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Halma, Danaher, CSU & Serial Acquirer Org Structures

"My observation is that acquisitions have the best chance of creating value where the business purchased as nearly as possible meets the following criteria: it is paid for by internally generated cash, it is a replica of one already owned by the purchaser, it is a bolt-on or quasi-bolt-on, and it is likely to improve the quality as well as the quantity of earnings. This is effectively the route we have followed in Halma."

David Barber, Halma Cofounder and Former CEO, 1998

Halma is a UK-listed serial acquirer of highly-specialized industrial and medical companies that dominate small, niche markets. In 1972, David Barber founded the company with a simple set of principles to create long-term shareholder value: use retained earnings to acquire profitable, niche businesses that management understands. Over the last 20 years, Halma has compounded FCF at 15% and the dividend per share has compounded 5% for over 33 years. Barber’s philosophy underpins Halma’s success and forms the foundation of the company’s strategy today.

There are many great write-ups by Scott Management here, Exploring Context here, and Demesne Investments here which explain and categorize types of serial acquirers. This note builds on these write-ups so if you haven't already, we'd advise reading each piece before this Weekly Analysis.

In December, we interviewed three former executives of Halma operating companies to explore a question that we believe is crucial for ‘platform-type’ roll-ups: how is the company organised to scale acquisitions.

Halma started as an ‘accumulator’ serial acquirer. Operating companies were decentralised with CEOs running individual P&L’s reporting to Barber. This structure is similar to Constellation Software (CSU) in VMS or Addtech in B2B distribution where the parent company aims to add value by sharing best practices across opcos rather than centralising services to cut costs.

This strategy worked well until the early 2000s when Halma’s revenue and FCF hit a wall. The business didn’t grow for 4 years. In 2005, Andrew Williams became CEO, sold off underperforming businesses and moved into the medical equipment business. Prior to 1997, over 70% of Halma’s acquisitions were small, niche businesses within existing health and safety sectors. We would argue that Williams started Halma’s transition from an ‘accumulator’ to a ‘platform’ acquirer. In other words, from a Constellation Software-like operating model closer towards a Danaher-like operating model.

In 2015, Halma deepened this transition by reorganising into four ‘Sectors’; Process Safety, Infrastructure Safety, Medical, and Environmental and Analysis.

Halma introduced ‘Sector Teams’ which added a layer of middle management between opcos and Sector CEO’s: the opco CEO would report to a Divisional CEO, who reports to a Sector CEO, who then reports to Andrew Williams, Halma Group CEO. The Divisional Sector CEO (DCE) would also have a CFO and a VP of M&A to help run the sub-sector. Halma effectively has two management layers above the operating company: the Divisional Sector CEO and the Sector CEO.

In some sub-sectors like trapped interlocking keys, Halma merged opcos and restructured the individual CEO’s to regional President roles:

"We did several things which we had spoken about for years. Halma did a nice job, perhaps to a fault, of letting companies run in a very decentralized environment. KIRK Key, Castell, Fortress and several others, all owned by Halma, were competing in the marketplace, but we were all still run as separate companies. During that time, we started to focus on how to create a trapped key interlock solution for North America. We created a North American and a European company to drive these different brands into the marketplace."

This means there is no CEO at the opco level with full P&L responsibility in Halma’s trapped key business. Typically, decentralised acquirers push as much responsibility down to those at the opco who are dealing with customers on a daily basis. In the long run, we believe Halma's reorg may create perverse incentives by reducing the agency of those running the operating company. However, it can generate significant revenue opportunities and was a key driver in Halma’s organic growth post-2015:

​​"We are in the switchgear and UPS marketplaces and needed to develop a product line in the machine guarding and logistics safety marketplaces. Prior to that consolidation, I would look at sister companies like Fortress who have a great product that sells well in this marketplace, and make something similar to them, to a point where we were incentivized to literally copy that product while utilizing our own cost to do that. Once you consolidate the businesses and drive that brand portfolio onto the marketplace, you are able to utilize some of the Fortress products and brand them as KIRK without reinventing the wheel and to drive growth that way. That was a big advantage to change the business structure to better manage the brands, instead of only a single business unit into the marketplace."

As with most serial acquirers, it's difficult to truly grasp how Halma organises each opco. Some are merged, some left standalone. Each sector is also different. For example, BEA Sensors, the second largest opco at Halma, was effectively unchanged in the reorg because it’s the only sensor business within the group and is large enough to operate alone.

Halma’s operating model resembles Danaher more than CSU in that it's platform-driven rather than truly decentralised. Opcos still have their own boards with the regional Presidents and the Divisional Sector CEO. We question whether the added layer of middle management risks distorting the incentives and reducing entrepreneurism at the opco level.

