Vitec, CSU & Lifco, CACC vs Westlake, GOOG Stadia, DHR & Cytiva Filtration, LGIH, UMG, Gyms, ACV Auctions

Content Published Last Week

1. CACC vs Westlake: Loan Origination Process

2. Danaher: Cytiva's Bioprocessing Filtration Portfolio

3. Google Stadia: Challenges Scaling a Cloud Gaming Service

4. Universal Music: Artist Management In A Streaming Era

5. LGI Homes, Lennar, D.R Horton: US Homebuilder Market Dynamics

6. Pure Gym vs The Gym Group

7. Evolution Gaming: Asia iGaming Value Chain & Crypto Casinos

8. America's Auto Auction, ADESA, Manheim, & US Wholesale Auctions

Vitec, CSU, Lifco, & Redeye's Serial Acquirer Event

Last week, we attended Redeye’s Serial Acquirer event in Stockholm. It’s one of our favorite events of the year where companies such as Vitec, Lagercrantz, and Lifco present. Each of these companies has compounded FCF per share at over 20% for decades.

Redeye’s attendance supposedly doubled YoY. Such growth seems better for those raising than deploying capital. Given the event can feel like being in a cold, rollup bubble, it’s hard not to come away questioning whether we are at a peak “serial acquirer”.

Even smaller, arguably unproven acquirers trade at premium multiples. Also, on the surface, each company has a similar pitch: we’re a decentralized acquirer of high-margin, high ROCE companies at <8x EBIT with a long runway to deploy capital.

But not all acquirers are created equally. The nuances are important. For example, how do they really define decentralized? On one end, Lifco has 14 Group Managers, typically former operating company Directors, with clear accountability over ~16+ opcos. Each GM is incentivised on EBT growth of their group.

On the other hand, Vitec offers HR, marketing, and IT services to operating companies and has a group of 7 operational execs free to help all opcos. Both claim to be decentralized. Understanding this nuance is important as the org structure defines the operational playbook. It also provides insight into where and how acquirers believe they can add value.

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There are also nuances in capital allocation, incentive structures, and scaling M&A. We believe understanding such subtle differences can help handicap the underlying quality of companies conducting accretive M&A.

Over the next few weeks, we plan to share our framework for analysing companies such as Lifco and Vitec. This week, we share a few takeaways from the Redeye event.

VMS Competition

At the event, Rollup Europe shared a stat that was fascinating:

Of ~140 software acquirers tracked, ~50 were started since 2020

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This aligns with learnings from our research published last year on CSU. We mapped out over 40 VMS acquirers, their M&A strategy, and how this may impact CSU’s ROIIC and future deployment rate.

Another supporting data point of higher competition came from a meeting with Vitec who reported seeing ‘significantly more competition over the last few years’. This is also reflected in Vitec’s acquisition multiples:

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Multiple unnamed VMS acquirers also claimed to have rarely seen CSU bidding for assets. Some even boasted of ‘never losing an auction versus CSU’. We’re not sure if this is something to be shouting from the rooftops. Anyone can win an auction. Deploying capital effectively at high ROICs is the game.

It’s more likely such comments highlight how CSU and most other acquirers are different businesses. CSU is increasingly buying VMS assets with low or even declining organic growth; not paying 2-3x revenue in an auction for double-digit organic growers. Just as nuance matters in org structure, it matters in understanding exactly what assets are being acquired. 'Software' is a big word.

CSU seems to be fishing in a different pond. Maybe because their 1000+ M&A case studies enable them to operate slow-growers better than anyone else. Or maybe increased competition is pushing them to lower quality assets. Both can also be true.

Either way, CSU and the majority of the new software acquirers are very different businesses: one relies on harvesting FCF, the other on executing and growing software assets. Requiring an operational strategy to generate FCF that underpins 3x revenue is a very different game to paying 6x EBIT and harvesting cash flows. The nuance matters.

Profit Growth > Revenue Growth

It was refreshing to have multiple conversations with operators who focus on growing profit, not revenue. Interestingly, multiple CEOs claimed they rarely, if ever, look at organic revenue growth. One CEO said he can’t even recall the revenue figure but he knows every single opcos EBT.

We’re still thinking about how to interpret this. When does organic growth matter? And why wouldn’t it matter?

On one hand, Mark Leonard claimed he wished he focused more on organic growth in the early days. On the other, multiple top Nordic acquirers barely look at organic revenue growth. They solely focus on EBT growth.

One potential reason is that it’s more capital intensive to grow an industrial business than a VMS asset. Industrials typically require inventory and other working capital to grow. This can go wrong pretty quickly. Especially when trying to grow niche, engineering businesses after the founder leaves. Organic growth in VMS drives higher ROIIC than in industrial assets.

