Self storage companies have been some of the best-performing real estate companies over the last decade. UK-based Safestore particularly stands out. Spurred by a recent In Practise interview, Andvari delved deeper into Safestore and discovered it exhibits many of the features for which Andvari looks in a high quality business.

LONG-TERM GROWTH TAILWINDS

Safestore was founded in 1998 with just a handful of locations and has grown to be the largest self storage company in the UK. Safestore has 126 wholly owned sites followed by Big Yellow with 75 wholly owned stores. Safestore has also ventured into Europe in the last few years.

With Safestore, there’s still opportunity to grow the business. The company will continue to consolidate a highly fragmented market and will continue to grow organically. In terms of fragmentation, there are roughly 1,900 storage sites in the UK. However, the six largest operators own just 352 of these, barely 20% of the total UK market.

In terms of organic growth, there remains a huge opportunity for the self storage industry to continue growing in the UK and Europe. First, according to Dave Davies, a former Operations Director at Safestore (see the In Practise interview), the UK has 0.7 square feet of self storage per capita compared to nearly 10 square feet in the US, 1.9 in Australia, and only 0.2 throughout Europe. Second, surveys indicate that roughly half of consumers in the UK either knew nothing about the service offered by self storage operators or had not heard of self storage at all. 

PREDICTABLE REVENUES, RECESSION RESISTANT

Although customer churn is high at 100% to 120% per year (meaning Safestore must replace all its customers every year), revenues are still steady and predictable. For example, customers that existed prior to the start of 2020 contributed 70% to 80% of Safestore’s 2020 revenues.

Andvari also likes that the self storage business is recession resistant. Births, marriages, deaths, divorces, and downsizing happen regardless of the economy. All these life events drive the need for storage space. (See also Andvari’s blogs on other recession resistant businesses like Chemed's Roto-Rooter and Water Intelligence).

COMPETITIVE MOAT

The self storage industry cannot be disrupted by tech companies. If you need physical space to store physical items, a self storage company is the only option outside of moving into a larger home or office. Another barrier to entry that is specific to Safestore is that the majority of its revenues come from its locations in London and Paris. Both are densely populated areas where land is scarce and land values are high. This means extremely limited availability for new sites. Safestore also enjoys the protections of city planning regulations as well as laws that strongly favor the rights of leaseholders.

LOW CAPEX REQUIREMENTS

Capital expenditures to maintain Safestore’s current business are small relative to total revenues at just £7 million on £162 million of revenues. This allows Safestore to allocate generous cash flows towards building or buying new stores. This will in turn provide more fuel for Safestore to buy and build a greater number of stores each year.

ANDVARI TAKEAWAY

Safestore’s qualitative features combine to create a high margin, resilient business with a high probability of many decades of growth left ahead of it. Andvari believes Safestore and its peers are worthy of addition to our investment watch list.

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Further Reading

• In Practise interview of Former Operations Director at Safestore Holdings
• Safestore Investor Relations
• Big Yellow Self Storage Investor Relations
• Extra Space Storage Investor Relations

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of publication of this blog, Andvari clients had no position in Safestore or Water Intelligence. Andvari clients do have a position in Chemed. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

Andvari has found yet another highly profitable and fast-growing services business. The business is Water Intelligence plc. It’s based in London, but it’s core subsidiary, American Leak Detection (“ALD”), does business in the States. ALD is a franchise business and a leader in using technology to pinpoint and repair water leaks without destruction. ALD possesses several attributes of a high quality business. In fact, ALD shares many of the same qualities of Chemed’s Roto-Rooter business (see "How a Boring Service Business Produced Tech-Like Returns"). The qualitative features of the business has led to astounding share price performance: 3,700% cumulative returns over the last decade.

RECESSION-RESISTANT AND HIGH MARGINS

ALD's purpose is to help find and repair water leaks without tearing open walls, ceilings, or floors. Leaks and water damage happen regardless of whether the economy is good or bad. Finding and repairing the leak is something a homeowner must do. Further, because these situations are non-discretionary and somewhat urgent, the consumer is less sensitive to price. This is very similar to the situation of a Roto-Rooter customer. Thus, ALD currently has operating margins in the upper teens and there is still room to increase these margins.

REACQUIRING FRANCHISEES

Over the last decade, ALD has reacquired the operations of its franchisees (also similar to Roto-Rooter). This has unlocked significant value as it transforms indirect royalty income to higher margin direct corporate income. To illustrate, if ALD’s $17.4 million of revenues (as of 2020) from corporate-operated locations were executed by franchisees, ALD would only receive $0.27 million of pre-tax profit instead of $3.8 million. Although ALD certainly seeks to grow the number of franchisees, the selective reacquisition of these franchises to operate them internally has created tremendous value.

