Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I think a good place to start is the relatively large new acquisition they have made. Does anyone have any thoughts on Geotek and when that hit press?

Analyst 1: I was happy to see a deal because it is one of the things that was a missed opportunity for Judges in the last few years. One of the reasons why it is such a good capital allocator is because they are so disciplined. But there is also a flip side where they may not be as active in periods where you want them to reinvest capital. That has definitely been the case in the last five years. I heard that it was something that was in the works for a while, from various investors that have spoken with David.

I was very excited but I was also curious to see how they came up with valuation of £6.5 million of pre-tax EBIT that they had. From what I've seen, at Companies House, for example, it seems as if there were a lot of variations, because of Covid. There is still a lot of risk, in that sense. But at first glance, I was very happy to see them putting their capital to work.

Isn't that a pre-Covid EBIT number? I think they've priced it on a normalized EBIT?

Analyst 1: I think it was averaged over three years and there were definitely some variations.

Analyst 2: I have similar thoughts. When you look at the last five years, the reinvestment rate had gone down. The internal discussion we have is, of course, the future return on Judges is dependent on the reinvestment rate and what sort of multiples they end up being. You can model different scenarios.

I would say, overall, it was definitely a big step in a positive direction. It could turn out to be an outlier case but we know how David operates. He is one of the managers I would say I trust the most, in terms of the whole portfolio, so I am not worried about misallocation of capital. I just want him to deploy as much as he can. The biggest question for Judges is, what will their reinvestment rate be, in the future?

This alleviates it a bit, saying they are willing to be a bit more aggressive, in the sense of paying a slightly higher multiple for the size. There are some parallels to Constellation, if you think about it. Overall, I see it as a positive. It doesn't fully answer the internal questions we have as to whether their reinvestment rate can be high because it's not VMS where you can do programmatic acquisitions; it's a different animal.

Analyst 3: I was surprised when I read the press release, thinking it was much larger than the typical deal and a slightly higher premium than they typically pay. I'm not sure what I think about it yet. On the one hand I think, yes, it's nice to see them going for it. But it's a large deal for them. I think the management team have earned a measure of confidence and support from shareholders; their track record is really good. When I talk to people about Judges, the first complaint I always here is, their acquisitions have really slowed down. To the comment that was just made, one investor I spoke with said, they need to do what Constellation has done and lower their internal hurdle.

When I was at the shareholder meeting, a couple of years ago, there was a shareholder in the audience who, for 10 or 15 minutes, held David to task. I think this was right after a two-year stretch where they hadn't done any deals. They asked what was going on? Maybe things have permanently changed and you guys are being too cheap? Maybe you just need to pay higher multiples. Agree or disagree, David stood his ground and said, I don't think things have permanently changed. We're aware of every deal that happens in our space; we know very well what is going on. We think there is a lot of cheap money floating around and prices are artificially elevated. He said he would rather return capital to shareholders than overpay for an acquisition.

The entire board, sitting up there with him, chimed in their support. They are very disciplined. I can't see them pulling a Constellation and lowering their hurdles. I think they are going to continue doing what they've done; it's worked so well for them.

I would be lying if I said I wasn't a little nervous about this deal because it's bigger and it's different. But they've earned my trust so I'm interested in seeing what happens with it. One other important point is that their organic growth has been pretty strong. David always gives Mark credit for that. Their organic growth has been interesting. I don't know what the latest number is. Last time I remember looking at it, it was high single digits. Judges is still relatively small; they still tout the pool of 2,000 candidates.

It's easy for outsiders to say, what are these guys doing? They just need to pay up and lower their hurdle. I'm going to defer to the guys that have done it and trust what they say and hope they can continue doing what they've done.

Why do you think David is so good? What about him makes his such a good capital allocator?

Analyst 3: I think the whole team is really strong. I have three interns working for me this summer and we've just finished reading Quality Investing and today is our last day discussing the outsiders. One of the points here is that charisma is over-rated. David certainly has a certain amount of charm, for sure. I have so much respect for Mark and Brad, but they're just competent guys; I think they do their jobs very well; it's not glitz and glamour. They are just laser focused on that order intake, that graph that they put together, on supporting their companies and investing in those that have the brightest prospects. David is laser focused on the deals.

