Addtech: Winning Formula For Acquisitions Shows No Signs Of Slowing Down

Opener

Since its spinoff in 2001, Addtech AB (publ.) (OTCPK:ADDHY) has been a massive winner for patient shareholders. The stock has compounded mainly because of its culture, its business formula, its care for shareholders, and lots of growth. In my view, it will not stop now and has plenty of growth ahead. Moreover, the price is reasonable in my view, maybe even cheap.

History

Essentially, when a stock experiences multi-decade success, I believe it must be due to factors beyond just having a good business and high margins; it’s ingrained in the culture, the people, and the company’s history and leadership. Well, Addtech’s history actually doesn’t start in 2001. It is a spinoff from the great Bergman & Beving, alongside Lagernatz. All three have been winners for their shareholders, mainly because of a winning formula and culture that we will discuss in this article.

The Business

Serial acquirers have two main advantages in my view. Firstly, if done properly, the company can control growth to a large extent. It can accelerate and decelerate acquisitions based on its targets and organic growth. The second advantage is diversification among many different businesses and industries. As a result, in my view, the downside risk is very low, and the upside is unlimited.

I prefer to look for small serial acquirers because the law of large numbers hits hard when you need to acquire 50 businesses a year instead of 10. Once you struggle to find new deals, you will need to pay more, and the system and management will pay less attention to each business. Of course, there is the famous exception to Constellation Software Inc. (OTCPK:CNSWF), but I don’t know how many could follow in its footsteps, as it has a great leader and an amazing culture.

Addtech has two main goals. Firstly, to grow profit by 15% annually, which they have managed to succeed in so far. Secondly, to achieve an EBITA/working capital ratio above 45%. This ratio is common among serial acquirers and represents the efficiency of operations. In the last quarter, Addtech achieved a 68% ratio, well above its average.

How do they do it? Well, it can be consolidated into a few major points.

• Addtech is all about entrepreneurial spirit. It’s all about decentralization, providing a home for the selling owner. In a common theme among the best serial acquirers, the owner, who is often a family, is not seeking the highest price to sell their business. They seek independence, the ability to continue running operations, a safe home for employees, opportunities to grow, and more. Addtech can support such cases and has receipts to present to potential sellers. In his excellent blog about serial acquirers, Gustaf Hakansson tells a story about one of the potential sellers for Addtech.

One who has sold a firm to Addtech is Anders Claesson. When one of Claesson’s business partners (the majority owner) wanted to sell Sittab in 2013, Claesson was strongly opposed to the idea of selling in general. Conversations started with Addtech, and Claesson interviewed an Addtech-affiliated supplier hoping that they would say that Addtech was “crap”.

But the supplier (who had been a selling entrepreneur) praised Addtech instead. Claesson warmed up to the idea of selling to Addtech, as they were down-to-earth and interested in really getting to know Sittab and its people. Addtech was not in a hurry, and they asked good questions, had a pedagogical acquisition process, and offered sister companies with similar customers.

Addtech was also flexible in structuring the deal and made great efforts to inform employees about the transaction.

• Addtech has specific criteria when seeking companies for acquisition: they target entities with good profitability and growth potential, a high level of knowledge and technical content, a focus on proprietary products, niche market concentration, relationship-based sales, sustainability orientation, and cultural alignment. The advantage of niche businesses lies in their low competition, higher profit margins, and market sizes too small for significant competition to emerge. On average, Addtech acquires 10-15 businesses annually, with each business typically generating sales ranging from 60 to 110 million SEK, depending on the year.
• Organically, Addtech experiences approximately 3% annual growth through its five business segments, operating via 150 independent businesses, primarily in the industrial sector. These segments mainly focus on areas with significant business potential, such as renewable energy sources, industrial automation, energy efficiency, and power grid expansion. While the majority of Addtech’s businesses are located in the Nordic region, the company is expanding its global presence.

• Anders Börjesson, a former member of the original Bergman and Beving management team, holds the largest share in Addtech, with 16% of the votes. He brings the acquisition of DNA from Bergman and Beving into Addtech.
• The current CEO has been with the company since 2010 and assumed the role of CEO in 2018. During his tenure, the company has experienced substantial growth and delivered impressive results in terms of stock performance.

