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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.

{audio:0:00:20} Richard, can you share some context to back when you first joined Stockford, many years ago?

{audio:0:00:27} I was a Group Executive for St George Bank, in their investment services business. One part of that was a company called Silcorp which was one of Australia’s first and leading master trust in ancillary services. As part of their strategy, they were looking at how they would build an ecosystem and Stockford was about to go through an IPO at that stage. We got a very good price to go into Stockford, pre-IPO, and they were going to form an alliance with St George, to back up one part of their strategy, which was to build out wealth management and offer that through all of their rolled up accounting practices.

{audio:0:01:09} We did that investment and I was the responsible executive for that area, so I went onto their board, and that’s how I got involved in Stockford.

{audio:0:01:21} What was Stockford’s strategy?

{audio:0:01:25} They thought there was an opportunity to create an accounting practice of scale, by rolling up and creating a branded offering in the marketplace, around accounting practices. They were acquiring practices for somewhere between 0.9 times revenue up to about 1.2 times revenue, depending on the type of revenue. They were looking at how they rolled up those practices and they thought there was a significant arbitrage between what public markets would reward and what they could acquire that revenue and those businesses for.

They had a focus on small business. They also had a focus on the entrepreneurial side of it and then on the larger private clients. In that sense, it is a bit like Kelly+Partners.

{audio:0:02:20} So focusing on SMEs but also trying to cross-sell wealth management business?

{audio:0:02:27} Pretty much, but behind every small business is a small business owner and so it’s the wealth management around that entrepreneurial area; that was where the focus was.

{audio:0:02:40} Is that where all of these businesses eventually head? Is that where the money really is, in the long run, in terms of getting hold of those assets and managing them for the clients? Stockford, Kelly, WHK and these other businesses all seem to gravitate towards getting access to wealth management business.

{audio:0:03:02} That was clearly WHK, right from the get go. They did a far better job at integrating the wealth management practices into the accounting firms. It expressed an interest in understanding why the central costs, within Stockford, were so high. They wanted to create value for the group by doing wealth management out of the central practice and then do a revenue share, back to each of the practices. All of those costs for marketing the wealth management practice and some of the related infrastructure for the wealth management were borne by Stockford central office and they would be distributing some of the profits back to the practices that had been rolled up.

{audio:0:03:50} That never really occurred so the costs were never really fully recouped. Whereas in WHK, the IFAs were put out into each of the practices, to the best of my knowledge.

{audio:0:04:00} So Stockford actually had all those IFAs at a centralized cost base?

{audio:0:04:08} Yes. In retrospect, I’m not sure it was ever agreed what those revenue splits would be and that created a degree of contention. The wealth practices never really got to any critical mass, through Stockford.

{audio:0:04:22} I guess that was also because the incentives weren’t completely aligned at the practice level?

{audio:0:04:27} In fact, I think that goes to the heart of the questions I always have around why do you roll up and why professional services? Rolling up is all about incentives. Are the incentives aligned? What are the benefits to the practices, to roll up? If it is purely succession planning and allowing people who have built a professional services practice to cash out and to keep running their business for a while, then I think it’s fraught. There needs to be some benefit to the roll up and I think those benefits really come from scale. There has got to be scale benefits and that can come from needing capital. I think that is probably the biggest distinguisher between that and the dentistry roll ups. Dentistry is, implicitly, a capital-intensive business and if you can provide the capital through the public markets, at a lower cost, you are benefiting everyone in your network.

{audio:0:05:22} But if you don’t need the capital – and pure professional services only need working capital – that capital benefit is not there. Then there is purchasing scale. I think you can scale on the cost side, how you scale up and grow. If you think about Steadfast, OAMPS and the other roll ups in the insurance market, they were based firmly on their supply arrangements. The bigger they were, the better deal they got from their insurance backers and the more they could then deploy capital into providing insurance agency and other related business. All of that just added a lot of benefit to it. If you also need to invest in systems, you need to disperse or defray that across a large revenue stream, so that’s another example of a scale benefit.

{audio:0:06:12} Apart from that, the other one is really cost of acquisition benefits, in terms of customer acquisition. That relies on practices needing growth and I’m not so sure that pure professional services businesses rely on growth. They are basically lifestyle businesses for the founders, but once they get to a certain size, they don’t really want to work that much harder, so more business is not really a major driver.

{audio:0:06:39} I think pure professional services, without either scale or acquisition benefits, doesn’t work particularly well. Whereas in other areas, where roll ups work, those benefits come through pretty strongly.

{audio:0:06:53} If you look at Kelly+Partners, for example, around 50% of the cost base is labor?

