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Welcome everyone. Today's episode is about Bergman & Beving, a Swedish serial acquirer that is probably one of the oldest in existence. The company sells niche industrial and construction products, but also operates a more commoditized B2B distribution business, which accounts for around 40% to 45% of revenue. This is one of the most intriguing ideas we've encountered in the last 18 months, primarily due to its history, the new CEO, the potential growth, and the valuation. Last time I checked, it was trading at around 12 times normalized free cash flow. There's a long potential runway of accretive M&A ahead. It's a slightly more complex and messier story than the Lifcos or Constellations of the world, but that's what makes it so interesting. Please enjoy and let us know your thoughts. As always, please conduct your own research. Nothing here is investment advice. So, what are your thoughts on the Bergman & Beving piece?

I found it quite interesting. However, I'd like to turn the question back to you and ask how you discovered this business.

I've been aware of the business's history for years. It's actually quite amusing because Bergman & Beving is the original serial acquirer. It started over a hundred years ago, and while it's not a traditional serial acquirer like Constellation and similar companies, its history is well-known in this space. But if you look at the numbers for Bergman & Beving, the listed company, they don't look very good, so people tend to overlook it. We're all more interested in Lifco, Indutrade, Lagercrantz, and other businesses that have clean high returns on equity, nice organic growth. Like everyone else, I didn't pay much attention to this business for that reason. But what caught my attention was a change in management a couple of years ago. The current CEO, who spent 14 years at Lagercrantz handling M&A for Jorgen, the current CEO at Lagercrantz, is now running the show. After briefly reviewing his comments and presentations, it's clear that the business is on a very different path than it was over the last five years. It might be worth delving into a bit of history because it is quite complicated.

I agree. There's the history of the business itself, and then there's Magnus's history, which I found particularly interesting in the interview you conducted with him.

Bergman & Beving has a history spanning over 130 years. The Nordics is an interesting region due to the variety of languages spoken there. Historically, before the World Wars, European, Western, and Japanese industrial companies found it difficult to sell machinery, equipment, or industrial goods in the Nordics.

They would use sales offices and people would set up shops to sell products in the Nordics on behalf of companies like Samsung or other Nordic industrial players. They would act as B2B distributors, taking inventory and selling it to manufacturing plants in the Nordics. This was the birth of the B2B distribution business.

Later, they started to offer value-added distribution services, such as installation and technical advice. This is where they could earn margin beyond just being a reseller. The Nordics is full of such companies, making it an interesting space for reselling products throughout Europe. It's a very stable business if run properly.

Bergman & Beving has been doing this for hundreds of years. They operate in a very decentralized manner, rolling out small local distributors. It was a very profitable model until they spun off Addtech in 2002. Similar to what Constellation did when they spun out Topicus and Momentum. However, around mid-2010, they seemed to have lost their way, and it's quite fascinating. I'm not exactly sure what happened.

It seems like some form of vertical integration occurred.

The question is, where did it all start? Addtech and Lagercrantz have been successful for hundreds of years, especially in the last 15 years in the Nordics. For some reason, Bergman & Beving decided to experiment with vertical integration. They founded B&B Tools, a retail chain to sell their products. However, this centralization governance and vertical integration strategy didn't work out. Over the last four or five years, this has led to many spin-offs and name changes, which can be confusing.

To simplify, Bergman & Beving, the original company, spun out Lagercrantz and Addtech in 2001. These were the more pure B2B distribution businesses. They then decided to buy product companies. They kept the tools and consumables business. In 2015, they started a vertical integration strategy that didn't work out.

This is where it gets interesting. The current CEO of Momentum Group was then hired at Bergman & Beving. He decided to return to the company's roots and ended up splitting up all the businesses. Bergman & Beving spun out Momentum Group, which was part of the business. The current CEO of Momentum Group led this spin-off. Momentum Group then bought another retail business to combine with the B&B Tools business they owned, which is now called Allego.

So, they split up all the retail businesses under Allego, and now they have Momentum Group, which is separate. Over the last five years, Bergman & Beving has become three entities. It's become Bergman & Beving, Allego and become Momentum Group, all pioneered by the Momentum Group CEO, and he's the CEO of that listed company. So he's obviously he's clearly planned this to benefit Momentum Group.

The current Bergman & Beving listed business has three segments in their reporting structure. However, I see it as two businesses. It's a B2B distribution business, which includes Luna and another PPE kind of distributor, and then it includes all the other called it product companies. What makes this particularly interesting is that Magnus, where he comes from, Lagercrantz, he spent 14 years buying product companies like proper serial acquisition, so programmatic acquisition. He's done 60 acquisitions in 14, 15 years. He's been doing four or five a year for 15 years. There's not many people on planet Earth that have done that. And you can check what that done to Lagercrantz. Obviously, it's improved the margin structure and the return on equity and stuff like that.