If you go to the website under the acquisition section and David's name is on there. He is the one, I guess, still negotiating the deals. I think he just gets it. His background is a turnaround guy and, building this company from the beginning, he just understands. What they have done has worked; the formula has worked. He found the broker, who introduced him to the first company and found this little niche that is phenomenal. In my first conversation with him, back in 2018, I asked him how they had been able to create so much value via acquisitions when a lot of companies just vaporize value. The wording he used stuck in my head. He said, because I'm scared. Those were his exact words. He said, every time I sign on the line, I'm scared; I've got all my net worth tied up in this. I've got friends and family who are shareholders, and I'm scared we are going to do a bad deal.

He said, I know you are going to ask me about succession. He said, the biggest question for me is, can I find somebody who is going to be as scared as I am. I think he just wants to make sure they don't do a deal, just to do deal, that they don't overpay. They've done 20 deals; that's not a lot. I just think he's very, very careful. He had two years when they didn't do an acquisition, but there was a year when they did three.

I think he takes his job very seriously. He is still one of the largest shareholders and he has proven that he knows how to deploy it and that the model that they have designed works. I think he is successful because he is scared. He is very, very careful and he is an owner-operator. When I asked him what he was most proud of, he said, the value we've created for shareholders. He said, we could be a billion-dollar company if we wanted to be; the Street are always bringing deals to me. I could pay myself a million dollars a year, with a million-dollar bonus, but we would have issued so many shares, we would have diluted shareholders so much that the only people who would have made any money would have been the investment bankers. I think he gets it. He has so many things you look for; it's his legacy. It is about building a phenomenal company and creating value for shareholders and, in my opinion, nothing else.

Analyst 2: I completely agree with that and I think that his conservatism lets investors sleep at night. With Judges, you don't feel any stress. You know it is going to be business as usual. Internally, we think about it as, which of our company managers would you trust your wallet with and not worry about it. With Judges, I think David and the team would be right up there. Their integrity is top notch; I would rank them the highest, in our portfolio, in terms of integrity and consistency of what they say they do. That's rare.

The power of not having to worry about what the CEOs will do, and you just completely trust them is, in a way, a superpower. For us, it's a decentralization where you know they are going to manage it perfectly well and you don't have to worry about it. Of course, we still have to make sure that they will generate the maximum amount of EVA they can and that is our job.

Going back to the acquisition, it's very big. It's huge and it's based on pre-Covid numbers which, arguably, is probably normal for acquisitions that have been done over the last year. One thing that stuck out to me was that 2014 to 2016 period where I think two of the largest acquisitions that Judges has ever done – Scientific and Armfield – arguably, to date, have been failures.

It is obviously very hard to understand whether this could be the same but how do you think about the risk that such an acquisition puts into the business? If we go back to that other period, where there were less businesses – I think there were 14, 15 businesses in 2014, 2015 – so maybe those two businesses had a much larger impact on the whole group. But this business is sizable and if it does go wrong or is miscalculated in any way, especially based on pre-Covid numbers, maybe the stock could lose three years, again? I don't know how to handicap that.

Analyst 1: Yes; I think that's a big risk. That's also why I thought about the variability between the three years that they have taken to do the valuation. If you actually pair the less than expected performance with less than expected reinvestments, at the current valuation, it makes it very difficult for the stock or share. They probably don't think it's the same, because they wouldn't have done the acquisition if they did. But with such a big acquisition, maybe it turns out that such relatively large acquisitions are not really for them.

Has anyone spoken to David about those acquisitions or that period, specifically?

Analyst 3: I sent Brad an email to set up a call but we haven't been able to set it up yet. It's a valid concern, for sure. It does make me a little nervous. When you think about it, this is their 20th deal; two that haven't been successful. I guess you should probably look at it in terms of capital instead of just quantity?

It's the weighting?

Analyst 3: Yes. I'm sure, if you dig into any of these serial acquirers, there is going to be some deals that were successful. I'm sure the same has happened to Constellation.

It's obviously very different when you are doing 100 a year? We can also talk, later on, about comparing the serial acquirers and comparing how to look at the portfolio. Obviously, Judges is much smaller and has a much lower hurdle to grow organically. But one thing that stood out to me, in studying the history of Judges, was that stock did seem to go nowhere.

Armfield and Scientific are really painful for David but I am not worried about that aspect of it. Of course, it is a risk.

How much do you know about David's process and the whole funnel, in terms of getting companies into the system? From my understanding, he actually outsources a bunch of the DD. Obviously, you have got to outsource the legal side.

Analyst 3: I don't know much about the due diligence, but I'd love to know more, for sure.

He speaks to the management and he, obviously, understands the business.

