acquirers”.

This whitepaper on serial acquirers is designed to unpack the traits and characteristics of these organisations and explain:

What a serial acquirer is,
How the business model typically works,
How to identify a high-performing serial acquirer, and
Why serial acquirers can deliver such good returns over the long term.

What is a serial acquirer?

The business model of the serial acquirer is to acquire predominantly small, cashflow-positive businesses and operate them in a decentralised manner. Typical characteristics of a serial acquirer are:

They acquire potential niche market leaders with a track record of profitability that are asset-light and can generate a good IRR irrespective of high or low organic growth.
They have an M&A process that is simple and fast, their DD focuses on understanding the business and has a smooth legal process, and they can provide high transaction certainty to sellers and hold acquisitions in perpetuity.
They run the underlying portfolio companies in a decentralised model, with minimal bureaucracy, aggressively allocating capital to its highest return projects, with incentives based around cash returns on capital deployed.
They use less leverage than traditional private equity firms, buy businesses at lower multiples than private equity firms, and provide more risk diversification for investors, and
As they grow, their diversified nature provides less cyclicality and volatility than comparable-sized organisations.

I was first introduced to the serial acquirer model around ten years ago when I came across a business called Constellation Software. Constellation began in 1995 with $25 million (CAD), has made approximately 1000 acquisitions of vertical market software businesses and has 850 independently operated SMEs. It operates a decentralised model, meaning that each business runs independently, with its CEO calling the shots and responsible for delivering results. Other than a requirement to use a particular piece of accounting software, all other decisions are in the realm of the CEO. For most investors, the idea that one company can operate 850 independently operated businesses and deal with all the challenges of keeping track of who is doing what, seems almost fanciful, but the results speak for themselves. In 2006, Constellation Software was listed at $17 a share on the Toronto Stock Exchange. It now trades at $2700 a share³, a 160x increase since listing, an extraordinary return that doesn’t consider further returns generated by dividends or subsequent spinoffs. Their total shareholder return of 38% per annum since 2006, has outpaced Amazon, Netflix, and Apple, to name a few, which begs the question: “Why are so few investors familiar with Constellation Software?”

TSR CAGR since Constellation’s 2006 IPO

(Image: A bar chart showing Constellation Software with the highest TSR CAGR, followed by Netflix, Amazon, Apple, and NVIDIA)

While the results at Constellation are truly remarkable, what’s more impressive is that these returns are not unique. In other parts of the world, serial acquirers also deliver extraordinary returns to investors. Appendix 1 lists approximately 30 serial acquirers who’s median 3, 5, and 10-year returns are 29% pa, 27.5% pa, and 28% pa, respectively.

Why do serial acquirers generate such good long-term returns?

There are several parts to answering this question:

Firstly, serial acquirers are attractive because they can usually reinvest most and sometimes all of their free cash flow for a very long time at very high rates of return, making them the ultimate long-term compounders. While the term “compounder” is hard to define precisely, it is often defined as a business that grows its intrinsic value at a rate of 15% pa for at least ten years. The key to achieving this for any company is being able to reinvest its free cash flow at high rates of return. This requires a business model that is both scalable and enduring. An example of how good these serial acquirers are at compounding is demonstrated by Bergman & Beving Group (B&B) based in Sweden. Here’s a snapshot of their performance:
- a. B&B is a trading company for technical products in the industrial space in Sweden that was founded in 1906 and listed in 1976. It began rolling up businesses in the 1970s and, in 2001, split itself into three independent, listed entities: AddTech, Lagercrantz, and the Bergman & Beving remain-co. AddTech spun off AddLife in 2016, and the Bergman & Beving remain-co has since split itself into Bergman & Beving and Momentum Group.
- b. B&B compounded at ~13% pa from 1989 (earliest data) to 2001 when the split occurred. From 2001 to early 2021, it compounded at ~10% pa. Momentum Group, which B&B spun out in 2017, has had a compound annual growth rate of ~22% since then. AddTech itself compounded at 21.5% from 2001 to October 2016, when the AddLife spin-off occurred. It continued to compound at 34% from that day until today. AddLife has compounded at 50% since its spin-off in October 2016. Lagercrantz has compounded at ~21% since its spin-off in 2001 to today. If you invested in B&B on December 30, 1999, and held all the spin-shares, you’d be up ~38x. A 20% CAGR for 20 years. This group has compounded capital for decades with no end in sight! This is an extraordinary return for a very diverse set of niche businesses.”5
The second reason serial acquirers can generate such good long-term returns is because their model allows them to acquire businesses that other investors can’t.