{audio:0:07:02} You might get some scale benefits on procuring accounting systems or software?

{audio:0:07:14} What are the real scale benefits from in accountancy roll ups?

{audio:0:07:18} For the large professional services firms, such as the EYs and the KPMGs, it is around their recruitment and workforce management. It is around recruitment, training and the ability to deploy larger workforces on an ad hoc basis, as well as on a consistent basis. But that’s not the small SME accountant.

{audio:0:07:40} Putting aside the fact that some of these guys probably don’t need or want to acquire more customers, even if they were, how does that work?

{audio:0:08:02} If you’ve got a one-brand strategy, which Stockford had, it made sense, because you could use that for customer acquisition; you would build a brand around that. Even then, that didn’t last very long because each of the underlying practices were, quite rightly, fond of their own name. So we ended up creating Stockford XYZ, to try and get some benefit from a central brand. At that stage, web marketing was not such a big thing; now it certainly is and can drive traffic. But the issue is, where do you get growth? In a public company space, you need the benefits of being a public company, at a lower cost of capital, but it expects growth and it expects that return on growth, which is savings and revenue growth. If you’re not driving that, I think roll ups are pretty hard.

{audio:0:08:55} From what I’ve looked at with regard to Kelly+Partners, they are trying to drive that growth and they are trying to drive the benefits out of it. They are focused on the right things; I’m just not sure the comparables in the insurance broking market are the same comparables. For instance, if you are an insurance customer, once you have sold them a premium, the repeat premium is almost locked in the bag unless you really do a bad job. That is similar in the wealth management business.

{audio:0:09:29} This comes back to your question. In all of these areas, what they really see, is their ability to create recurring revenue streams through wealth management and that has strong returns to scale. If you can build a large book of business, then you’ve got strong returns from scale, from having billions of dollars of assets under management. That is where I can see some scale benefits in Kelly+Partners, if they can really bring to life their wealth management aspirations.

{audio:0:09:56} It’s almost as if you are rolling up the SMEs private clients, to then get access to some of the assets that potentially have scale benefits?

{audio:0:10:10} We look at other roll ups in the financial services space and the IFA distribution and they haven’t been fantastically successful either. That’s because, basically, for professional services firms, their largest cost is people and that’s not scalable. There has to be those drivers of scale benefits or acquisition benefits into an organization that wants growth, for roll ups to be a compelling example.

{audio:0:10:38} Certainly, the arbitrage exists; public markets prepared to pay for revenue. But it means that you have always got to be on the acquisition trail and that’s hard yards.

{audio:0:10:48} You mentioned how, for the typical SME practice owner, it’s a lifestyle job and they don’t necessarily want growth, so why do they sell to a group such as Kelly?

{audio:0:11:00} I can’t speak for them, but if you’re in your late 40s or early 50s, you’ve built a practice and you’re finding it hard to get resources – and resources are attracted to bigger organizations – you’re looking at how you extract the value of all of the career that you’ve built in your practice. You can call it succession planning, but it’s actually a liquidity event for people that are either at, or can see, the end of their career.

{audio:0:11:29} One question I had was, why are accountancy firms partnerships in the first place? Why are the big four not public?

{audio:0:11:38} If you don’t need capital, then you’re looking at an earn out and, effectively, it is a structured personal services endeavor, I don’t think there is a real driving example into the public markets. From my own history, looking at Goldman Sachs and Morgan Stanley, when they became public, they did so because they became capital hungry, to drive their trading desks and their principal activities. But while they were just brokerages and straight investment and advisory firms, not doing much underwriting, the capital needs were incredibly light so the return goes to the people who are involved in the business. That sounds like a partnership to me; it doesn’t sound like a public company.

{audio:0:12:21} Let’s say, I’m running an SME practice and Stockford is looking to acquire my business. What would the typical structure be?

{audio:0:12:33} Stockford and Kelly are quite different; Kelly is probably much better aligned. Stockford bought 100% of the businesses, with some buy back entitlements for some of the people, for equity in Stockford. They were paying a little bit of cash out, but it was mostly in stock and they acquired 100% of the organization. The incentives were great while Stockford’s share price was going up. As soon as it turned around, the incentives were appalling, because everyone wanted to own their own business again.

{audio:0:13:13} So selling partners only received a very small amount of cash, up front?

{audio:0:13:18} Whereas, I think, for Kelly, they are really working hard on the lessons that are coming out of it and trying to make sure that their incentives are aligned. They’re trying to create perpetuity structures. Their 10-year automatic rollover is a way of making a partnership look more like a company; you’ve got longevity in the equity position or in the partnership.