But you still have to be able to execute and grow software organically. Maybe a decade of cheap money has ingrained an unhealthy focus on revenue growth at software firms regardless of the underlying profitability? The SBC and true underlying FCF of many listed software companies may support such a view.

According to top Nordic acquirers, organic revenue isn’t helpful unless it translates into growth in EBT. This was refreshing. Please reach out if you have any ideas on when and why organic growth does and doesn’t matter for these types of businesses. We will be exploring this topic throughout Q2.

EBT not EBITA

More specifically, the experienced Nordic acquirers are focused on growth in EBT not EBITA. Amortisation can muddy the waters. There are reasons why many investors shun highly-accretive companies: one of those is purchase price accounting. This leaves much judgment to management. And this judgment opens many doors for acquirers to play games.

For example, shifting costs or revenue pre and post-acquisition or allocating more to goodwill than intangibles can distort profitability comparisons. It's also difficult for outsiders to track. The best acquirers are purists; they look at returns net of both amortisation and interest at the opco level. This lens also provides an unfiltered insight into the quality and nature of management.

We plan to publish a comparative piece on acquirer accounting shortly.

CACC vs Westlake: Loan Origination Process

We’ve long been fascinated by CACC’s lending model relative to competitors. Unlike Westlake and other competitors, CACC claims it structures loans to best align the dealer, end customer, and its own ROE. It typically advances less upfront to dealers in return for sharing a larger portion of the return of the loan over time. This aims to encourage dealers to put customers in affordable cars so they can maximize repayments and share profit over the life of the loan.

This is what CACC claims, yet it consistently receives lawsuits of predatory lending.

In this research analysis, we aim to understand exactly how loans are originated via CACC vs Westlake by walking through a dealer's origination process and understanding how dealers structure loans. We show how dealers can modify loans to optimise their profitability and ensure customer affordability.

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This research shares each step of the loan origination process on CAPS and compares it to Westlake. This piece uncovers many differences in the culture and philosophy of loan origination between CACC and Westlake that is insightful for anyone curious of subprime lending.

Danaher: Cytiva's Bioprocessing Filtration Portfolio

As part of our work on DHR, this interview with a Former VP at DHR explores Cytiva (formerly Pall given it has now integrated into Cytiva) and its bioprocessing filtration portfolio. At the time of DHRs acquisition, Pall had a 90/10 revenue split between consumables and equipment. The majority of Pall's historical biotech equipment revenue was earned from Tangential Flow Filtration (TFF) systems and chromatography columns. The disposable filters for the TFF skids drove the majority of consumable revenue.

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This interview walks through Cytiva's filtration portfolio, the quality of its IP, risks from competitors like Repligen, and, more importantly, synergies when combined with GE's chromatography monopoly.

Although Cytiva has a ~80% share in chroma resins, there still seems room for Cytiva to grow Pall's market share across different types of filtration in bioprocessing. One core question we're exploring is: how can Cytiva leverage its positioning in chromatography to win more filtration business?

One challenge is that the buyer of filters and chromatography columns and resins are different people and even business units within the customer. But DHR's strength in chromatography mean it's involved early in most specification processes. Whether such advantage can be used to sell filtration equipment is unclear:

If I were to structure a go-to-market strategy, the advantage I see is that being involved in the chromatography resin discussion early in drug development gives you the opportunity to position your filters. Since Cytiva is involved in, let's say, 80% of the processes, as a salesperson, you'll have access to these people earlier than in your Pall days, when you didn't have chromatography media to discuss. - Former VP of Sales at Pall

Google Stadia: Challenges Scaling a Cloud Gaming Service

Stadia, Google’s Cloud Gaming platform, was closed last year because of its poor adoption. With a former Stadia Program Manager, we explore why the platform failed and how MSFT is positioning for cloud gaming:

"Stadia is a new platform, and we were asking publishers to allocate significant development resources to this unproven, untested platform. If I were a publisher, I would be wondering whether I would see a return on my investment if I devoted a significant amount of developers to Stadia. This made it difficult to have that conversation as a new player in the market. - Former Program Management Executive at Google Stadia

Content is king. Due to an early decision to build the service on Vulkan, an open-sourced alternative to Windows or PlayStation, this created a high barrier for barriers to develop Stadia games. The lack of high-quality games was one reason the platform struggled. This developer buy-in is a key advantage for Microsoft as most games are already being developed for Windows.