Take, for example, Constellation software. While it’s hard to accurately measure the number and size of the transactions they have completed, CEO Mark Leonard revealed in one of his investment letters that in 2017, it completed 85 acquisitions at an average price of $5.7 million. A source at Constellation Software indicated that in 2022, it deployed circa $1.5 billion in 134 acquisitions, implying an average acquisition price of $11 million. At the time, Constellation was a circa $45 billion (CAD) company. For most large corporates, making such small acquisitions doesn’t move the needle. This equally applies to most private equity firms. The business model of Constellation, and most serial acquirers, is to acquire predominantly small businesses, which provides many acquisition opportunities at attractive returns. Small acquisitions have several advantages in terms of generating outsized, risk-adjusted returns:
- a. Firstly they’re cheap! All other things being equal, small businesses trade at lower multiples than big businesses. This is largely a factor of supply and demand and perceived risk (more on this later). Take, for example, the Australian market. Every year, thousands of businesses with $1-$3 million of EBITDA change hands in Australia, while at the same time, there might be less than 100 that change ownership with EBITDA > $30 million. When you consider that the bulk of undeployed capital in Australian private equity funds (currently around $10 billion) needs to be deployed in sizes of >$20 million, there simply isn’t much interest from professional investors and corporates in acquiring small companies.
- b. Most $1-$3 million EBITDA businesses in Australia can be acquired for between 3 and 7 x EBITDA; however, larger businesses (>$30 million EBITDA) are typically in the 7-12x EBITDA range. It’s hard to generate consistently high returns for investors acquiring businesses at multiples of 7-12x EBITDA without aggressive growth and the use of leverage. This is why private equity firms commonly have debt levels of 5-6 x EBITDA, whereas most serial acquirers use debt levels of 1-3 x EBITDA. The lower debt levels utilised by serial acquirers further reduces risk to investors’ capital.
Serial acquirers can also buy businesses that other buyers can’t because of their risk profile. For example, a serial acquirer with 50 portfolio companies can look at an acquisition that might have a very attractive price because the target has a customer concentration issue that’s a key risk to its business model. An example might be that 80% of the revenue for the proposed acquisition is coming from one customer. For most buyers, like a competitor, a private equity firm, or a standalone owner-operator looking to acquire a business to run for themselves, an acquisition where 80% of the total revenue comes from one customer is likely an unacceptable risk. However, a serial acquirer making its 51st acquisition might only risk 1-2% of its capital. Therefore, it can take advantage of the opportunity where the risk (and then some) has already been baked into the sale price.
Thirdly, Serial Acquirers have a significant tax advantage over typical private equity investing fund models. Like serial acquirers, private equity funds acquire private companies, but unlike serial acquirers, they build and sell in a short period of time using a closed end fund model. The sale of these investments and subsequent return of capital to their investors triggers a capital gains tax event. Because serial acquirers hold assets for the long term, (often forever), all other things being equal their long term returns are much greater. This nuance of long term holding is something that Warren Buffet has highlighted many times. In the 2020 Berkshire Hathaway letter, he noted that “Berkshire Hathaway’s $26.7 billion gain in net unrealized capital gains did not result in an immediate tax liability because these gains are not taxed until the assets are sold. This allows the value to compound tax-free as long as the assets are held.”
Fourth, serial acquirers generate good returns because they have the added benefit of becoming more diversified businesses as they acquire more and more subsidiaries. This diversification is often across industry sectors and geographies, reducing the risk that a similar-sized business might be exposed to if it is a market leader in one sector.
Finally, serial acquirers typically function within enduring or permanent capital frameworks, which allows them time to develop relationships with potential sellers before they come to market. Engaging in casual interactions, like dining with prospective sellers, not only allows for a deeper understanding of the business, compared to the standard auction process, but also positions them as the preferred buyer when a sale becomes imminent. In contrast, conventional private equity entities often don’t enjoy this flexibility, typically bound by a 1-3-year investment period and a 4-5 year holding timeframe, which requires them to acquire businesses from sellers with little pre-existing relationship. For serial acquirers, developing a real relationship reduces the risk of acquiring a business they don’t understand from a seller whose character has not been fully assessed.

What are the traits of serial acquirers?