{audio:0:13:44} Although it’s not clear what the break clauses are. There is a large minority interest in Kelly; all the opcos have 49%. How do you look at the incentive structure of that, where you have such a large minority interest in the business?

{audio:0:14:07} I think they’ve got an incentive to drive adequate revenue, at a practice level. They’ve got real incentives to drive cost. The way that they’ve structured debt, which is at the subco level, they’re creating real business incentives down at that partner level; I think you’ve then got to say, what’s the benefit of being together? It is either central cost benefits or customer acquisition benefits. Do the underlying firms want that growth and that customer acquisition? How much growth do they really want in their practices?

{audio:0:14:45} If it’s going to come to your wealth management, everyone is happy; or not unhappy.

{audio:0:14:50} Because the opcos pay 5% for central office management and another 4% for, effectively brand marketing, they’re paying 9% of revenues up to the holdco, anyway, just for running the back office?

{audio:0:15:07} Yes; and you’ve got to fund all of your technology out of that 5% and all of your operations. That’s a pretty light model, unless it is additive to what is already going on in the operations, in the operating companies. But I can’t imagine the operating company want to be putting as much as they can into that 5% and stripping costs out of their own business, to increase their own returns, which would be the smart thing to do.

{audio:0:15:34} What really went wrong with the incentive structure at Stockford?

{audio:0:15:38} While the share price was going up, the incentives were absolutely aligned. As soon as they were misaligned, people could see that a dollar worth of revenue was worth 2X or 3X revenue in the marketplace. There was real benefit to keep on driving revenue. Once it came down, people were worried about how much costs they were paying to central and what their returns were, coming from it, and they were then looking at the stock price going down. That became a negative spiral, in the sense that they weren’t seeing the benefit from central and they weren’t experiencing any benefit from the group. They were being asked to work hard but they were still earning a salary. There became a misalignment of incentives on the way down.

{audio:0:16:32} Could that happen with Kelly, if the stock turns?

{audio:0:16:35} Actually, I think Kelly has learnt some real lessons out of the roll ups. I’m not sure that they are going to get everyone to play nicely in the sandpit together, because they’re not owned. But all of them have an incentive to run their businesses well. That’s a great story. If everyone is running their businesses well and the central is adding value, either on technology, operations or other areas, then you’ve got a great platform; but where does the growth come from?

{audio:0:17:09} I think they’ve managed the downside well, relative to other roll ups, but my big question would be, where does their growth and their returns to shareholders come from, without just perpetual acquisition?

{audio:0:17:21} In terms of how the structure is different, in Stockford the partners received 100% equity plus maybe a little bit of cash. Kelly doesn’t actually issue any equity; I think they fund most of the acquisition with debt. Part of the working capital and vendor facilities are actually at the opco level, to make them really incentivized to run their business very lean. But Kelly only buys 50% of the practice. Does the practice receive any cash up front?

{audio:0:18:00} In looking at the prospectus, it looks as if the practices do receive cash; I’m just not intimate enough with the model. It looks as if there is fair value given for that 51%.

{audio:0:18:13} So the partners get a good payout on day one and then they are also part of a group that makes their life easier, plus they have an opportunity to grow?

{audio:0:18:25} Yes; and my guess is that there is an earn out; it wouldn’t just be all cash up front. There is likely to be an earn out, plus the existing partners are getting 49% of what they would have got before.

{audio:0:18:40} How did the practices at Stockford react when the share price went down?

{audio:0:18:58} The morale was not good, at the end of it. Some of the practices wanted to leave and they did have exit rights. The CEO really tried very hard to rally the troops, but once the incentives were misaligned, it’s pretty hard. That’s where Kelly+Partners have got it pretty much right on the incentive front. They are incentivized on both the upside and the downside.

{audio:0:19:30} I’m just thinking about how this structure is very different from a typical roll up. As you said, most other roll ups, that have real scale benefits, they can purchase 100% of the company, roll some of the earn out into the equity of the holdco and it can work quite well, if there are real synergies and scale benefits?

{audio:0:19:50} Yes. If you look at 1300SMILES and the dentistry roll ups, they’re actually fairly capital intensive and there is a benefit from being one brand; they need regular customer acquisition, as a core part of their business. There are two driving reasons to come together.

{audio:0:20:12} On the insurance broker roll ups, there are scale benefits wherever they look, both on the operating cost, on their core infrastructure, but also on their ability to buy insurance. Additionally, their ability, in the insurance agents, to create particular pools and get a better deal from understanding their customers’ risks and centralizing that risk.