This can also lead to problems when dealing with more specialized opcos like Halma owns. For example, Crowcon, Halma’s gas detection business and one of the oldest in the group, lost 10 years of growth in the late 90s due to low-end disruption from an overseas competitor. We interviewed a Former Director at Crowcon who believes the biggest problem was the lack of gas detection expertise within Crowcon and higher up at Halma’s Divisional Sector level:

"Crowcon went wrong at that time by not having the market knowledge or expertise in their industry. The situation they found themselves in is one where whatever decision they make has to be right, because if they get it wrong, it would be disastrous. It is hard to understand the right decision. Many times, you end up with an inertia where people would rather do nothing than be wrong. That goes against the Halma entrepreneurial concept, but that is what happened to Crowcon…When I joined Crowcon for the second time, I was shocked at how little knowledge there was of the market we were operating in. That leads to the organization doing things any organization entering a new area would do, that is look at the markets to see what is going on. We did a lot of work around who used gas detection and why they used it and which were the most profitable areas for us; business development stuff."

It seems like Halma has regional Presidents running single opcos (BEA Sensors) or multiple product lines across multiple opcos (trapped interlocking keys). These individuals have deep expertise in the end market but it’s unclear exactly how much agency they have to run their business unit.

It’s interesting to compare Halma’s structure to Danaher, arguably the best performing "platform" serial acquirer. Danaher acquires larger, leading assets that form the beginning of a platform for bolt-on acquisitions in a new end market.

As platform acquirers scale, they typically choose to buy fewer but bigger businesses rather than increase the volume of small acquisitions. It's a much quicker and easier way to scale but typically leads ROIC to revert to the mean. Today, Danaher is 14x the size of Halma with under half the opcos. If Halma follows in Danaher's footsteps, the larger the company becomes, the more Williams' capital allocation skill matters to conduct fewer, large acquisitions.

There is also one big difference between the two: the Danaher Business System (DBS).

The DBS is the lifeblood of DHR and informs every business decision throughout the group. The DBS mindset enables DHR to drive significant revenue and margin improvement post-acquisition regardless of size. Halma has yet to implement a rigorous, group-wide culture that focuses on relentless improvement at the opco level. This could be because Halma owns few manufacturing assets and is mostly assembly and sales operations at the opco level. It also seems to be because the company is stuck between a decentralized CSU strategy and platform-led Danaher.

Without DBS-type operating principles stitching together the culture across the group, Halma has to rely on the quality of the assets purchased on day 1. The company can merge and share insights from other opcos, but the kaizen mentality to improve the acquired assets doesn't seem as deep-rooted as the DBS is at Danaher.

Halma has two limitations to scale as a platform acquirer:

1. The number of acquisitions per year

2. The size of each acquisition

Most companies end up increasing the size of each acquisition. This is a quick way to a standard business formula focused on economies of scale, centralised management, and cost cutting to ensure the large-scale M&A drives a return. Something Mark Leonard is actively avoiding.

Danaher followed this route while the DBS enables the company to pay up for larger assets and drive enough post-acquisition synergies that each deal is accretive. This is exactly what makes Danaher so unique.

Constellation Software is focused more on increasing the number of small acquisitions per year. Over the last 4 years, CSU has increasingly been pushing M&A duties down to the Business Unit (BU) level, equipping opco leaders with M&A skills and the responsibility to allocate capital to grow their own BUs.

This was Mark Leonard in 2017:

"When I look at the current generation of Portfolio Managers, I see some that have the potential to be exceptional managers and capital deployers. While that bodes well for continued growth, there aren’t enough of them to get us the ten-fold growth that we’ve had in the last eleven years. To generate that sort of growth, we need more Portfolio Managers and they need to be as competent as our current Operating Group Managers. That’s a tall order. It will require an intense training and coaching effort with our existing Portfolio Managers, possibly some outside hires into Portfolio Manager roles, and the acceleration of some existing BU Managers into Player/Coach and Portfolio Manager roles."

In the four years following this comment, CSU has scaled from ~40 acquisitions per year to a current run-rate of 100 per year. This is an incredible achievement. Is CSU buying lower quality or higher priced VMS businesses to hit this volume?

Scaling small acquisitions is the hardest task to solve for serial acquirers. It’s a human and organisational problem rather than a business model or financial problem. Although it seems like CSU has found a solution, it’s hard to understand exactly how. From the outside looking in, it’s unclear how each Operating Group is organised. We couldn’t find an org chart and nor a detailed perspective description of how each Operating Group is organised.