My research into serial acquirers over the last few years led me to a piece written by Ryan Krafft of Scott Management (one of the best-researched pieces on serial acquirers I’ve found to date) where he categorised serial acquirers into four groups: Roll-ups, Platforms, Accumulators, and Hold-Co’s.

Buckets of Serial Acquirers

Krafft writes:

“In my experience, two of these buckets have tended to offer better opportunities than others. Specifically, I target platforms and accumulators but avoid roll-ups and holding companies. I’m looking for industries where small companies can be good businesses on a standalone basis (which typically excludes consolidation-driven roll-ups).”

The group definitions of Roll-Up, Platform, Accumulator, and Hold Co can be confusing, so for the sake of clarity, here’s a deeper explanation of the four categories:

Roll-Ups:

Roll-ups focus on acquiring businesses that typically provide a homogenous product or service across one vertical. They usually operate in industries with a large addressable market, which is fragmented with lots of sub-scale operators. They create value in 2 ways:

Buying businesses and removing costs through synergies, and
Price arbitrage, i.e., acquiring a lot of smaller businesses at low earnings multiples and selling them as one large business at a high earnings multiple, often in the public markets.

Roll-ups are a favourite operating model of private equity firms because many acquisitions can be made quickly. This is because:

The businesses acquired are all very similar,
There is no need for executives to learn a new industry each time an acquisition is made, and
The financial performance of a target can easily be compared to those acquisitions already made.

But the performance of roll-ups as a category is chequered. Australian-based Toll Holdings was a good roll-up until it was acquired by Japan Post, which was financially disastrous for them. The world’s first publicly listed law firm, Slater and Gordon, a roll-up of smaller law firms, went well until the $1.3 billion acquisition of British professional services firm Quindell. The result was the most value destructive deal in Australian Corporate History.”

One of the big hurdles for roll-ups is that if multiple roll-ups occur simultaneously in one market, the competition to make acquisitions competes away the margins. As I write this, in 2023, this very issue is happening in Australia in the Insurance Broker market, where EBITDA multiples for Insurance Brokers have increased from 7-8 x EBITDA to around 10-12x EBITDA over the last few years and also in the IT Managed Services Industry where multiples have increased form 6-8x EBITDA to 9-12 x EBITDA in just the last couple of years.

Anecdotally, the model works well for those doing the roll-up, less so for those who buy the finished rolled-up business. Often, the problem with roll-ups is that the underlying businesses acquired are not good standalone businesses, which depend on entrepreneurial founders to lead them. Once these businesses are corporatised, they often incur additional costs in the form of bureaucratic red tape placed on them by a centralised leadership that sits too far from the customer and the day-to-day operations of the business. In addition, with the entrepreneurial leader having left with their payout, the driving force behind the business, along with key relationships, has gone, and performance tends to decline.

Holding Companies:

Holding companies sit at the opposite end of the spectrum to roll-ups and are best explained as a portfolio of unrelated businesses that are owned passively. Other characteristics of holding companies are:

Holding company executives typically only influence the underlying business at a board level, tending to stay out of the day-to-day operational aspects of the business.
They hold unrelated businesses in a range of structures and sizes, such as minority and majority interests in both public and private entities. This extensive approach makes it challenging to systemise the process that creates value. As such, there is no secret sauce to value creation.
They have no degree of integration or synergies between companies, which, added to the lack of a value-creating process, means the investing prowess of the senior management largely determines results.

This is not to say that Holding Companies can’t be successful; Berkshire Hathaway is the prime example of a holding company at its best. However, it’s a difficult strategy to duplicate without the benefit of an investing genius at the helm. Scott Management, which spends about a third of its time following serial acquirers, states, “We avoid investing in roll-ups and holding companies as they rarely become long-term compounders.” This leaves Platforms and Accumulators.

Platforms:

Platforms in the context of serial acquirers are collections of similar businesses. However, unlike roll-ups, they tend to create value mostly by focusing on improvement through knowledge and skills transfer. An example would be Transdigm, which acquires businesses in the aerospace industry manufacturing aftermarket parts for aircraft. It doesn’t typically merge businesses or cut costs through synergies like a traditional roll-up (although this doesn’t mean it doesn’t cut costs). Its underlying businesses are operated in a decentralised manner, and value is created through the transfer of manufacturing expertise, cost management, process improvement and pricing excellence. At Transdigm, the key link between the businesses is their expertise in understanding the needs of aircraft owners and manufacturers, which need a reliable supply of aftermarket parts. As former Transdigm CEO Nick Howley explains:

“Our criteria was fairly straightforward, proprietary aerospace businesses with significant aftermarket content, where we could see a clear path to private equity-like return. If the business hit the aerospace aftermarket and had a proprietary product, we could run this play over and over again.”