MANAGEMENT WITH SKIN IN THE GAME

Patrick DeSouza is the current Executive Chairman of Water Intelligence. He also is the largest shareholder of the company, owning 28.19% of outstanding shares. With the market cap at about $270 million (USD), DeSouza’s shares are worth $76 million. Andvari always appreciates management with a lot of skin in the game. This makes it more likely a manager will invest for the long-term. It also aligns the manager’s interests with all other shareholders. By doing well for himself, DeSouza has done well for all other shareholders.

OPPORTUNITIES FOR CONTINUED GROWTH

There is still a long runway for growth. First, Water Intelligence is still a small business. Reported annual revenues are just now approaching $35 million. However, the gross revenues have passed $140 million million. This gross revenue figure includes the indirect sales by franchisees from which ALD’s franchise royalty income is derived. 

Second, as noted in the above paragraph, there is a huge opportunity to reacquire franchisees. There is nearly $100 million of revenues ALD can acquire from which it can earn greater profits.

Finally, Water Intelligence is in the beginning innings of expanding internationally. Although they are starting from a low base, operations in the UK, Australia, and Canada grew at a combined rate of 27% during 2020.

ANDVARI TAKEAWAY

Although Water Intelligence currently trades at a very high multiple of earnings, there are many reasons why it should. It’s a profitable, growing, and recession-resistant service business run by an owner operator with skin in the game. Finally, the corollaries to Chemed’s Roto-Rooter business, or even Rollins with their Orkin pest control business, should give a potential shareholder conviction Water Intelligence deserves to be highly valued. Water Intelligence is a recent, and well-deserved addition to Andvari’s watch list. We look forward to keeping tabs on this company in the years to come.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of publication of this blog, Andvari clients had no position in Water Intelligence or Rollins. Andvari clients do have a position in Chemed. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

CCC Intelligent Solutions (“CCCS”) is a company that is recently public. The company helped pioneer Direct Repair Programs for the auto insurance economy in 1992. Since then, CCCS has built a software platform and network that solves the needs of auto insurance companies and auto collision repair shops. Andvari has added CCCS to its watchlist as it has many of the hallmarks of a high quality business for which we always seek.

SOLVING PROBLEMS FOR HIGHLY COMPLEX AND REGULATED INDUSTRY

How an auto collision is handled by all industry participants is highly complex. A single collision event can require the resolution of hundreds of transactions and decisions. Who will be the best repair facility and part supplier? What local rates and prices apply? What local regulations apply? What’s the damage to the vehicle and what is needed to restore it? The slide below shows all the different variables that must be considered.

Building a system to handle such complexity has taken decades and hundreds of millions of dollars. The time and money it would take a new competitor to effectively compete against CCCS is substantial. Andvari views this both as a formidable moat for the company against new competition and as the source of CCCS’s attractive financials.

NETWORK AND ECOSYSTEM EFFECTS

More than 300 insurers and over 26,000 repair facilities are connected to CCCS’s network. Parts suppliers, auto OEMs, and financial institutions are also connected. This network creates value for all connected parties by enabling collaboration, streamlining of operations, and the reduction of claims management costs.

Andvari always appreciates how network effects can strengthen business. A strong network effect helps retain customers and increases the likelihood of adding new customers. This makes revenue growth stronger and more certain. A company with a dominant network, which CCCS might have, is a moat that a competitor usually has low odds of duplicating.

TREASURE TROVE OF DATA

CCCS has processed $1 trillion of historical data through its network. It is now processing $100 billion of transactions annually. They use the data to help reduce costs for insurance carriers and drive revenues to repair shops. This treasure trove of data will be extraordinarily hard for any other company to replicate and acts as another barrier to new competition.

STICKY CUSTOMERS AND PREDICTABLE REVENUES

CCCS’s business model enables sticky customer relationships and highly predictable revenues. Average contract length is around 3-5 years in length. 96% of revenues are recurring software revenues. As of 2019, gross dollar retention was 97% while net dollar retention was 107%. Given its customer-centric approach to business, it’s not surprising CCCS has a high net promoter score of 80. For comparison, Starbucks has an NPS of 77 and Apple has an NPS of 47.

Another awesome data point is that 70% of CCCS revenues come from accounts that are 10 years or older. Furthermore, the average revenue per long-term insurance customer has risen 80% from 2010 to 2019.

CAPITAL EFFICIENT BUSINESS MODEL

With gross margins in the mid 70s and adjusted EBITDA margins in the mid-30s, the company spits out cash. Andvari loves software businesses like CCCS as they require little capital to grow. CCCS aims to have capex as a percent of revenue in the 4-7% range and working capital as a % of revenue in the low single-digits. A capital efficient business enables higher cash flows that can be used to reinvest in the business, acquire other businesses, or else be returned to shareholders. Cash can compound at a higher rate in businesses like this.

MANAGEMENT WITH SKIN IN THE GAME

Githesh Ramamurthy is the Chairman and CEO of CCCS. He’s been with the company for 29 years and is the beneficial owner of a little over 33.5 million shares (5.6% of outstanding shares). At a share price of $11.53, Githesh’s stake in CCCS is worth nearly $390 million. As a group, directors and executives own 6.2% of shares outstanding. We believe this is more than enough motivation for them to continue to create value for themselves and all other shareholders.