Analyst 2: Where did you get that information because my understanding is that, pretty much, he sits there, waiting for the phone to ring, somewhat like Buffett. As opposed to Constellation, which have a machine. I was not of the understanding that they outsourced the due diligence.

Executives that we've spoken to have said that there are commercial DD players that come in and do that kind of work. They do a fair bit of work on providing the reports to David. Obviously, David does get involved with the management and does that negotiating part of the deal. Maybe that's to do with how niche the businesses are and that they are private and fairly small, so there needs to be some kind of work around it, to give him information. I expected more to be done in-house.

Analyst 2: My understanding is that he's really in the weeds on the acquisitions and that is where he spends his time. Mark does the operational bit, once they're acquired. Brad is more on the finance side. His main job is to get the acquisitions and the due diligence. I don't know the exact answer to how much time he spends on it, really.

My expectation is that if you combine what we know about him, saying he's risk averse – you could say conservative – really cares about trading value then, by definition, he would try to make sure these are really right. I know cases where he has passed on stuff, where they say it's lower quality and then, SDI, maybe their one public competitor, goes and acquires it. He does take a really deep look into what he thinks fits the quality bill, for him and Judges.

Analyst 3: I'd love to know more of the details on that. If it's a matter of having auditors come in and look at the books, that's one thing. My assumption was that David was very involved and they talk repeatedly about how the engagement with these targets can take a long time. On the website, they talk about how they are always dealing directly with management. My assumption was that it was David and, maybe, Brad and Mark, talking with company management and understanding the market and the position this particular target occupies in the market. To me, that's the big thing, as well as understanding the team they would be inheriting and what the opportunities are. If he's bringing in an auditor to look at the books, I think that's smart.

Of course; I think it was more the commercial side. I don't think it's necessarily a problem. The other thing is, how much does David really know, or even need to know, about the specific end markets? They are obviously highly technical and niche businesses. It's very different from Buffett knowing insurance or Buffett knowing Coca-Cola; it's a very different type of investment. I just wonder how much David is involved in handicapping or understanding the product positioning of every company. I would be amazed if he actually understood the product position of every company in his portfolio and the potential risks to the technology.

Analyst 1: I think it's fair to assume he probably has a deeper understanding than we could have, but definitely not as deep as the managing director of the business. I don't think he really needs to get that deep to get a feel for the business. That is partly because, obviously, he has 20 acquisitions to have an idea about. Usually, the managing director remains.

Which is probably why he doesn't pay up.

Analyst 3: I would assume he understands a fair bit. If there is a list of companies they have been watching for a long time, they have multiple conversations with some of these companies, maybe it's a no for three years and then it's a yes. For most of these companies, it's an engineer or scientist who work for somebody who worked at a university, had an idea, started his own firm, spent 20 years building it and then said, what do I do now and came to Judges.

He's a sharp guy; he's surrounded by bright people, such as Mark and Brad, but also the MDs at the other company that are engineers and scientists. I'm going to assume that the target is going to educate him enough for him to feel comfortable and, obviously, he's going to be looking at the numbers and the numbers should speak for themselves. If they've got a strong position then that should show up in profitability and returns.

They've only done 20 acquisitions so, clearly, he's passed on some stuff, so I'm assuming he's giving things a very close look. The MD has got to sell it and say, this is why this is a great business and this is why we are in a great position. I'm assuming he doesn't take this lightly and gets as much information as he needs to feel comfortable.

Analyst 2: Of course, not paying up for acquisitions is a protection in itself. But there is another reason why David has been quite reluctant to pay and that is mainly because, once you drop the hurdle rate, then it's very hard to go back to keeping it at the same level. He has been very careful to not do it for smaller acquisitions. I think his rationale was, focus on a bigger one that we really like and we can pay up, but we can still then say, if some smaller acquisitions come along that that multiple was only for the bigger ones and the lower multiple for the smaller ones. I think that is how he is thinking about it.

How do you think Mark and David work together?

Analyst 3: Every indication I've seen is that they work together well. In the conversations I've had with both, they are complimentary about one another. Seeing them interacting at the annual meeting and in the videos, I think Mark has respect for what David has built and David is thrilled with what Mark has brought to the team, given they didn't have a COO before. That is my impression; I hope I am not misinformed.

I think Mark would probably be one of the candidates when David finally retires. I think Brad could probably do a phenomenal job, as well. My impression is that they respect one another and work together well.

Is he the successor?