He's effectively running the same strategy as Lagercrantz 15 years ago, but with a major caveat that 50% of revenue is B2B distribution. And that's the catch, right, where Luna is their reselling or bit of value added, but mainly just commoditized distribution on tools and consumables and all that kind of stuff. So somewhat commoditized distribution business, which is why the business seems like it earns low returns on capital and is not that attractive to some, on the surface.

Upon closer examination of the numbers, it's evident that since Magnus took over, the incremental return on capital is nearly 25%. The return on equity is slightly higher because he is reinvesting all the free cash flow from the business into product companies. These are companies that own intellectual property and brands, not just reselling commoditized items like screws and hammers.

However, returning to the original point, what intrigues me is the ongoing debate about whether serial acquirers are interested in this more complex business model. It may not be as straightforward as Judges or Constellation or other similar companies. Yet, a few months ago, it was trading at 12 times free cash flow.

This is a business that purchases companies for five to six times EBIT, and spends 50% to 60% of free cash flow acquiring businesses at five to six times EBIT. Yet, it trades at 12 times free cash flow. This is likely due to the fact that they also have 40% of their business in lower quality company operations.

How has your opinion been shaped regarding their ability to improve Luna? And, for that matter, what is your view on Magnus's ability to apply what he learned while building Lagercrantz?

I don't have a strong opinion on how they can improve, other than what I've observed from the numbers. It's difficult to discern exactly how Luna is performing because they categorize it within tools. However, you can make an educated guess about Luna's performance, and the last quarter was the highest margin for that segment in history, with Luna being the largest part of it.

Magnus, the CEO, explained in an interview that he has eliminated all unprofitable business. This is because with distributors, you have these major brands with strong reputations. These brands have significant bargaining power, and Luna is primarily interested in volume, so they don't take on any unprofitable business. It seems they were losing money on some business to achieve scale, and Magnus has put a stop to that.

It's a complex business to manage, as being a distributor can drain your returns on capital due to the need to hold inventory. If you're a major brand and I'm a distributor needing your volume, I'll offer to store your inventory, freeing up your capital. This makes me a more attractive distributor, but it drains my own capital.

It appears that Magnus is willing to forego organic growth for Luna, which is part of the challenge. When you're focused on B2B distribution, you want to grow. But growth typically requires capital, as distributors need to maintain a wide inventory and offer good credit terms. This means always having stock available and extending credit to customers, which can tie up capital.

However, Magnus seems to have decided that Luna doesn't need to grow organically because it's growing through acquisitions. This creates a unique dynamic that may not attract investors who are looking for organic growth. Luna is intentionally declining organically by refusing unprofitable business.

As a result, we'll likely see a slowdown in the consolidated top line for Bergman & Beving. The B2B side of the business will decline due to Luna's decline. However, this will free up capital, leading to increased margins and reinvestment in acquisitions, which will grow the top line. We can expect low to mid single-digit top line growth, but probably 10% to 20% EBITDA growth.

It's a more complicated story, which is why it's trading at 12 times free cash flow, not the 30 times that other companies are trading at. But the question I ask myself is, why take the risk of buying a somewhat lower quality asset?

What insights have you gained about what motivates Magnus Söderlind?

Although I don't know him well, it seems he knows his strengths and has a track record at Lagercrantz. Now, he has an opportunity to shape his own public track record. He invested three million euros of his own money in stock, which is significant. They also have a strong board, including the Lagercrantz guy, who presumably supports him. The board appears to be competent.

It will be interesting to see how things develop. If I were running this business, I would compare it to companies like Constellation, Judges Scientific, or Lifco. These businesses have high margins and high EBITA margins. They don't have a working capital drag as they grow, and all the free cash flow is effectively available. Consider the P&L, all of that EBITA like operating income plus amortization of intangibles converts into free cash flow at a high rate, probably 100%.

So, you have all of your free cash flow. This is the whole model. All this free cash flow requires little capital expenditure into the business, maybe a tiny bit of R&D or capital expenditure for some of these businesses just to maintain their current status, as they're not growing too much organically. All that free cash flow can be reinvested in acquisitions. So, you've got a 100% return.

To simplify, if you're earning a 20% return on equity and you've got 100% free cash flow that you can reinvest at 20%, you can grow by 20% a year just by reinvesting it, plus the growth rate in the existing business. Now, if I'm running Bergman & Beving and I've got Luna there, which allows me to invest only 50% of my free cash flow, it's like operating with one arm.

