Content Published Last Week

1. Halma, Judges Scientific, SDI, & Scaling Niche Manufacturing Serial Acquirers

2. SDI Group: Niche Manufacturing Serial Acquirer

3. Confluent, Amazon MSK, & Apache Kafka

4. Livechat Software: Customer Angle

5. Porch Group: Home Services to Insurance

6. OneWater Marine: Boat Manufacturer and Dealer Relationship

Halma, SDI, & Scaling Niche Manufacturing Serial Acquirers

In 1972, David Barber founded Halma, a UK-based serial acquirer of niche manufacturing businesses, with a clear set of principles to grow by acquisition:

  1. Use internally generated cash, not equity
  2. Only buy assets in markets you deeply understand
  3. Focus on bolt-ons or quasi-bolt-ons, rarely move into new areas

Since then, HLMA has compounded EBIT 15.3% and dividend per share ~4% for almost 50 years. It's one of the highest-performing stocks ever in the UK.

SDI Group and Judges Scientific are two smaller UK-based serial acquirers looking to follow in Halma’s footsteps. Both companies focus on market-leading, scientific instrument manufacturing businesses in niche markets. A typical acquisition exchanges at ~5x EBIT, grows organically low single-digits and earns ~50%+ return on tangible capital.

Last week, we interviewed the CEO of SDI Group. One specific comment stood out:

Halma was the first business I looked at. Halma started exactly the same as us and the same as David did in the 1980s…They started getting bigger and bigger, buying bigger businesses. Then they started putting divisions and then managers and CEOs over the divisions. That is a structure that you do – I’m sure we will do it and David will do it – as you grow the businesses. What you don’t want to do is put a structure in place, at head office – which I’ve seen many times – where you say, now we’re going to buy the business; it kills it. These businesses run autonomously. - Current CEO of SDI Group

There is an obvious limitation to scale for serial acquirers: the greater the revenue the base, the more ‘acquired’ revenue needed to grow.

At £150m revenue, it’s more difficult to grow inorganically 10%+ annually if a company is acquiring businesses with £4-5m revenue. Especially if only the CEO is allocating the capital.

This is what Halma found out in the 1980’s as it struggled to scale beyond 25 companies. This is also the challenge Mark Leonard seems to have resolved; Constellation is now acquiring 100+ $4-5m revenue companies per year.

Both Judges and SDI will face a similar hurdle of scaling beyond 25 companies and £150m revenue over the next few years.

We dug through Halma’s filings dating back to 1976 to understand the history of how it scaled. We also published our full analysis of the challenges Halma faced and the potential solutions to scaling a niche manufacturing acquisition machine. A few snippets of our work are posted below.

There are a few different serial acquirer operating models best cateogrised by Scott Management. JDG and SDI Group more closely resemble CSU’s early operating model, and Halma is closer to Danaher. It's very difficult for smaller serial acquirers to replicate Danaher without the DBS mindset.

In the mid-80's, DHR was an early US adopter and innovator in kaizen and lean manufacturing which morphed into its own unique business system. This takes 30+ years to refine and has to be ingrained in the early culture. We will also be exploring the history of DHR in weeks to come.

This leaves SDI Group and JDG with two potential strategies to follow: replicate CSU or replicate HLMA.

CSU delegates M&A responsibility down to Divisional CEO’s but keeps the VMS businesses standalone. HLMA delegates to Divisional CEO’s but integrates, merges, and drives more synergies post-acquisition.

The SDI CEO believes replicating HLMA is the most likely option. So how did Halma do it?

From the beginning, Halma was merging and integrating portfolio companies. For example, this was from the 1983 annual report:

Source: HLMA 1983 Annual report
Source: HLMA 1983 Annual report

HLMA would consistently make acquisitions and also spin or merge existing portfolio companies. This ensured the number of subsidiaries was manageable. From 1978-86, HLMA consistently had between 17-22 operating companies yet revenue tripled.

Source: HLMA, IP
Source: HLMA, IP

This dates back to Barber’s original philosophy focusing on bolt-ons or quasi-bolt-ons. Barber argues that simultaneously adding new companies and rationalizing the portfolio continually upgrades the technical strength and dominance of its products. This is a powerful concept and difficult to execute.

“It is interesting to note that despite the Group’s systematic and continuous acquisition programme over the past decade, the number of operating companies within the group has risen very gradually. This is because the acquisition process is accompanied by a parallel programme of rationalization. The overall effect of this combined activity, in addition to its cash generating tendency, has been a progressive and continuing upgrading of the technical strength, sophistication, and market dominance of the Group’s portfolio products’’ - David Barber, 1989 HLMA Annual Report

In the early 80’s, HLMA faced an operational challenge scaling beyond ~20 companies. It couldn't buy and integrate enough companies each year to grow at the required inorganic growth rate. In 1981, HLMA made a pivotal change: it added four divisions each under the control of a Divisional CEO.

Instead of each individual company being a profit center, each Division became its own profit center. Today, the business has 3 sectors and 4 divisions with 3-4 portfolio companies each.

Source: In Practise
Source: In Practise

By 1990, HLMA’s 5-year revenue CAGR had doubled.

However, pushing M&A responsibility down the organization doesn’t come without risks. By 2002, HLMA revenue was declining. Between 2001-04, the stock was down 40% and revenue was stagnant.

In our full analysis, we explore the challenges HLMA faced in the 90’s and how Williams, the Former CEO, turned the business around in 2005.

Although HLMA didn’t grow from 2002-05, the company still earned ~£70m in cumulative FCF before acquisitions and EBIT margins were consistently 18-20%. The stability in gross and EBIT margins and the high ROCE of a portfolio of niche manufacturing companies provides a strong foundation in any downturn.