Analyst 1: I think he is probably the successor too but I have actually been looking back at the older presentations, since Mark joined. Basically, Mark's role and what he is doing in the organization has become more and more prominent. He is talking through what he is doing with all the new companies that are coming into the group, and companies that are already in the group. I definitely think his experience Halma and what he has done with Judges Scientific, for the last few years, means I would be very comfortable with him as a CEO.

I probably marginally prefer him over Brad but that's really because Mark has the operational angle which I think is very valuable. If them working together is a sign of anything, I think Mark has been getting a much more prominent role in discussions when the earnings are presented and I think that is a good sign.

Analyst 3: That's a good point.

Given the expertise and how niche the segments are, that Judges operates in, how do you think Mark or another successor could take over? How do you think about the risk that Mark could fully execute on what David has done? Would he be as scared as David?

Analyst 2: I think there are two elements to that. Firstly, I don't think David is anywhere close to retiring. He loves what he is doing. Even though he is 70, he has not ever indicated that he wants to stop. He started relatively later in his career, so he still wants to continue this. We are not really worried about succession, in the near term.

Longer term, I'm sure David will have that in mind and, with Mark, I think he has been a great addition to the team. To bring that analytical rigor and operating experience from Halma to benchmark all companies against each other, to pull companies up, to create a scorecard across the board and see how they can push each other to be better, I think that has been great for Judges. I think there is a great amount of mutual respect amongst all three that seems to come across.

That's not my big concern in the short term and, in the long term, I think Mark is extremely capable. I think David has a certain charisma to him and maybe that is something to think about in terms of attracting founders or people to sell to Judges. I think that will change if he leaves, at some point. But in operational terms and being able to do the job, per se, I wouldn't be worried.

Do you think Judges could become a mini Halma? Halma has 50 odd companies. They have merged many of them together, in the past, sold a few and grouped them together in different categories. They are not purely decentralized, like Judges. Do you think Mark could take it that way or is this segment somewhat different from what Halma operates in?

Analyst 2: I think that is somewhat related to my big open question with Judges. For the lack of a better way to put it, how big can they be? In other words, how big is the market for acquisitions? Obviously, the larger it gets, the more it takes to move the needle. As we discussed earlier, there is only a certain amount of companies, which is both a strength when you are smaller, because there are less people who are interested but, potentially, a weakness as you become larger and larger.

Then the question is, when do you draw the line and when do they hit a ceiling? I don't know the answer to that question. I think they are still relatively small and the runway is large. I would be curious as to what other people think?

Analyst 3: I agree, mostly, with what you said. I think they are still small enough that it is not a huge issue for me, at the moment. I think Halma is a high bar. Can they get that big? I would say that I am skeptical. I haven't straight up asked David this but, for sure, they have learned from Halma. When they hired Mark, they interviewed three other candidates and all three were from Halma. I think they've certainly taken some inspiration from Halma which is not a bad role model, at all. I don't think size is a goal for them. Either it's just about creating value, deal by deal, and running them better.

Halma do various different things. As I said, they've merged entities, they offer private label for some brands and they sell from the US office for the UK brands. They really try and drive synergies, both on the cost on revenue side. I don't how applicable that is to Judges, given how niche, small and unique those businesses seem to be, unless Mark or David eventually do take it – as we see with Geotek – move up the size of the acquisition which could then make the economics work, if you want to start merging stuff and doing more operational changes?

Analyst 1: I would say that has been more of a recent thing; recent to Halma's history.

Yes; in the last 10 to 15 years. Since Andrew Williams really took charge properly, in 2005, he has spun out five or six businesses and then started to move into a different area, group them together and change the org structure.

Analyst 1: I believe, before that, it was a bit more similar to Judges Scientific but, even then, when all that started happening, Halma was multiples the size of what Judges is today. I think there is still a bit of runway until we hit that point but I do agree that the specialized aspects of Judges makes it a bit less conducive to that type of strategy. But if you look at Halma, right now, lots of their acquisitions are mergers and they have the same number of operating groups over operating companies, but twice the revenue. Basically, that's twice the revenue per operating company that they had 10 years ago, I believe.

It's very difficult, it's very different but also, the scale of the business is just magnitudes larger.

Analyst 2: One point on that is, usually, great companies, with experience, find a way of figuring it out. For example, you could look at Constellation expanding internationally, finding new geographies, or going into new sectors. Maybe Judges is sticking to what it does right now, because it doesn't feel the need to experiment or push the envelope because they are achieving whatever they need to, without having to do slightly more risky things.