At some point, it will reach a stage where this is not what they want. I would consider selling the business because it would not only free up the free cash flow for reinvestment and faster growth, but it would also improve the return on equity and return on invested capital for the whole business. Running a business like this is obviously much more challenging than running Lagercrantz or Judges.

The history of Bergman & Beving is that they don't sell; they are perpetual owners. I'm aware that the product companies sell via Luna, which accounts for some intra-company revenue, although it's not that much, perhaps around 5%. But what I don't know is, if Luna were to be sold, would the new Luna owner want to sell Bergman & Beving companies? Is the IP and the brand strong enough to sell? Would selling Luna impair some of the value that you have in your business?

Despite these unknowns, it seems to me that the benefits would outweigh the risks. If you do sell, you also get multiple arbitrage. The multiple wouldn't be 12 times free cash flow because the returns on equity and capital would be on par with, or at least close to, where all the other guys are. You would end up with a much cleaner business in theory.

This has been done before. Look at Sdiptech. They spun out two lower-quality businesses with low margins, around 7% to 8% EBITA margin. Luna's EBITA margin is around 2%, maybe 1% to 2% and 3% if you're lucky, but it's probably below 2%. Sdiptech sold these two businesses, 7% to 8% margin, and bought another business with a 30% margin. The stock's value increased fivefold in about three years because you've got a completely different business. They spun out two lower-quality businesses and bought an excellent one. This changed the whole structure of the capital base and the returns.

I believe this is possible here, but we'll see. I have faith that they'll make the wisest decision. Perhaps they'll say, actually, can we get Luna to 3%, 4%, 5% EBIT margins? If so, maybe it's worth keeping.

To summarize, we have a business with a rich history in the region that has undergone a failed vertical integration experiment. Currently, it's quite complex to disentangle what Bergman & Beving is now, after these spin-outs. It's challenging to determine its position and it doesn't seem attractive compared to other acquirers. As per the analysis piece we published, the numbers suggest it's barely earned its cost of capital. Now, Magnus Söderlind, who has a credible pedigree, has come in.

If we look back at the last 10 to 11 quarters since he's been there, the return on capital is about 2.5 times the historical numbers. However, we can't go back more than five years for this business because the businesses don't exist there anymore. They've become Allego, the retail business, and Momentum. It's probably trading where it is because it's complicated, the numbers aren't impressive, and there's very short history on what these businesses can actually do.

What's interesting is Magnus's approach. He's allocating 250 million SEK a year on acquiring businesses at a 15% EBITA margin, and he's essentially paying one times revenue, or five to six times profit EBITA. That's his strategy. I'm confident he will allocate that every year. It could even be more than that if they free up cash flow.

The valuation looks attractive because you can model out Luna's decline. I've modeled Luna declining 2% to 3% a year for the next five to six years. With Magnus spending 250 million SEK on businesses, which he's already done this year, the business will continue to compound. EBITA will compound at 15% to 20% a year. He has to acquire five companies at the same valuation, and he needs to know what he's doing and be diligent.

You can afford for Luna to decline. I've modeled it out at 4% for the next two years, then 3%, with some margin improvement because they're selling off. As they reduce the volume, the quality of the business increases because they're keeping better business. This leads to a high teens return, just by acquiring five companies a year and running the current strategy. The main risk is that Luna throws a curveball because it's very unpredictable. Or there's a big recession and Luna's revenue declines by 15%. That's the risk we're buying.

Given this situation, which could potentially be interesting for the reasons we've discussed, what research questions are you currently exploring or planning to explore in the coming months?

I'm interested in learning more about Luna. There's a history behind why Luna is structurally impaired. There's also a significant business called [Alsa 00:26:57], which has been successful in vertical integration and has been challenging Luna.

This leads me to another area of interest, Momentum. If you're the CEO of the original company, Bergman & Beving, and you've spun out your own smaller version, it's likely that you'll produce some quality outcomes. Perhaps I should be focusing on this instead. Momentum appears to be a higher quality distribution business. It's more service-based and seems to be closer to Fastenal than Rexel.

Rexel is a French electrical supplier, a distributor throughout Europe, while Fastenal is often on their customer side. The core business of Momentum, which constitutes about 70% to 80% of their operations, is in the industrial B2B sector, which has more recurring revenue. Luna, on the other hand, has virtually no recurring revenue.

I'm not sure about the potential of Momentum in mergers and acquisitions, and it's trading at 30 times free cash flow. But perhaps it's worth paying 30 times. You never know.