{audio:0:20:33} What was Stockford’s growth strategy, in helping to drive growth at the opco level?

{audio:0:20:40} They were marketing very heavily into those practices but the willingness of each of the sub-practices to grow and take customer referrals was mixed. Some were fantastic and just rocked and rolled and some were not. The wealth management area was seen as being a big growth driver, which was the interest for St George in the first place.

{audio:0:21:09} Is it very difficult for the opcos, prior to being part of a bigger holdco, to get access to wealth management?

{audio:0:21:17} You can get access to them easily but, as you get access to them, you don’t get the benefit of scale; that goes to someone else. Everyone sees that the asset management fees on a billion dollars is worth a lot of money and they look at how much wealth their customers have and they think, if we can manage that, that’s a good return.

{audio:0:21:38} When a practice left Stockford, how would the exit actually work? Could they take all their clients again?

{audio:0:21:48} When that was happening, I’d left St George and resigned my board seat at Stockford, so I’m not exactly sure how that end game played out.

{audio:0:21:59} I guess the whole value in the business is the book of clients and the customer relationships?

{audio:0:22:05} That’s true, but in reality, who owns the client? The client. If they want to get serviced by the guy that was servicing them for the last 15 or 20 years, it doesn’t matter what you say, they’re going to go and get serviced by that person. In financial services, there is a lovely habit of talking about customer ownership and I think most professional services miss the point. The customer owns themselves and you’ve got to keep earning that and relationships win. Particularly in accounting practices, where I’ve formed a relationship with my accountant, I may have formed a relationship with the firm, but I don’t think about that; I think about the people I’ve formed a relationship with and they are the ones that provide that service on a daily basis. That’s where my loyalty sits.

{audio:0:22:54} Even if there are some kind of terms where the practice can’t take the clients, the client can do what they want?

{audio:0:23:01} Exactly; and they do. In some of the wealth management practices, the experience has been that, when the advisor leaves, as much as they try and maintain the balances, the client goes. The client owns themselves and, if they’ve got a strong relationship, they’ll go where the relationship goes.

{audio:0:23:18} As you said, incentives are the number one priority when you are rolling up assets. What are the principles that you would take away from that experience that you think are crucial to aligning incentives?

{audio:0:23:39} It has to answer the question, what is in it for me, on both sides. While they can be different, they can’t be completely misaligned. There has got to be a reason for us to trade and a benefit from that trade that can sustain different environments. That is where Kelly has done a pretty good job.

{audio:0:24:05} It makes integration very difficult and very hard and so how they get cost benefit of it, I don’t know. But they’ve got aligned incentives and it is aligned on both the upside and the downside. The things that I look at, in roll ups, is what are the incentives, what are the scale benefits and what are the growth benefits? If there is not a coherent story on all of those, then I’m not a fan of investing in roll ups.

{audio:0:24:33} In that case, the incentives seem aligned on the upside and downside. Arguably, there are little cost benefits from scale but, potentially, huge benefits from growth, if the wealth management opportunity plays out?

{audio:0:24:49} That’s the way I’m looking at it, whether it’s right or wrong. I’d like to understand, from the company, where they see that earnings growth coming from. If it’s just practice customer growth, that’s difficult in a professional services firm. If it’s coming from cost synergies, then you want to see what and how long that investment is going to take and what sort of consistent returns you will get from it. Then it’s going to come down to, what other scale benefits are in their plan.

{audio:0:25:20} However, Kelly does report that they drive margins up from sub 20% EBITDA to over 30%, post-acquisition.

{audio:0:25:35} That is seriously aligned with the practices. The practices are then getting a dynamite benefit from it. I can understand why practices are saying, hey, this is a good thing. As long as the practices aren’t getting disadvantaged by it and they’re getting a shared benefit from cost out, then everyone is looking good.

{audio:0:25:52} That either has to come from massively reducing the costs or driving more business?

{audio:0:26:00} A bit of both. It is a bums on seats business, so it’s hard to get scale in that client side, unless you can grow each of those practices.

{audio:0:26:15} Where do you think that could be coming from?

{audio:0:26:21} I presume it’s on the cost side, on their central operations side and it appears as if they have done a good job there. But it’s going to be a balance; it’s not all going to be one thing. I think they’ve done a great job on margins. Is that a one time hit or is it an ongoing hit? To keep that earning growth that you get from margin growth, do they need to keep on acquiring or can they grow their existing businesses?

{audio:0:26:44} You mentioned how Stockford’s cost structure, from the public documentation, it seems as if it was really bloated, especially relative to Kelly. Was that due only to the wealth management practice being at the central HQ or were there other reasons that drove costs?