If push comes to shove, there is optionality there and we just don't know what that could look like. That is just something to keep in mind. It is not necessarily that they constrain themselves to these 2,000 companies that you keep hearing about.

Analyst 3: At some point, you have to look at the track record, look at the margins, look at the returns, look at the growth – albeit lumpy – and that 10-year stock chart sure is nice. You've got to look at the management team and you have to trust them. For me, when I am evaluating is a company, it's all about free cash flow yield, so I try to model out cash flow over five years. Five years out, under conservative assumptions, if the cash flow they are generating in five years out looks attractive at today's price – double digits – then it's interesting to me.

In terms of modeling the growth, if it's an organic type company and you are looking at growth in units, it's so tricky. Maybe this is my simplistic mind, with serial acquirers, but I take comfort in the fact that they are going to grow because they are going to acquire something. Sometimes, it's counter-cyclical. Lifco is another name that has been in our portfolio for a while and, during peak Covid, they bought five or six companies, over a matter of months. They could scoop in and pick up some companies at really attractive prices.

At some point, the law of large numbers starts working against them. I would say that Constellation is probably one in a million. I've owned it for a few years but to me, at this point, I'm not going to lie, I'm getting a little concerned. They talk about decentralization and I remember one of the big deals with Mark. When they used to do the breakfast, somebody asked him, why don't you centralize some of these functions? Don't you think it would make sense to centralize purchasing? He said, no; I don't believe in that at all. In fact, the opposite. He said, what you might gain in efficiencies, you lose in entrepreneurship and ownership.

I believe in that and I've seen it work, but it's one thing when it's a $400 million market cap company with however many people, but when it gets to the Constellation size and they are trying to do 100 acquisitions in a year, it makes me nervous. There is nobody I have seen who has been able to pull it off, other than Constellation.

Why own Judges over Constellation?

Analyst 3: For me, I didn't have to choose. We happened to start our position with Judges when we had the taper tantrum, late 2018, when the price was attractive. We doubled our position in March 2020, so it was about price. Honestly, for me, Judges was a whole lot easier to understand. They've become so secretive the last couple of years that, to me, it has sort of turned them into a black box.

This is why I don't own Brookfield Asset Management; I don't understand it. If I woke up tomorrow and the stock was down 30%, I wouldn't know what to do. To me, l like Judges and there is a beauty in how small some of these businesses are. This is why they don't have a lot of inventory.

The underlying assets are somewhat the same size, on average. I think Constellations buys for $4 or $5 million; it's roughly the same.

Analyst 3: Yes, that's true.

It's just the size of the entity that makes it attractive, in terms of the lower hurdle rate to grow?

Analyst 3: It's easier for me to wrap my head around Judges. I can't keep up with what's going on at Constellation on a daily basis. You have all these entities doing their own acquisitions, I can't even stay on top of all the press releases. Their communication with investors used to be phenomenal and I hate the fact that they've gotten secretive. I'm not assuming anything nefarious; I think Judges does a great job on the investor relation side and all the material they put on the website. At a previous company I ran, we had 6,000 people and so I know the problems we had; I don't know who even owned anything in the portfolio larger than that, I understand that size. To me small is beautiful, I guess that's the answer for me.

Analyst 2: I think that's the best way I would summarize it. I have the same feeling. I think both are amazing companies and Constellation has a longer track record and there are a lot of similarities too you could say in terms of how they do things. But just in terms of being smaller, it gives me a much easier or better handle on how things are doing. You can individually go and look at every subsidiary, for example; you can go visit them, which help and I think it comes down to that.

Doesn't that make it also riskier though, given this Geotek acquisition, for example?

Analyst 2: Yes, you could argue that. There's a different type of risk with Constellation; they're bigger so there's a different risk there. How long can this keep going on for is maybe a bigger question for them than for Judges. In other words, the high reinvestment rates.

But for Constellation, the way I look at is you might not acquire 100 but you're going to acquire 50 or 75 and you might do a couple of big deals, whereas Judges, if they get Geotek wrong, that's a real problem?

Analyst 3: It is, there's no doubt.

On the other side of that, I modeled out 3% organic growth; I think the 10-year average is 5% or 6% organic. They basically have to acquire one company a year to get 10% revenue growth over time, which gives you a 14% IRR from here, which is a fairly low hurdle rate right, since acquiring one company you'd expect them to at least do that. They have done that over the last 20 years


Analyst 2: Yes, I would agree with that; I think they've been under levered in general. If you just think of it as purely debt funded, yes, do the ROE calculation on that. But basically, the point is that they could even push the leverage more if they wanted to, so that was just the point I wanted to make.

