Programmatic Serial Acquirers: finding underappreciated compounders

In the dynamic world of investing, there are loads of strategies, many pitched by self-interested pundits claiming to provide sage advice. One strategy that is almost never suggested, flying well under the radar, yet holding significant potential for compounding investor returns over the long term, is the systematic acquisition or roll-up of small and profitable companies. McKinsey and Co. refers to such a company as a ‘programmatic serial acquirer’. Despite its merits, this approach is often misunderstood, even avoided. After all, how will CNBC sell ads, how will your advisor get paid and how will your broker survive, if we all simply buy shares in proven serial acquirers — and hold them forever?

Let’s delve into the essence of programmatic serial acquirers, their misunderstood nature, and how they have the capacity to persistently compound market-beating returns for investors, over time and with less risk.

Understanding Programmatic Serial Acquirers

Programmatic serial acquisition involves a systematic approach to steadily acquiring business after business, typically with the goal of aggregating profits to fund continued acquisition activities. Unlike traditional mergers and acquisitions, which may be driven by specific opportunities or market conditions, programmatic serial acquirers operate on a consistent and deliberate basis. It’s a business model, not an opportunistic endeavour of sorts.

The key characteristics of this strategy include:

• Consistency: Programmatic serial acquisition follows a structured and consistent approach to identifying, evaluating, and acquiring companies. This consistency allows for the gradual accumulation of assets, knowledge and capabilities through deploying repeatable and proven systems. When a serial acquisition company consistently follows proven systems, they will become better capital allocators over time, driving ever-improving returns for shareholders.
• Strategic Focus: Each acquisition is carefully selected to align with the overarching strategic goals of the acquiring company. For example, Constellation Software acquires vertical market software companies, StorageVault acquires self storage facilities, Dental Group acquires dental practices, etc. This channelled focus ensures that the acquired businesses complement each other, providing predictable returns and contributing to the continuous compounding of shareholder value, on a per share basis.
• Long-Term Perspective: Programmatic serial acquisition is not about quick wins or short-term gains. Instead, it emphasizes the creation of long-term value through aggregating and appropriately deploying cash flows, sustaining the perpetual repeatability of the model.

Misconceptions Surrounding Programmatic Serial Acquisition

Despite its potential benefits, programmatic serial acquirers are often misunderstood or overlooked by investors and analysts. Several misconceptions contribute to this oversight:

• Perceived Complexity: The systematic nature of programmatic serial acquisition may lead some to perceive it as overly complex or difficult to execute. However, with educated and experienced leadership — careful planning and executing, this strategy can be implemented effectively by companies of all sizes.
• Short-Term Focus: In a world driven by quarterly results and immediate returns, the long-term perspective of programmatic serial acquisition may be undervalued. Investors focused solely on short-term gains may overlook the potential for compounding greater returns over time.
• Risk Aversion: Some investors may view serial acquisition as inherently risky, associating it with the potential pitfalls of overextension or integration challenges. While there are risks involved, a well-executed programmatic approach can mitigate these risks through disciplined execution, strategic alignment and repeatedly acquiring new businesses.
• Reliability of leadership/management: To justify investing, you must trust that management will operate in a manner that consistently creates value for shareholders. This is a trust based model. Will management make decisions that prioritize self-interest? This will assuredly lead to lower shareholder returns and possible bankruptcy, leaving shareholders with nothing. Bottom line: Over time the effect of poor leadership will come out in the data. If a serial acquirer has been around for 5 to 10 years or more, consistently producing a stellar ROI, then I would suggest investor interests are being considered. So ignore the fledgling acquirers with untested leadership. Only invest in the proven data-supported serial acquirer leaders.

The Potential for Compounded Returns

Despite these misconceptions, programmatic serial acquisition holds significant potential for compounding investor returns over the long term. Here’s how:

• Strategic Diversification: By acquiring multiple businesses, companies can spread risk and reduce reliance on any single revenue stream. This strategic diversification can enhance stability and resilience, particularly during economic downturns or industry disruptions.
• Economies of Scale: As the acquiring company grows through serial acquisitions, it may realize economies of scale in areas such as purchasing, production and distribution. These efficiencies can lead to cost savings and improved profitability over time.
• Synergies and Integration: When executed thoughtfully, serial acquirers can create synergies between acquired businesses, unlocking additional value through cooperative market opportunities. Effective integration efforts can further enhance operational efficiency and competitiveness. Many serial acquirers misunderstand synergies. You should never pay a higher multiple for an acquisition based on what you ‘expect’ to happen. You’ll be disappointed. Any synergies achieved are a ‘nice-to-have’ and never a given.
• Market Recognition and Valuation: A track record of successful acquisitions and sustainable growth can enhance the market perception of the acquiring company, leading to higher valuation multiples and increased investor confidence. This, in turn, can drive further opportunities for growth and expansion.

Case Studies and Real-World Examples

Several successful companies have embraced acquisition strategies as being core to their long-term growth. One notable example is Berkshire Hathaway, under the leadership of Warren Buffett. Over the decades, Berkshire Hathaway has steadily acquired a diverse portfolio of businesses across various industries, building a conglomerate with enduring competitive advantages and shareholder value.

Another example is Constellation Software, a programmatic serial acquirer. This Canadian company is known for its disciplined approach to acquiring vertical market software businesses. Through a combination of strategic acquisitions and operational excellence, Constellation Software has achieved remarkable growth and profitability, delivering substantial returns to its shareholders over the years. Interestingly, Constellation Software has compounded shareholder returns at an annual rate of 30% plus, over many years. This is a feat aspired to by many follow-on competitors, but rarely emulated. In order to continue this rapid growth Constellation has been spinning off smaller aggregators, birthing new publicly traded entities Topicus and Lumine Group. Over the next few years, we will see if their performance rivals the parent. I expect Yes.

Bringing it together

Programmatic serial acquisition may not always receive the attention it deserves, but its potential for compounding investor returns over the long term is undeniable. By adopting a disciplined and strategic approach to acquiring and integrating businesses, serial acquirers can unlock tremendous value for shareholders, realize economies of scale, build sustainable competitive advantages and continuously scale acquisition activity, acquiring new cash streams in near perpetuity.

Done right, this is a very sustainable model and largely immune from competitive forces. For investors willing to look beyond short-term fluctuations and embrace a long-term perspective, programmatic serial acquisition represents a compelling strategy for wealth creation. Think of it this way, a diversified serial acquirer owns many profitable, smaller businesses, providing resilience, stability and continued profitability in any economic environment. Considering any company is at risk of failure due to market forces, competitors, or unknown shocks – a well managed serial acquirer should not be derailed by a single competitor. Recurring revenue streams from a mix of quality businesses, will make sure of that.

If I had to estimate the likely failure rate of fledgeling serial acquirers, I would say 90 to 95%, similar to the rate of failure in any business venture. Buying a basket of small, emerging serial acquirer stocks is not the way to go. It’s better to invest in the proven leaders with perhaps 10 years of data that supports management discipline and decision-making. New leaders will need to learn hard lessons. Many will foolishly reinvest profits back into acquired companies without meaningful analysis. Flushing profits is not the path to success yet many will succumb to this error of inexperience.

In a way, you could compare a serial acquirer to a mutual fund. They are both diversified holders of businesses. But, that’s a shallow comparison. During an economic downturn the mutual fund will face redemptions, forced to sell assets at exactly the wrong time when values are deeply depressed. In contrast a great serial acquirer, like Constellation Software, will have the cash-flows/funds available to scoop up quality businesses at lower multiples, thriving during the downturn and never forced to sell when the tide goes out. Something to think about.