" The first option was to have Stadia run on Microsoft Windows. This would be great for publishers because they would only need to make minimal changes to run their game on Stadia natively. However, the downside is that we would have to pay a license fee to Microsoft, which is quite expensive and is charged per minute of usage, if I remember correctly. - Former Program Management Executive at Google Stadia

Universal Music: Artist Management In A Streaming Era

We have explored the changing environment in the Music business through a series of interviews. In this interview, an A&R executive with >20 years experience discusses how artist management has evolved over the last decade. One interesting takeaway is how Sync revenue has become more important given it's both marketing and a large revenue line equivalent to millions of streams.

The most effective strategy for promoting an artist currently is through film and TV licensing. This involves placing songs in films, TV shows, and advertising campaigns. It's a lucrative approach that pays well and promptly, unlike royalties from streaming, which can take nine months to a year and a half to come in. This strategy has proven to be very effective for many artists, especially those who are not yet well-known, because licensing only requires the right song for the right project, regardless of the artist's fame. - Former UMG Executive

LGI Homes, Lennar, D.R Horton: US Homebuilder Market Dynamics

Being methodical and process-oriented can be advantageous for a spec builder like LGI Homes, as it enables the company to streamline the home-building process, facilitates procurement, and accelerates construction. However, adhering to one's process too rigidly can prevent the company from adapting to changing market conditions.

However, they face challenges due to their rigid adherence to their systems. They are not open to input from their employees. Having worked for other builders, I see this as a significant difference. This rigidity could hinder their progress in the long run. - Former VP of Sales, LGIH

In this interview, a former VP of sales at LGI Homes sheds light on the dynamics of the US homebuilding market, highlighting the difference in strategies between LGI Homes and its main competitors.

Pure Gym vs The Gym Group

A Former CFO of Pure Gym, the leading discount gym and major competitor to listed The Gym Group, shares more about the nature of competition between the two major players. Behaviour seems rational:

We've always been rational, and I believe The Gym Group has been too. We didn't abandon rationality. As we opened more gyms, we learned more about customer behavior, how far they are willing to travel to a gym, and what catchment area you need. When you've only opened a few gyms, you don't have that information. As we opened more, we realized that opening a gym drives demand. As John mentioned earlier, you generate new memberships just by opening a gym. If the only option before a low-cost gym opened was a mid-market gym with a 12-month contract costing £50 a month, that excludes many people. But when you open a low-cost gym, suddenly many more people can afford to go. Also, being open 24 hours allows people who finish late shifts, like in restaurants or hospitals, to go to the gym at midnight. - Former CFO at Pure Gym

One common misconception around discount gyms surrounds “churn”. Given they target a young, more transitory demographic, the revenue is more transactionary than subscription. Although customers churn, the low-cost for such high value consistently attracts new recruits to the gym:

Yes, churn is high, but many people misunderstand the churn in these businesses. It's often the same people coming and going in a particular period of time. For example, students often cancel over the summer and return later. The population attracted to low-cost gyms is quite young and transient. They're leaving home, going to university, starting a new job, but they're being replaced by other people. So churn is a factor of the type of people that go to these gyms. - Former CFO at Pure Gym

Evolution Gaming: Asia iGaming Value Chain & Crypto Casinos

Through a series of interviews, we aim to uncover how the Asian iGaming value chain functions and exactly where and how EVO earns GGR across APAC. In an interview with a competitor focused on Asia, we explore the workings and penetration of crypto casinos and how suppliers mitigate risk.

"As providers, we received numerous requests from operators to support cryptocurrencies, not only for the reasons I mentioned, but also because of the anonymity they offer. Operators wanted to provide players in certain regions with a transparent, decentralized environment that doesn't rely on traditional banking. Players can use their crypto wallet to play directly, without their bank even knowing they're gambling. - Senior Operations Executive at APAC iGaming Supplier

Crypto is used for players and operators that prefer to avoid traditional payment providers that require AML and KYC processes and have slower payment processing times. These advantages have led to crypto becoming a significant part of the market in unregulated jurisdictions. The interview goes on to lay out estimates of just how much of the market is driven by crypto and the risks game suppliers like EVO may be taking.

America's Auto Auction, ADESA, Manheim, & US Wholesale Auctions

As part of our work on ACV Auctions, this interview with a General Manager at America's Auction Auction, a leading indie, physical wholesale auto auction, sheds light on how a vehicle flows through their system. Despite being unable to touch and feel the car when acquiring it from an online auction, arbitration rates seem lower for online auctions than for physical ones. One of the main reasons for this, is the seller being very specific about the car's condition when selling it online since returns can be very costly for him.

When they sign up for these programs, they have to know that there can be an arbitration policy. That vehicle could be sent out to three states over, and then we've got to take it to a third-party auction, which will look it over and decide if the arbitration is founded or not. And then the seller might have to buy it back and transport it back. So it's in their best interest to be honest. - General Manager America’s Auto Auction