I wanted to discuss that because my pro forma numbers for the end of this year, 2022, I still get them at one times net leverage. Even then – I don't know how much they want to – I can't imagine him levering this up too far at all, but even 1.5 times doesn't seem too crazy for a business like this, so there's a bit of room to increase that.

Analyst 1: With 90% or 100% cash conversion there's definitely room to go, but preferably not. But if the opportunity presents itself, I don't see a problem either.

Analyst 3: I think that's just David. It gets back to his comment about being scared and he's 70 years old, the generation he comes from and in his prior job he was in turnaround. The bank sent him in to try to turn around entities that had failed and it's why they've only done 20 deals. It's why there's a little bit more of a focus on dividends.

Just on that point, has David mentioned what he's comfortable with in terms of leverage or what cash balance he wants to always run with as a portion of?

Analyst 3: I thought I had read somewhere that they were willing to go as high as 2.5 times.

Analyst 1: It's worded a bit differently. He said that he's willing to pay 2.5 times EBITDA for an acquisition, but basically, they use the cash flows to almost instantly repay the debt. So they are financing the deal with debt, but the debt isn't meant to really stay on the balance sheet, or it should be carried over, so it's worded a bit differently.

Analyst 3: This is where maybe the next successor could be a little more aggressive. Just like their high hurdle rate, I assume there's a margin of safety built into that because maybe they know that not all of these acquisitions are going to work out as swimmingly as they would like. It's funny, I used to hate dividends. Especially for a serial acquirer who's in growth mode, I used to bug some of these; it was one of the questions I used to ask all the time. Why are you paying a dividend; I don't understand, you're growing? Then I have got to pay taxes on it. A lot of these serial acquirers, especially in Europe – you look at the guys in Sweden – they at least pay a small dividend. I sort of come to the view that it serves as a reminder to the management team that, hey, this isn't our capital; this is shareholders' capital. There's an element to that that I appreciate and I think while David's at the helm, they're going to be conservative on all of these things and I'm okay with it. Look at how the business has done the last decade.

You could also run this as like a very mini, lowly levered recap, where they just keep paying out special dividends, because they have enough cash. My model just goes to 7% inorganic growth and you don't need to require much revenue; seven million, eight million, nine million, 10 million in dollars and pounds in revenue every year for the next five years. Which is pretty much one or one and a half companies at least, and therefore if you're doing that at the similar price, you can pay out special dividends every other year almost?

Analyst 3: Or buy back shares.

Or buy back shares, yes. What do you guys model out in terms of acquisitions or revenue growth to get that free cash flow? How do you look at the next 10 years? What do you expect; do you expect one acquisition per year?

Analyst 2: I think quite similar to what you mentioned, high level and the outcome also. I think, in my mind, the range of outcomes for Judges is somewhat lower than other companies in a sense; I think it's unlikely it will do much worse, or much better. It's a way for me to say I feel quite comfortable and confident in how they will do. I don't think it's going to be the highest compound rate in the portfolio and I don't think it will be the lowest, but I think it will be the most steady and I feel quite comfortable with it and the one stop which lets you really sleep well at night. But in terms of assumptions, I think it would be similar to what you said about high level. The biggest question is about reinvestment rate. I am less worried about the multiples that they pay because we know how David operates and how he thinks about things, and I think one acquisition a year is doable and the numbers you laid out are quite doable and that's what would roughly be my base case.

Analyst 3: Yes, I agree. I think with a combination of organic growth and acquisitions you can easily get to 14%, 15%, 16% CAGR on it. There have been periods where it's so illiquid, it's crazy; it's the most illiquid $400 million company I've ever. At least for me, it's very hard to get a hold of shares. But I think in March 2020 it was down, it got cut in half, and so opportunistically, I add to the position when it falls out of bed. My target is, every 60 months double our capital. I would bet that money on Judges; they have certainly done better than that. You look at the businesses that they've acquired and the cash they generate and the pool they say they have, and you look at that team. David, Mark and Brad, to me, that's a stellar team and if you put all of it together, I'm confident they're going to outperform the S&P 500.

What worries you most?

Analyst 3: What worries me most right now is this big deal and, other than that, just the macro. David constantly talks about how, for many of these instrument businesses, a lot of them are universities funded by the government. If things get really rough, I suspect some of that funding may disappear, so in the short term I'm a little worried about the macro.