Once Transdigm acquires a business, the model of what it does is pretty standard, as Howley explains:

“We probably take 20% of the cost out in about 60 days, and that’s mostly people. You can get the cost out of the other things, but they take a while. The quick move is too many people and not people doing nothing, just doing things that don’t matter. They weren’t value-creative. The other thing we went into a lot of detail on, as we did in the acquisition, is all the products and did a whole slice and dice on the pricing structure. Which products were old? What was low quantity? What could be replaced? What had no chance of replacing? We then increased the prices in the aftermarket.”

Howley explains they specifically focussed on businesses that manufactured parts for aircraft where they were often the only manufacturer. Their industry knowledge allowed them to determine how many of a particular aircraft are in use worldwide, how old they are, what their useful life was, and predict demand for various parts. As the only manufacturer of a part and able to determine demand, they could price those parts to generate optimal profits. Transdigm’s knowledge of the industry and its customer base also allows it to see which businesses in its portfolio are underperforming, as Howley explains:

“So, if they [2 portfolio companies] are servicing the same market, and one is consistently getting a 4.5% price increase, and you have a similar product, and you’re only getting 3%, the question is why? This is the benefit of the ownership structure. If someone is consistently underperforming, we know about it.”

Transdigm’s model has been extraordinarily effective at generating returns for investors. The company had its 28th anniversary in September 2021. If you had invested $1 when they started in September 1993, you would have generated an Internal Rate of Return of 37% per annum for 28 years. If you had invested $100,000, that money today would have compounded into $175 million. The company went public in an IPO on the New York Stock Exchange in March of 2006. The IRR over the 15 and a half years since the IPO has been 35% pa. Since being a public company, Transdigm has outperformed the S&P by 15-fold.

Accumulators:

Accumulators sit between Holding Companies and Platforms. They also operate based on a decentralised model. This means each company they acquire runs independently, has its own CEO and financial controller and operates as a unique profit centre. They rarely share customers between businesses, and each portfolio company is selling a different unrelated product to the other portfolio companies in the group, so even though a serial acquirer in this category might have a theme, like Constellation Software, which invests in VMS software, their portfolio companies are in different industries, providing different software to different customers. This is one of the main differences between accumulators and platforms. Platforms can leverage knowledge of specific customers or industries between businesses. The upside for accumulators is that because they are usually industry agnostic, their pool of potential acquisitions is often larger than serial acquirers operating the platform model.

If you compare Constellation (Accumulator) to Transdigm (Platform), Transdigm, which sticks to the aerospace industry, has fewer acquisition opportunities, forcing it to make larger acquisitions, which require more leverage and operational improvements to generate outsized returns. Constellation has more acquisition opportunities because it can buy businesses servicing any industry. It has a very long tail of small potential targets, typically acquired for lower multiples, generating higher returns on capital with less need for debt.

Despite being an accumulator, Constellation still has a sector focus, in this case, VMS businesses. However, there are a number of good examples of sector agnostic serial acquirers. An interesting case study on the merits of a sector-focused approach vs an agnostic approach to making acquisitions for a serial acquirer is best explained by the former CEO of Swedish-based Lifco, Fredrik Karlson. Lifco is a serial acquirer formally run by Karlson, who, during his 20-year tenure, increased shareholder value by around 100x. Lifco initially focussed on acquiring dental businesses before branching out to other industries. They break their portfolio companies into three groups: Dental, Demolition and Tools, and System Solutions. Karlson says, “I think you can be successful being a focussed serial acquirer, and you can be successful being a sector agnostic serial acquirer. During my history at Lifco, we started in dental, and when I bought a company in dental, I knew exactly what margins I could achieve. I knew exactly what I was buying. The problem was when I did the IPO of Lifco in 2014 if I continued just buying dental companies, we wouldn’t have grown as much. And you can see the results in our Systems Solutions Group. System Solutions basically means you buy any business. We became sector agnostic, and because the choice is much bigger, we were able to grow the profits 10x [Compared to the dental business growing 2x over the same time.].””8

Lifco’s development since IPO in 2014

The Perpetual Owner. Sector agnostic serial acquirers have demonstrated higher growth potential than sector focused RŌKO. Source: Lifco annual report 2014 and year-end report 2022

Karlson left Lifco in 2019 to start Roko, another sector-agnostic serial acquirer. Another example of a sector-agnostic serial acquirer is Teqnion, also based in Sweden but operating businesses across Europe. Their portfolio companies are typically manufacturers of niche products. Examples include businesses that manufacture a wide variety of products, including high-end food trucks, designer lamps, electric wheelchairs, electronic components, and industrial scales. Teqnion listed on the Nasdaq First North Exchange, a growth exchange for Nordic Companies in 2019, and its share price has grown more than 5-fold since.