For example, the stability of HLMA’s EBIT margin over 40 years is incredible. I guess this is what consistently buying market-leading companies at 40-50% ROCE gets you!

Source: HLMA, IP
Source: HLMA, IP

Members can read the full analysis and everyone on our free tier can read our interview with the SDI Group CEO.

Confluent, Amazon MSK, and Apache Kafka

Many infrastructure SaaS players are in the tricky position of proving their worth beyond AWS' managed service offering. And even more so for those built on open source technology.

Confluent is one of those businesses. It competes with Amazon's MSK offering, an Apache Kafka service that helps customers ingest and stream data in real time. Confluent's challenge, similar to Hashicorp in a way, is to persuade customers that its paid tier offers additional value-add AND saves more engineering time than both Amazon MSK and the free tier.

Confluent Cloud is part of this monetisation strategy.

We interviewed a Former Confluent VP and now customer of the service to compare the product to AMZN MSK:

You have a larger pie that you can sell into of the existing open-source Kafka users, especially the organizations that are like, wow, it's actually pretty hard to run Kafka; many places have teams dedicated to that. Maybe they want to free up those engineers to work on something else. I think that’s pretty compelling, and the ease of getting going with Confluent Cloud is the thing that will drive growth there...I think MSK got a head start. The difference, of course, is that with a lot of Amazon’s products, they don’t make it super easy for you. Amazon still requires a lot of engineering effort to work, and if the Confluent thing works right, it will take that away from you. You don't have to do that work. - Former VP of Confluent

Livechat Software: Customer Perspective

Livechat software, a Polish-listed chatbot SaaS player that competes with Zendesk, has one of the best SaaS margin profiles we've ever seen:

Source: Livechat Presentation
Source: Livechat Presentation

LVC's FCF margin in the LTM to Q1 22 was ~45%. And it's actually real, there is no SBC!

We published an interesting perspective from Former Head of Customer Service at IKEA, a LVC customer:

For me, it was attractive, and there was an excellent ability to test. When we were testing for the new platform, we wanted to temporarily switch off LiveChat for a week and see what happened in terms of the new platform. Did we get better conversion than we did with the last? It was a good test, but the reality was that some people were used to the old platform, and when they got to the new platform, customers were taking a bit longer and were even contacting us saying have you changed your web platform? This looks a little bit different to me. We needed a more extended test, but ultimately I got the sales director saying you need to put LiveChat back on because we need to get the conversion rate sales back to where they were.

Porch Group

ANGI, Porch and other struggling home services platforms are pivoting to monetise their existing platforms in all ways possible. Porch aims to leverage its home services CRM for home inspectors to generate proprietary, high-quality leads for its Moving Concierge service. It does this by waiving the cost of the CRM if the home inspector turns on the data flow to Porch and paying $4 per inspection. Porch needs to further incentivize home inspectors to turn the data flow on and introduce Porch services to the consumer. With only ~100 inspections a year, a $4 per inspection fee is not too exciting for inspectors.

about the time that I left, Porch was working to pay a commission back to inspectors. Part of the sales motion is the inspector should have some leave behind to prepare the homeowner for the call. If they have contact with the homeowner, they should let them know Porch will call them and it's a great service and these are the reasons why. For a time, there was an experiment that was looking at, if we monetize 500 bucks, let's give some of that back to the inspector. I don't know if that's still going on, but to that end, that was one of the things that was in flight to try to keep inspectors not only sticky, but also incentivize them to help warm up the lead prior to Porch getting it. - Former VP at Porch Group

Onewater Marine Group

Over the last 20 years, each and every year, 40% of boat owners sell and leave the market. During COVID, the industry saw a huge number of boaters enter the market. A Former VP of Brunswick, an OEM Boat manufacturer and supplier to ONEW, believes even with 40% of boaters leaving, the absolute units sold will be structurally ~25% higher, from ~200k boats pre-covid to a stable 250k units per year in FY23.

Used boats out sell new boats seven to one, all the time. Having used boats on the lot for dealers, always good things when times get tough. There's a cycle that might help frame this a little bit. We know that every year, 40% of the people that bought a brand-new boat are going to get out of boating. We know that. It's correlated, it's linear, it's going to happen. During this pandemic, 40% of all these boats that we've sold – these crazy boats – over the two-year period, are going to end up back on dealers’ lots. Once that gets saturated and full and all of that, new boat sales slump, because they're selling all these used boats. They don't need to floorplan them; we pay the interest on floorplan for a while. They don't need to do any of that. We will slow, they'll get rid of those and the cycle turns back up to new boats. For people that are shopping for used boats, depending on the segment, pontoons are not the same as offshore fishing boats, are not same as ski boats. - Former Brunswick VP

With such harsh cycles, scale matters as a dealer. Quality service, a more resilient parts and finance business, and scale in selection drives dealer profitability. ONEW is trading at low-single digit PE but it may just be that the normalised E is a fraction of last year!

I think, in large part, because it's hard to make money being a boat dealer. When times are good, they're good, when they're not, they're not. You've got to be very good at service. You have to have other sources of revenue, to be able to support it through the good times and the bad times. The first thing people want when times are good is a boat, and the last thing people want when times are bad is a boat. You've got to be willing to take that risk and live with that sort of volatility. The good ones will have storage, they'll have slips, they'll have really good service. They'll do all of that kind of stuff, at least as much as the new boat guys, which means you've got to have the facility to do it. You've got to have the people to do it. It's a different sort of level of business. - Former Brunswick VP