Analyst 2: What specifically worries you about Geotek? What's the concern? That it's bigger? Is it just a size thing or is there something else?

Analyst 3: No, it's a size thing and it's hard to find info on the business; I don't have a good feel for the business. I'm not saying it's completely rational but it's much bigger than any deal they've done before and there's a lot riding on it. On the flip side, I'm going to assume they know all of that is true, I'm going to assume they have done the necessary work to get comfortable with it. But yes, it makes me a little nervous because it's a big deal and yes, if things go wrong, we had a couple of those that didn't work out before and they had three years where results were not great.

Yes, that wasn't in a recession either. What happens if you get a double whammy with that?

Analyst 2: I guess there's an element of the larger deals they have done have not worked, but in terms of hit ratio, if you would say two out of 20 didn't work you would say you would take that any day.

Analyst 3: For sure.

Analyst 2: Yes, but I guess the larger ones haven't worked and I think you wrote in your note, Will, that they still have done stunningly well?

That's kind of the beauty of these models, that you might lose two or three years but then once the reallocated free cash generates more free cash, it catches up and then you restart the compounding, although this one could make a dent in that if they do get it wrong, but we shall see. How do you compare Judges to Lifco?

Analyst 3: Lifco is an interesting one; I think the management team is just absolutely stellar. There's something about the Swedes. I think they have a disproportionately high number of companies who really seem to get capital allocation and management teams that focus on returns on capital. Lifco is a little more complicated because they've got the dental division, they've got the systems division, they've got the demolition; it's different, but I think it's a great business. I think they've done a great job. Once again for a simpleton like me, simplicity gets bonus points, but for Lifco, it was same thing; when we jumped in it was pretty cheap.

They have also hundreds of companies as well; it's not like 20. It's very different in terms of the size; similar sized companies but just five times more.

Analyst 1: 400 or something; 200 operating groups or something. It's enormous.

Analyst 3: I mean they announced an acquisition, last week or the week before, of this little company that had five employees. In the press release it says, this will have no material impact on our financial performance, but it doesn't keep them from doing these. But still, I like them; phenomenal record. Carl Bennet who owns half the company, I think is a legend.

One thing I want to just quickly raise before we close is about what I wrote this in the piece a few weeks ago. Obviously, just doing a bunch of work in all these different companies – Lifco, Halma, Diploma, Constellation, there's many of them out there – and Judges is its own smaller unique version of that, one thing that puts me off Judges slightly is at this stage – it's a double-edged sword – you can grow quicker but there's also more risk of getting the acquisition right, especially with Geotek, for example.

The other thing that I find interesting is that because these businesses are arguably much more technical and much more niche than your average VMS business, plus they are lumpier in sales – which is great because they have competition – that also means that it's a capital sale with a long life cycle, with long R&D cycles. Typically, you also get the management that leaves after one or two years, so for the original core business, if you have arguably the people with the most knowledge that have left, you are relying on the structural elements of that core business, the market share and, basically, the technology not being obsolete for you to get an IRR. If and when that does go wrong, like Scientific and Armfield, David and Mark and frankly anyone is probably not in a position to turn that business around.

If you can compare that to VMS, you have much shorter feedback loops for your customers, you have embedded recurring revenue, you can add features, you can increase pricing much easier and you have much shorter R&D cycles. It seems to me that it's much lower risk, even if you do get something wrong. Some of the stuff we've done on Topicus and Constellation, because it's so mission critical and sticky, you have two years to turn it around with the customer. I just think that feedback loop makes the terminal value risk so much lower in Constellation buying a VMS business at five or six times EBIT, than Judges buying a very niche instrumentation business at six times EBIT. It seems to me that Constellation is a much better business?

Analyst 1: Yes, and I think your observation is pretty spot on, but I think it's more a testament of how good a VMS business is, especially how well suited for a roll up, as opposed to maybe that most SMBs operate in a very similar way to the companies Judges acquires. The VMS business from Constellation Software's perspective or any subsidiary that has the capital allocation, they just acquired a new software business, it doesn't really matter about the exact vertical, it's just software and then they have the people with the know-how.

It doesn't mean they can't be great investments to different sites, it just seems to me, timing Judges is much more important. Obviously, the valuation matters for both. If they get Geotek wrong, that could be a serious problem for the equity, over the next few years?