{audio:0:27:00} They had a big technology play of trying to put in central technologies and central CRM and other components, such as central marketing and I don’t think they ever really panned out.

{audio:0:27:13} Just mismanagement of spend?

{audio:0:27:17} Not so much mismanagement, but I think the benefits from it were never realized. It relied on the practices willingly adopting new methods of work and new technologies and there is a degree of resistance there. The alignment behind brand, the desire to get more customers and to give up control of their own marketing and fiefdoms; that was always fraught.

{audio:0:27:44} You’re talking about people that have built and run their own business and, all of a sudden, they are an employee.

{audio:0:27:50} And you’re trying to tell them to use some kind of software solution?

{audio:0:27:55} Again, Kelly+Partners have learnt those lessons. They are saying, we will generate returns by using X, Y and Z; that is aligning the interests.

{audio:0:28:06} They do also claim to have certain strategies or manuals or central office management systems that the opcos could use to drive costs. There is still some reliance on the practices adopting those methods, to drive growth?

{audio:0:28:26} Yes. But if you are demonstrably lower cost, with the same or better quality the way they’ve structured it, the partners would adopt it. Whereas the ex-owners of the Stockford practices were now getting a salary from Stockford, roughly based on their revenues and the incentives, again, were misaligned.

{audio:0:28:51} They couldn’t see the benefit because it was rolled into their equity which was based on the market value?

{audio:0:28:59} And it meant giving up their freedoms and control.

{audio:0:29:03} How would you describe a typical Stockford partner when they were acquired? Were they typically much older? I think Kelly’s is around 41; was it similar?

{audio:0:29:15} No; it was people in their late 40s and into their 50s and some in their 60s. If I look at the prospectus in Kelly+Partners, 41 is a surprise to me.

{audio:0:29:28} It goes back to the point you made about the fact that these practices have to want to grow and maybe the younger practice owner still has that drive?

{audio:0:29:38} But you’ve only got 24 hours in a day and you may not want to work seven days a week. Then, like all large professional services firms, it becomes about how you can recruit, with good quality control, in lower cost resources that allow you to scale and to maintain the partners’ share and the partners’ interest. That’s where the large accounting practices have done pretty well, in their recruitment, training and then deployment of resources. In law firms and large accounting firms, each partner sits on a very productive engine, underneath them.

{audio:0:30:19} Was Stockford doing the hiring, running the HR for the practices?

{audio:0:30:24} They were running HR but it was, effectively, an outsourced recruitment and contracting service, to each of the practices. They wanted to get into training but didn’t manage to get into it, from what I remember.

{audio:0:30:36} What do you think is the optimal hiring strategy for a roll up like this?

{audio:0:30:42} I don’t really know enough about the detail. From what I’m seeing, accounting is getting really heavily disrupted by technology; the AIs, the low-cost bookkeeping services, the balance matching and order reconciliations. That should make the partners and practices far more productive, but they require a degree of technology savvy and adoption. That’s a wild field; just think about how much it’s shaking up all the large professional services firms. It is way beyond my pay grade to figure out what their recruitment and training strategy should be.

{audio:0:31:18} Would you allow the opcos to recruit? I assume that HR would be a central cost that you could, potentially, get some scale benefits from. Therefore, you do take that away from the opco, which could be quite difficult if this partner has to go up to Kelly and get a new employee or PA?

Former Chairman at Redbubble and Director at Stockford

Kelly Partners Group & Accountancy Roll-Ups

Redbubble: A Three-Sided Marketplace

Kelly Partners Group (KPG) & Accountancy Roll-Ups

Managing Director at William Buck

William Buck & Australian Accounting Roll-Ups

Kelly Partners Group

Kelly Partners Group (KPG) is based in Sydney, Australia. KPG does tax accounting for private companies and their owners. The firm was founded 15 years ago by Brett Kelly and went public in mid-2017. It consists of 26 operating units. 49% of each unit is owned by the partner and 51% by the parent. With around 9,500 customers, KPG has a total turnover of A$48.9 million and an EBITDA margin of 33%.

Since its foundation, the company has grown revenues by 30% per year. KPG systematically acquires smaller tax firms. The purchase price multiple is usually six times the cash flow post implementation of KPG best practices. Banks finance about two-thirds of the full price and the rest is financed by a vendor loan. As a result, KPG can grow through acquisitions without having to reinvest its equity. This creates a fabulous compounding engine.

Brett Kelly, the CEO of KPG, owns 50% of the company. There may be an element of key man risk as the firm appears to be reliant on Brett for upholding the culture and driving the vision for the firm.