So, what is the difference between a sector-agnostic Accumulator and a Holding Company? The key difference is that Holding Companies typically have little or no involvement in the operations of their investments other than from a board level. Holding companies are also often a combination of public and private investments and majority and minority positions. An Accumulator, however, has a direct line of sight over the business, a controlling stake and works with the portfolio companies to improve performance.

It is important to note that the categories of Rollup, Platform, Accumulator and Holding Company are a spectrum on which serial acquirers sit. There are some that sit between the Platform and Accumulator categories and others that are more purist Platforms. As a serial acquirer moves towards the Roll-Up end of the spectrum their acquisitions are more homogenous and integrated, as they move the other way, they are more diverse and less integrated.

What makes a good serial acquirer?

A good serial acquirer has a proven track record of successfully acquiring and operating multiple companies, generating free cash flow and reinvesting it at high rates of return over the long term. This is what creates the long-term compounding effect often found in their results. Some key characteristics of a successful serial acquirer include:

Clear Mandate: A good serial acquirer has a clear mandate of what type of businesses they will acquire. They understand the market and the competitive landscape and have a well-defined plan for how they work with businesses once they have been acquired to extract cash from them. Larry Culp, the long-time CEO of Danaher, described what he looked for in markets using criteria that are well-defined but which also allow for considerable latitude:

“First, the market size should exceed $1 billion. Second, core market growth should be at least 5%-7% without undue cyclicality or volatility. This excludes Rust Belt and Silicon Valley businesses for us. Third, we look for fragmented industries with a long tail of participants that have $25-$100 million in sales and that can be acquired for their products without necessarily needing their overheads. Fourth, we try to avoid outstanding competitors such as Toyota or Microsoft. Fifth, the target arena should present a good opportunity for applying the Danaher Business System so that we can leverage our Danaher skill sets. Last, we look for tangible product-centric businesses. This rules out, for example, financial services.”9
Strong Due Diligence: Successful serial acquirers conduct thorough due diligence on potential acquisition targets. They carefully evaluate the target company’s financials, market position, customer base, and management team but can do all this efficiently. Making large numbers of small acquisitions is time-consuming, and while returns on capital can be relatively easy to achieve by acquiring small businesses, returns on time are much harder to deliver. An inefficient acquisition process can result in increased head office costs that negatively affect the returns of the overall business. Mark Leonard, founder of Constellation Software, explains his perspective on DD:

“We do a lot of due diligence, but we try to do it quickly. We try to get to the heart of the matter quickly and understand the essence of the business, the key value drivers, and the culture of the business. We’re not looking for superficialities, but we try to get to the essence quickly. “10
Disciplined Approach: A good serial acquirer approaches each acquisition with discipline and a focus on long-term value creation. Rather than rushing into a bad acquisition, they are patient and willing to walk away from deals that do not meet their criteria. This is why most serial acquirers operate a permanent capital model, whether a long-term fund or a corporate-style investment. The luxury of having time to sit and wait significantly reduces risk. This luxury is not afforded to a typical closed-end private equity fund with limited time to invest, grow and exit businesses.
Financial Discipline: A good serial acquirer maintains financial discipline and avoids overpaying for acquisitions. They understand the value of a good deal and are willing to walk away from deals that are not priced appropriately.
Entrepreneurial Spirit: Successful serial acquirers have an entrepreneurial spirit and are unafraid to take risks. Mark Leonard from Constellation Software explains.

“One of the most important things we’ve tried to do is maintain the sense of entrepreneurialism as we’ve grown. When you have a company of thousands of people, it’s easy to get bogged down in bureaucracy and process. We’ve tried to keep a lean management structure and empower people to take risks and make decisions. We also try to promote a culture of learning and experimentation. We’re not afraid to fail as long as we learn from our failures and use that knowledge to do better next time. “11

The serial acquirer vs the closed-end private equity firm.

