We continued our work on Addtech with an interview with a Former Addtech Business Unit CEO that has experience both selling an operating company to Addtech and acquiring and operating companies within the energy division at Addtech.
In 2013, Addtech purchased Rutab AB, a Nordic cable component business, a company that is very typical of the 100’s Addtech has made over previous decades. In 2012, Rutab generated ~10m EUR revenue at 8-9% EBIT margins with only 40 employees. The company manufactures and sells machine cable glands to electrical wholesalers such as Ahlsell and Sonepar. These cables are used by industrial companies like ABB and Atlas Copco within large machining and automated technology. Rutab is the sole supplier of such cables and has a mini-monopoly on this small market.
Rutab is a perfect example of companies Addtech searches for: strong historical profitability, below 10m EUR sales, very few competitors, and a good management team.
Addtech acquires companies who have strong market positions. It was extremely important they had at least five years of being profitable. We did not want to acquire companies which fell down and lost 20% of the profit in two years. They do not focus on seeing future growth or demand you grow your business by 10% annually. They want to see stable secure cash flows in the future as well as strong management teams, and Rutab ticked those boxes.
Serial acquirers like Berkshire, Constellation Software, and Addtech are all competitively advantaged buyers of companies. Each of these companies has similar M&A principles: leave the acquired assets standalone, incentivise management to stay past their earn-outs, and maintain the existing culture of the acquired company. This is very attractive to entrepreneurs who have built their business over decades.
Rutab had over 50 bidders including Addtech, PE shops, and other industrial players such as Lagercrantz and Indutrade. The executive we interviewed was the CEO of Rutab as the business was sold to Addtech. He highlights Addtech’s differentiated approach to the bidding process that was pivotal in winning the deal:
The CEO of Addtech at the time, Johan Sjö, asked the right questions. He did not say that our business model would not work in future, whereas many private equity players questioned that and told us our commodity products would probably go down. The most important question was Johan asking what the management team wanted for the future, which is an efficient way of being on the same team. They said we could be self-sufficient and create our own strategy within Addtech. They also knew about selling products to electrical wholesalers, so spoke the same language.
Addtech has built a great home for selling entrepreneurs. The bolded sentence above also sticks out. How can such a simple question be unique in an M&A process? Johan asked Rutab’s management simply what they wanted. This question alone differentiated Addtech. Too often M&A is about squeezing the best price from the seller. Competitively advantaged buyers do the opposite. They ensure it’s a win-win for all parties. Competitively advantaged buyers are working with the sellers, not against them. This is M&A done the right way.
What has also been clear after researching Topicus and Addtech is that price is not the most important factor. It’s often the more emotional points that matter to entrepreneurs. Factors such as keeping the assistants employed or ensuring family members remain in their respective roles. The bolded sentence below from our recent Topicus interview highlights this point:
The price is always irrelevant, I think, with today’s mindset and culture. If it was pre-2008, yes, it was all about price and the big money. But nowadays, with the social environment and your social responsibility to your neighbors, at the end of the day, it does not matter to an entrepreneur if he is going to get 20 million or 22 million, or 100 million or 105 million for the company. That is not where the value is, with that specific entrepreneur. For the entrepreneur it is all about his value drivers and if he can have a good pension from what he is going to have and maybe also his kids can have a good life, then that’s okay. Then it’s not about the money; it’s about the lady who delivers the coffee.
Even though it’s more about the coffee lady than the money, the multiples paid by Addtech and Topicus are still very attractive. Addtech’s average historical acquisition multiple is 5.5x EBIT. One interesting takeaway from the Addtech interview was how persistent such low multiples are for these acquisitions:
Nobody will bid more than seven or eight times EBIT. That is a common understanding for everyone in the market. Logic tells you that people would pay more, until the marginal cost equals what you get for the price. But since the market pricing is what it is, there should be quite a significant discount when you buy a private company dependent on one person or two suppliers or five or six large customers. Everyone knows that you cannot do a discounted cash flow forecast earnings, growing in eternity because things will happen along the journey. For a small company there should definitely be 30% to 50% discount. That is how you end up with five times earnings multiples.
It’s important to internalise the risks of small companies that Topicus or Addtech acquire. The acquisitions are typically sub-$10m revenue, ~5% organic growth, owner-operated with considerable key-man risk, plus very concentrated suppliers and customers. Although you can reverse-DCF a 20% IRR paying over 12x EBIT, there is considerable risk given the nature of the company. These risks lead to a persistent 30-50% discount and sustainable 5-6x EBIT multiples.
It's clear companies like Addtech and Topicus have a competitive advantage in acquiring companies. When you layer on top the persistent multiple arbitrage, it’s no wonder the shareholder performance looks the way it does.
One last point that stood out was how companies like CSU, BRK, TDG, and Addtech all keep the acquired businesses standalone. They focus less on acquisition synergies and more on the underlying economics of the business. Acquiring for synergies could lead to acquiring a lower quality business in the belief cost or revenue synergies will improve profitability to make the deal work. This seems far riskier than acquiring small businesses with durable economics. Focusing on synergistic acquisitions can certainly work but given the historical performance of acquirers that keep the businesses standalone, it’s likely not the most effective way to create lasting shareholder value.