This is likely for a reason; Leonard is organising CSU to filter the Group’s FCF to the best capital allocators across all BU’s. And this likely requires a more fluid structure than a company like Danaher. This was a comment from Leonard at CSU's Q&A in 2018:

"An important item to keep in mind, is that we are not doctrinaire about organizational structure: we are willing to cater to exceptional people with exceptional talents who wish to ply their trade using unique reporting relationships or capital deployment models."

Some CSU BU’s can report directly to Operating Group Managers who report to Leonard. Other BU’s will be grouped together and report into a ‘Portfolio Manager’ (PM) who reports into an Operating Group Manager. We also estimate there are over 120 M&A professionals across the organisation working alongside BU managers and PM’s. The role and responsibilities of BU managers and Portfolio Managers is also unclear from the outside and is likely set on a case-by-case basis to optimise the allocation of FCF at each BU.

If Danaher has the DBS, Leonard has built an adaptive system that has institutionalized M&A principles all levels of the org. These M&A principles filter down from Leonard to Operating Group’s who train Portfolio Managers. The idea is that PMs can scale their BU’s into an Operating Group at CSU. Like Topicus, at a given scale, Operating Group's can then be spun into separate listed entities and the process repeats.

What’s also interesting is that even though CSU is decentralised, it has a quasi-middle management layer. Although it may not be defined as middle management, Portfolio Managers oversee BU’s and report into Operating Group Managers. CSU’s Portfolio Managers seem very similar to Halma’s Divisional Sector CEOs. Halma also has a VP of M&A working alongside Divisional Sector CEO's, similar to how CSU has M&A professionals alongside Portfolio Managers.

On the face of it, Halma has a similar org structure to CSU. The only difference is that the opcos don’t have full P&L responsibility like Business Units at CSU. This makes it difficult for Halma to push M&A responsibilities right down to the opco level but the Sector team is somewhat similar to CSU’s Operating Group and Portfolio Manager relationship.

Could Halma scale to 100 acquisitions per year?

We believe it's possible.

But one limitation could be the type of underlying companies Halma acquires. For example, Halma owns a gas detection business selling portable monitors to oil and gas customers and a cardiovascular business ambulatory blood pressure monitors. The range of expertise and knowledge of technical products, customers, and end markets makes it very difficult for opcos to stay ahead of the curve without an experienced opco CEO with full P&L ownership. It’s also difficult for CEO's up the chain, the Divisional CEO and the Sector CEO, to fully understand each potential acquisition.

On the other hand, Vertical Market Software businesses are not only higher quality companies, but also seem easier to manage and understand. This lends itself to a higher velocity of acquisitions. Constellation also prides itself on the fact it has only ever sold one business it acquired. A decision Leonard has since said he deeply regrets.

Between 2003 and 2006, Halma sold 14 businesses and purchased 7. This highlights the difficulty in acquiring and consistently growing opcos across such a wide range of markets and business models. Also, because of a lack of true opco P&L ownership, when an acquisition goes wrong, it’s very hard for Halma to turn it around. This can lead to regular disposals.

This could suggest Halma has a higher terminal value risk than CSU. Accumulators like Constellation may cover a wide range of end markets but every opco is VMS. Narrowing the focus can reduce the TAM but arguably reduces the terminal value risk of the parent company.

There is no doubt that Andrew Williams is one of the best UK capital allocators over the last 20 years. Building new platforms is difficult and Halma’s move into medical and life sciences has proven very successful. However, if Halma is going to 10x the business we will likely need to see one of two things:

1. Many more acquisitions per year

2. Fewer but larger acquisitions

The first strategy requires Williams to delegate more M&A responsibility down the organisation at both the Divisional CEO and opco level. It’s possible, but it could be difficult to train M&A principles across such diverse opcos and end markets. Counterintuitively, Williams' could be the limiting factor for Halma in this case.

The second strategy moves Halma even closer to Danaher. It will require a focus on fewer, larger acquisitions and a DBS-type culture to drive post-acquisition returns.

Both strategies are difficult and are human problems to solve. This is why most acquirers never break the 20 acquisitions per year level and returns revert to the mean at a certain scale.

Either way, there is enough runway for Williams to bolt-on 10-15 acquisitions per year with a focus on the medical platform. This will lead Halma to compound FCF at 10% per year but is unlikely to reach CSU-level returns.

It’s our mission over the next 6 months to truly understand how such businesses are organised and what ingredients can fuel decades of acquisition-led growth at scale. We still have many questions outstanding from this work so please reach out if you think we’re missing anything.