Since most serial acquirers start as small private entities investing in private companies, why do so few private equity firms take a long-term serial acquirer approach, holding acquisitions for the long term instead of the traditional private equity model based on buying, growing and selling businesses relatively rapidly?

To answer this accurately, it’s essential to understand the incentives at play in a typical private equity fund. The two key incentives are management fees and carry.

Management fees are annual fees a private equity fund charges its investors to cover its operating expenses. The typical private equity fund charges a management fee of around 2% of the committed capital. The management fee is usually charged on the total amount of committed capital, regardless of how much capital the fund has called to make investments.

Carried interest is a share of the profits generated by the private equity fund paid to the fund manager as an incentive for their performance. The typical carried interest rate is 20% of the profits, but it can vary depending on the terms negotiated between the fund managers and the investors.

This fee structure incentivises fund managers to grow significant funds because as the fund size grows, so does the management fee. This can be a considerable source of income for fund managers; therefore, they are incentivised to raise larger funds to earn more fees. Additionally, as the fund size grows, the potential profits increase, which means a larger carried interest payout for the fund managers.

One of the most difficult aspects of operating a successful serial acquirer is deploying large amounts of capital in relatively small businesses. Why? Because it’s labour intensive. The time and effort involved in making a $5 million investment is proportionally far higher than when making a $50 million investment. The serial acquirer model of investing in relatively small businesses prevents private equity firms from raising large amounts of capital as the capital would sit undeployed for too long. This reduces the size of profits and the speed with which they are generated. Added to this is the timing of carried interest payments. A typical private equity fund is entitled to carried interest payments as they exit investments, subject to meeting a return threshold (typically 8%) on the value of capital contributed to the fund. It’s common for private equity funds to begin exiting investments after holding them for as little as three years. This means that a PE manager could conceivably be entitled to take carried interest payments from around year 5 of the fund to year 10 as they exit each successive business (subject to them performing well). Additionally, a PE firm usually runs multiple funds in parallel, resulting in semi-regular carried interest payments.

On the other hand, the serial acquirer buys, grows and holds businesses in a permanent capital model, meaning the opportunity to calculate returns based on realising businesses doesn’t exist. In this model, liquidity is created for the investors infrequently, making it hard to remunerate key executives, who are used to receiving more regular carried interest bonuses. This requires a more novel structure, which can make the capital harder to raise.

All these hurdles mean that most private equity firms stick to a short-term focused, closed-end fund model, which ultimately is a barrier to long-term compounding wealth creation. Put simply, a closed-end private equity fund model maximises funds under management quickly, increasing fund managers’ ability to generate fees and reducing the number of organisations willing to take on the slower (but arguably better risk-return profile), serial acquirer approach to investing in private businesses.

With such a rich history of generating long-term returns above industry benchmarks, why is the serial acquirer model not better understood, and why are so many of these exceptional companies with long-term track records of extraordinary returns, not household names?

When un-informed investors first learn about the serial acquirer model, they often have the following misunderstandings:

Companies like these (or conglomerates) always sell for a discount to their net tangible assets,
Most acquisitions destroy shareholder value, and
Diversified conglomerates don’t perform well.

These are common misunderstandings that are easily dispelled by the informed investor.

Misunderstanding 1: “Diversified Investment Companies, Conglomerates and Listed Investment Companies always trade at a discount to their Net Tangible Assets (NTA).”

There are a lot of examples where the above statement is true. The reason is that most diversified investment companies, conglomerates, and listed investment companies comprise of a portfolio of large companies and/or investments in public companies. A portfolio of large companies is far more likely to trade at a discount to NTA than a portfolio of small companies, because large companies cost more to buy. Put simply if you pay a higher price for your portfolio of companies, it’s much easier for it to trade at a discount to what you paid! When you take a portfolio of unrelated companies that have been acquired at high prices and then overlay a set of costs related to head office personnel who assemble and oversee the portfolio, then unless they are stellar at picking stocks or adding value to the underlying companies, the portfolio will often trade at a discount to NTA. Serial acquirers, however, tend to acquire small companies with similar or related business models and operate very lean head office structures. A portfolio of small companies is far more likely to trade at a premium to NTA simply because they were acquired at low prices. For example, if a serial acquirer made 100 investments at an average price of 5 x EBITDA, it would need to trade somewhere around a PE ratio of 7-9 to trade at a discount. This is roughly half of the long-term ASX PE ratio and less than a quarter of the median PE ratio of the listed serial acquirers in the appendix.