Analyst 1: In this cycle, for sure. But maybe that's where you can have someone maybe like a Mark that could get even deeper into the core business.

It says it has services in this business, which is the first time they've actually moved into having somewhat recurring revenue baked in.

Analyst 2: I was just saying that I would maybe invert it and argue that Judges is a niche thing where there is only one or two players, they acquire these companies, so there's not much competition, both in what these companies do, and also in their acquisitions. If you talk about Constellation and VMS, everyone is jumping on the bandwagon and saying, I want to acquire VMS. If you look at it from that lens, you could say, VMS is great, now everyone is talking about wanting to acquire software companies, and then you could argue, that means that sounds like Constellation is much more risky because they are just putting a different lens on it.

Right; if they start paying 10 times EBITDA for everything, then yes. But even if they pay one times more, as long as they can do these at scale, you might get five percentage lower IRR but for the actual risk, not too hard.

Analyst 2: I get comfort for Judges from firstly, as I said they're nichey. I have gone and visited these companies and the sense you get is very specific, engineering type of stuff, and there are one or two competitors, there are not many people doing this stuff. I get comfort by looking at the historical financials and your point is valid; if Geotek is a dud, then of course we take that risk.

And I'm not even saying it just for Judges, I'm also saying for Halma. Halma is obviously different but is somewhere in between. It's in between Judges and it's in between Constellation. They have 40 to 50; they merged them; they operate in different segments. They're all very different. They actually have some level of middle management that doesn't necessarily deeply know the business, so if that goes wrong, you are almost writing that off in a way, so yes, it's interesting. They're different, there are similarities but differences across them.

Analyst 2: Roll ups are an interesting case study investing within itself; they're like a whole spectrum of roll ups.

Analyst 1: Let's pose the question maybe in a different way. Would it be a larger risk if Judges was actually larger and doing more deals a year? Now, in the current structure, they're actually very small, and they have the ability, when they do a deal, to actually focus just on that single deal, instead of spreading their attention over several deals with these very specialized businesses. Because they are right now small, that actually lends itself to do a deep look at those businesses.

If you look at the return on equity and the prices they're paying for these businesses, and then the relative risk that every incremental acquisition poses to the business, I would rather them move a bit quicker and pay a bit more, than move slower and do these bigger ones like Geotek. I think that adds a level of risk. I would rather them take a lower ROE or pay a turn higher, and do two or three a year and get to scale. One Geotek is not going to potentially put the business at risk for the next two to three years, but that's just my personal preference; maybe David has enough confidence?

Analyst 1: It seems like Geotek is, I won't say a one-off, but it's definitely a departure from what they have done historically in a sense. We mentioned there were two larger acquisitions, both unsuccessful unfortunately, and that was almost a decade ago, so in that sense it seems like an exception. But an exception that if it goes wrong, like you said, could definitely hurt shareholders.

Yes, but it's also part of the benefits of being small.

Analyst 2: I would say that I know that David has been mindful of the big acquisitions not doing well in the past, and there's some level of comfort and trust, given you know how diligent he is, that he would have decentralized that due diligence responsibility on him. Trust in him; he knows what he is doing. He would have spent extra effort to make sure this is not going to be a dud.

Let's just see what happens to Geotek.

Analyst 2: Yes; we will find out in a few years, or sooner.

Analyst 1: That is one thing I like with Judges, that they communicate with the market a bit more often. For investors, the feedback loop is very long, every six months or so; basically, three months after the end year results, we get a presentation. It would be nice to hear from them a bit more often.

What do you have it trading it at now? I have like 19 to 20 million pretty much free cash flow for this year; 22 million roughly the year after, assuming they acquire one a year. It's still trading at a massive premium I guess, in this environment.

Analyst 2: Yes, I guess that would be the main thing you could say, that if you really wanted to time it, there may be much higher IRR opportunities right now. That may be one lens some people may say okay, why would you want Judges when I could buy something that's, in this environment, maybe much higher IRR. That would be fair to potentially, to view it from that lens, but yes, it's not our game.

It's trading at 25 times free cash?

Analyst 2: Yes, so if we found something that was super interesting, that would be maybe the one thing put against it in this environment, but that's not their fault.

Analyst 1: I think 25 times in normal times for Judges, and I think that's a decent price. I definitely wouldn't say it's cheap, but I also don't think it's expensive. There are now some new risks with the Geotek acquisition. Yes, they have other opportunities but that's more a portfolio management question and not necessarily company specific in a sense.

We will soon find out.