Numbers

Addtech has grown its earnings at a rate of 21% annually since the spinoff in ’01. However, I don’t expect this pace to continue, and the target is a more modest 15% earnings growth. This growth will come from low organic growth, as well as acquisitions and margin expansion. Margins are gradually increasing as the business grows, providing shareholders with operating leverage. In contrast to my previous article on Sdiptech AB (publ) (OTC:SDTHF), Addtech is a more mature company and manages to deliver a 22% return on capital employed (ROCE), not to mention the 68% EBITA/working capital ratio.

Addtech spends, on average, 66% on mergers and acquisitions (M&A) out of funds from operations. This approach, in my view, is prudent. Rather than pursuing growth at all costs, it’s better to be cautious and avoid excessive debt. It’s preferable to purchase companies that will enhance returns on capital, rather than simply pursuing growth for its own sake.

The debt-to-EBITDA ratio for serial acquirers is around 2.5, for Sdiptech it’s around 3, but Addtech is more conservative, keeping it at 1.5. With two years of free cash flow, Addtech could cover all of its net debt.

Now, for growth estimates. These largely depend on management decisions, the target companies’ pipeline, and valuations. For example, Sdiptech lowered its acquisition pace because it found fewer opportunities to meet its hurdle rate. Assuming 3% organic growth, to reach its target, Addtech will need to purchase 2000 MSEK of revenue, plus operating leverage. If you think it will be challenging to find so many suitable companies to purchase, think again. According to a great article about serial acquirers by Req Capital, there are millions of European small private companies. Addtech only needs to acquire 10-15 a year to support its growth. Of course, higher organic growth would be desirable as well.

The rest of the cash flow is allocated towards dividends, with a payout ratio above 40% and a 10-year growth of 14% CAGR. Additionally, from time to time, Addtech engages in buybacks.

Valuation

Spoiler: It’s not screaming cheap. However, with this kind of company, I think you can hold it for decades. Because of the long-term horizon and the double-digit growth rates, I believe you can pay a hefty price and still win. If we look back 10 years, multiple expansions may be responsible for its doubling, but the growth itself is what transforms it into a long-lasting winner.

Now, serial acquirers have a lot of goodwill amortization, which makes them appear expensive on a P/E basis and keeps some investors away. However, if you consider EV/EBITDA multiple or FCF multiples, it paints a different picture. In terms of EV/EBITDA, the market recognizes Addtech’s greatness and assigns it a valuation similar to its peers. The same holds for FCF multiples. In my view, it’s a totally reasonable price for a high-quality business. Let’s also do a DCF.

Assuming a top-line growth of 12%, with margin expansion, we’d see 15% FCF growth per year. The WACC is 9%, and I assume an exit multiple of EV/FCF of 30, which is lower than the current multiple for peers such as Lifco AB (publ) (OTCPK:LFABF), Lagernatz, and more. In such a case, the stock is undervalued by 40%.

Risks

The first risk: Don’t buy on the OTC. Very low volume and illiquidity. Just don’t.

Another risk is stagnant organic growth. Europe does not have demographic growth and will encounter struggles in generating growth in the future. This could flatten organic growth or even worsen it.

Yet another risk is a tough acquisition market that will demand higher multiples for acquirers, resulting in less return with more investment.

Any major change in the culture will be a red flag for me. Perhaps a new CEO arrives and tries to implement changes or emphasizes synergies over decentralization.

Addtech is exposed to failed acquisitions. It could pay for a company that will perform below expectations, which means it overpaid. Another risk could be goodwill impairment on the balance sheet, which could reduce net income.

Lastly, valuation is not screaming cheap. It’s not a net-net situation, but in my view, it’s a classic GARP opportunity.

Conclusions

To conclude, I would rate the stock as a STRONG BUY. However, in my view, this is a stock to hold for a decade; it’s not a quick value play, so don’t sell too quickly.

Hope you enjoyed the article. Looking forward to your comments.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.