Further improving the likelihood of a serial acquirer’s portfolio trading at a premium is that small companies are much easier to improve than large companies. You rarely find a multi-billion dollar company for sale that hasn’t already undergone a profit improvement process led by a highly capable team of executives to maximise the sale price. However, you can find small businesses for sale that haven’t been optimised and can be found and acquired without going through a competitive bidding process.

One final reason as to why investors so often overlook serial acquirers is best explained by European Fund Manager Scott Management:

Future acquisitions are often not factored in:

“One quirk in the way that many analysts think about [serial acquirers] such as AddTech is that while analysts are happy to account for investments that find their way into current spending, working capital expansion, and capex, they do not consider future acquisitions. Although this is reasonable in most cases, it seems short-sighted in those instances where acquisitions are an integral component of a firm’s capital allocation strategy.

Wall Street often gives short shrift to the capital investment opportunities of adept serial acquirers. It ends up underestimating the rate and duration at which free cash flow per share can grow.

When considering the potential for growth via acquisition, it is important to make assumptions on an internally generated cash-only basis. That is, excluding any benefit the company may receive from accessing cheap equity or debt in the primary markets. Ignoring aspects of reflexivity in a serial acquirer’s playbook leads to severe consequences if its market standing deteriorates. Serial acquirers are an interesting hunting ground. Often overlooked, many of these companies are able to compound investors’ capital at a rapid clip. “

Misunderstanding 2: “Acquisitions destroy shareholder value”.

Investors often overlook businesses with a high acquisition rate. This mindset largely stems from the scepticism surrounding acquisition strategies in public markets, fuelled by insights from experts like McKinsey.

In their 1997 paper, “The Alchemy of Growth,” McKinsey highlighted the success rates of various growth tactics, including mergers and acquisitions (M&A). The study revealed that a significant portion of M&A ventures did not generate value for the purchasing company, often leading to reduced shareholder returns.

More specifically, the study discovered that roughly two out of three M&A ventures did not meet anticipated returns. Larger deals had an even higher failure rate. The reasons behind these high failure rates encompassed strategic misalignment between companies, overvaluing the targeted business, and challenges in consolidating the two entities.

McKinsey has consistently released research on M&A, offering advice on enhancing the success rate of such deals. Nonetheless, the prevailing belief is that many M&A transactions erode value, making companies and investors more wary and discerning about M&A opportunities.

However, discerning investors realise that many of the failure factors McKinsey outlined don’t hold true for serial acquirers:

McKinsey’s analysis mainly addressed the challenge of value creation through acquisitions, noting that bigger deals tended to falter more frequently. Notably, successful serial acquirers often target smaller entities. For instance, in 2017, Constellation Software purchased 85 firms at an average cost of $5.7 million each. Given their PE ratio at the time, even if they paid an average of 8x EBITDA, and EBITDA of a target declined 20% post-acquisition, it would still be value accretive to Constellation’s share price.
The prevailing narrative suggests that buying smaller firms is risky. However, evidence suggests otherwise. Acquiring larger entities inherently carries more risk, due to the hefty acquisition price paid to acquire large businesses. Moreover, the inherent complexities of larger firms, with their diverse product and service offerings, make integration a daunting task, leading me to the next point.
As highlighted by McKinsey, integration challenges often lead to value depletion during acquisitions. However, serial acquirers lean towards a decentralised structure, minimising the need for integration. CEOs of serial acquirers are often adamant about avoiding integration of any sort. As Nick Howley, CEO of Transdigm, rightly put it, “Decentralisation is almost a conviction. You need to empower people, respect their autonomy, and compensate them appropriately to foster an ownership mindset.”
Lastly, McKinsey pointed out the pitfalls of overpriced acquisitions, a situation more common with larger transactions. Imagine the boardroom discussions of a public company making a billion-dollar “strategic” acquisition. The justifications for a premium are abundant. Yet, the urgency for any single acquisition is absent for a serial acquirer making numerous deals annually. Given the vast number of potential acquisitions available annually, there’s no pressure on serial acquirers to seal any particular deal, enabling them to maintain pricing discipline.

Misunderstanding 3: Diversified conglomerates never perform well.

