Why Invest in Serial Acquirers?

Serial acquirers are companies that have an explicit strategy of redeploying all of their FCF back into M&A. Scott Management has a great article describing his thoughts on serial acquirers. His Roll-Up / Platform / Accumulator / Holdco framework is very useful. Exploring Context has another great article that takes the Scott Management framework and takes it to the next level by backing up the framework with hard data. Beyond these frameworks, I have little value to add but I thought I’d try anyways.

What are the types of serial acquirers?

Roll-Ups are acquirers with an explicit goal of obtaining scale and therefore synergies. For most investors, Roll-Ups make the most logical sense. A plastics manufacturer like Berry Global can acquire a company at 8x EBIT but due to cheaper resin costs, immediately drive enough synergies to lower their purchase multiple to 5x. While Roll-Ups can be great compounders, they run into several issues. First, if there are two or three equal sized Roll-Ups, purchase multiples inflate quickly so its often a race to the bottom to see who can scale faster. Second, Roll-Ups often forget the revenue piece meaning in an effort to obtain cost synergies, employees leave, customers churn and the long-term revenue trajectory starts declining. However, the right Roll-Up in the right industry can lead to exceptional returns.

Platforms and Accumulators acquire companies but may not be specifically focused on scale, but rather, are trying to build a portfolio of businesses in a vertical with varying levels of integrations. Unlike Roll-Ups, Platforms and Accumulators play in niche markets where scale is not important like vertical market software, scientific instruments, sensors, or industrial controls. Platforms and Accumulators are interesting because their ability to buy businesses at attractive prices normally stems from 1) their ability to be a great home to an owner who may not always go for the highest price and 2) their ability to scale the volume of deals so that they can grow via smaller deals allowing them to sustain returns. Platforms and Accumulators can eventually scale to dozens, hundreds, or even thousands of subsidiaries so careful analysis has to be done to determine whether the company has the management and organizational structure to scale without blowing up. Pursuing zero integration can lead to a portfolio of stale or stagnant businesses whereas pursuing too much integration can become too complex a management endeavour and may threaten sustainability. As a result, many of these platforms end up building loose structures like Sector CEOs or corporate-wide processes like the Danaher Business Systems to manage the complexity.

Holdcos buy any and all things. The best example is Berkshire Hathaway. There are no explicit synergies or industry focuses. Returns are based purely on the opportunism and skill of the manager.

Why do I like to invest in Serial Acquirers?

Mathematically, serial acquirers have the potential to compound. A compounder is usually a company that can reinvest all of their FCF back into the business at a high return. If a business with 50% ROIC only reinvests 10% of FCF back, they only grow 5%. Serial acquirers are typically trying to reinvest 100% (sometimes more) back into M&A so if you have differentiated insight on the future reinvestment rate and the longer-term ROIC on reinvestment, then these businesses can generate sustainable FCF growth of mid-teens or better.

Differentiated insight is subjective. With serial acquirers, you are investing based on your assessment of the management, the organizational structure, and the organizational culture. These are very fuzzy things. While this increases the chance of error, it also eliminates a lot of quants, pod shops, and sell-side analysts from properly evaluating these businesses and even fundamental analysts may be hesitant to translate their subjective views of management’s capital allocation prowess into objective intrinsic value per share. This leaves an inefficiency to exploit.

There is reflexivity. Target multiples tend to be more attractive during recessions or industry downturns meaning the headwinds from a cycle can get offset by the tailwinds of deploying capital at higher returns. While companies like Judges Scientific have had periods of organic declines, total revenue growth can accelerate during these same periods. As a result, periods of subdued M&A activity or choppy organic growth can be attractive opportunities to invest in serial acquirers.