The research (of which there has been plenty) on the correlation between diversification and performance is inconclusive. In 1993, Michael Goold and Kathleen Luchs reviewed four decades of management thinking on diversification. As they put it: “In the 1960s, the spectacular performance of a few successful conglomerates seemed to prove that any degree of diversification was possible. In the 1970s, many diversified companies turned to portfolio planning, aiming to achieve an appropriate mix of diversification. In the 1980s, many corporations restructured and rationalised, basing their strategies on sticking to the knitting and avoided wide-scale diversification. The authors conclusion based on the research was that evidence on the performance of companies pursuing more or less related diversification strategies is ambiguous and contradictory. There is no firm relationship between diversification and performance. “12

In his Book “The Diversification Blueprint” ” researcher Graham Kenny writes: “I, like many others, went with the flow on diversification. The conventional wisdom for me was, as it is for many, that firms shouldn’t diversify. I didn’t have any evidence to put forward as a counterargument; I do now. Diversification does not have to be managements leper. “Di-Worsification” is not accurate!”13

More importantly, you only need to look at the median ten-year return of 28% per annum of the companies in Appendix 1 identifying as serial acquirers to completely dismiss the view “That diversified conglomerates never perform well.”

In Conclusion:

While not commonly understood by investors, the serial acquirer model has demonstrated a potent ability to generate exceptional long-term returns. This whitepaper has highlighted how these entities have consistently outperformed their peers by operating a distinctive business model. Serial acquirers exhibit the following advantages:

High Rates of Return: They have the capability to reinvest cash flows at high rates of return for long periods, enabling them to compound their returns over time.
Acquisition Expertise: Unlike other players, serial acquirers can target and acquire businesses other investors overlook. This strategy provides them vast opportunities at competitive valuations, further boosting their returns.
Pricing Arbitrage: For publicly listed serial acquirers, purchasing businesses at lower EBITDA multiples while being traded at higher PE ratios can drive significant share price accretion, turning them into potent compounding machines.
Diversification: As they acquire more entities, their diversification across sectors and geographies grows, which inherently reduces risk and offers resilience against market downturns.
Small Businesses Equals Low Prices: The low-price multiples serial acquirers need to pay to acquire small businesses and the relative ease that small businesses can be improved means serial acquirers need to use less leverage to generate high returns.
Long-term Relationships: Their enduring or permanent capital framework allows serial acquirers to nurture relationships with potential sellers, positioning them as the preferred buyer if they are in competition with other buyers, which, in many cases, they are not.

Serial acquirers operate a very different model to traditional private equity entities. Serial acquirers focus on the long game, with a buy-and-hold strategy, leveraging their distinct knowledge to improve businesses, while private equity firms often work within a more rigid timeframe, driven by different incentives and structural commitments.

However, despite their track record, serial acquirers remain under the radar of many investors. Part of the reason is the prevailing misconceptions in the investment world. While it’s commonly believed that diversified companies or conglomerates trade at a discount to their NTA or that most acquisitions are detrimental to shareholder value, serial acquirers have consistently disproven these notions. Instead, the model shows that successful serial acquirers trade at significant premiums to ΝΤΑ.

For astute investors willing to break from the norm, serial acquirers present a promising opportunity. Their unique approach, characterised by discipline when making acquisitions, operational efficiency, and a long-term view, can unlock value in ways that many traditional models cannot match. In an investment landscape dominated by short-term thinking and a herd mentality, the serial acquirer model stands out as one that has consistently delivered long-term returns well beyond those provided by other asset classes.

About PieLAB Capital:

PieLAB is an Australian based serial acquirer that acquires businesses with between $3 million and $15 million of revenue annually, generate more than $1 million EBITDA in annual profits, and have a stable revenue model, such as recurring or subscription revenue, or a strong repeat customer base. Our ideal partner is a business owner who would like to step back or step out of their business either immediately or staged over time. Or alternatively if you are a general manager, CEO or senior team member who would like to step up and own some of the business you currently run, talk to us about how we can help.

For businesses owners, working with PieLAB can take many forms, including:

Reducing your financial exposure to the business you own by selling down some of your stake but remaining involved on either a full-time or part-time basis.
Bringing in a partner like PieLAB to help your current management team buy some equity in the business, or
Selling your business outright.

If you own or work in a business that you think might fit PieLAB’s model, please contact us at: info@pielab.com.au

For investors: While we aren’t currently raising capital, we do occasionally allow new investors to become shareholders alongside us in Australia’s only genuine serial acquirer. If this is of interest, please contacts us at: info@pielab.com.au.

Appendix 1: List of Serial Acquirers

(The original document contains a list of serial acquirers in a table format here. As per the request, this table is not included in this HTML version.)

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If you think your business could be ready to join PieLAB’s portfolio, get in touch with the team today.

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