ANDVARI TAKEAWAY

From a high-level view, CCCS possesses many of the characteristics of a high quality business. It has a deep understanding of a highly complex and highly regulated industry. It’s software platform benefits from network effects and has an enormous treasure trove of historic data. Revenues are sticky and predictable, margins are high, cap-ex is low, and the CEO and Chairman has an enormous stake in the company. CCCS is worthy of addition to any watchlist as it has high potential to grow and compound shareholder value for years to come.

Further reading:

• CCCS August, 27, 2021 S-1 Filing
• CCCS February 2021 investor presentation

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of publication of this blog, Andvari clients had no position in CCCS. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

Below is a selection from Andvari's latest quarterly letter. Please enjoy.

Dear Friends,

For the first nine months of 2021 Andvari is up 6.5% net of fees while the S&P 500 is up 15.9%.^[i] Andvari clients, please refer to your reports for your specific performance figures. The table below shows Andvari’s composite performance against two benchmarks while the chart shows the cumulative gains of $100,000 investments.

ANDVARI HOLDINGS

During the third quarter, one of our largest and longest-held investments—“Company A”—announced the largest acquisition in its history. Company A will increase its revenue base by about 40% by acquiring “Company B”. Company B has a set of genetic analysis products that enable labs and pharmaceutical companies to perform certain types of diagnostics more quickly and at a lower cost.

Andvari believes the best is still yet to come with our investment in Company A. Depending on the size and pace of future acquisitions, this serial acquirer can grow revenues 4x–5x over the next ten years while maintaining high margins and cash flows. As Company A grows, it will have ever-increasing cash flows to allocate to larger and larger acquisitions. Cash flows will compound. At a minimum, Andvari expects over the long run to earn annualized returns in the low-teens as shareholders of Company A.

A new entrant to Andvari’s portfolio is Chemed. We sold our investment in a large, customer-focused enterprise software company to make room for this overlooked holding company based in Cincinnati, Ohio. Chemed’s two subsidiaries are Roto-Rooter (plumbing and drain cleaning) and VITAS Healthcare (hospice care provider). Chemed checks many of the boxes within Andvari’s qualitative-based investment framework:

• Stable and predictable revenues from two recession resistant businesses;
• Low capital expenditure requirements;
• Roto-Rooter and VITAS have good organic and inorganic growth opportunities as both are the largest players in markets that are still highly fragmented and populated mainly with “mom-and-pop” competitors;
• Management has demonstrated excellent capital allocation skills; and
• Management is long-tenured and highly aligned with shareholders.

…

ANDVARI PARTNERS LP

In the prior quarter’s letter we mentioned the launch of Andvari Partners LP, Andvari’s first investment fund. The fund’s track record officially started in early August. For more information we urge you to contact us at info@andvariassociates.com.

ANDVARI TAKEAWAY

For the first nine months of 2021, Andvari still trails the market by a wide margin. However, we’ve caught up a bit in the third quarter. Looking at our collective performance over the past three and five years, Andvari has outperformed the market net of management fees. This outperformance is in spite of the fact that Company A—our largest holding now—has significantly underperformed against the market this year. Finally, we are strong believers in Company A and in our new Chemed investment.

As always, I love to hear from clients and interested parties about anything on your mind. Please contact me with your thoughts, comments, or questions.

Sincerely,

Douglas E. Ott, II

DISCLOSURES AND END NOTES

^[i] Andvari performance represents actual trading performance of all, actual clients beginning on 4/12/13. Performance from 12/31/12 to 4/12/13 is actual performance of proprietary accounts, namely the accounts of Andvari’s principal, Douglas Ott. Andvari believes including Ott’s performance figures for the first 4 months and 12 days of 2013 is fair as he managed those accounts similarly to Andvari’s first clients. All performance, including the initial proprietary period, are net of management fees (assumed to be 1.25% per annum, paid quarterly, as currently advertised), net of brokerage commissions and expenses, time-weighted, and includes all cash and other securities. Performance includes realized and unrealized returns and excludes the effects of taxes on incurred gains or losses. Andvari does not certify the accuracy of these numbers. Performance data quoted represents past performance and does not guarantee future results.

The indexes are listed as benchmarks and are total return figures and assumes dividends are reinvested. The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. The Russell 2000 Index is an index of 2,000 U.S. small-cap stocks. It is not possible to invest directly in an index. Because Andvari client portfolios are non-diversified, the performance of each holding will have a greater impact on results and may make them more volatile than a more diversified index. Andvari also engages or may engage in strategies not employed by the S&P 500 or the Russell 2000 including, without limitation, the use of leverage.

One may request a list of all securities mentioned or recommended for the preceding year as of the date of this letter. You may contact Andvari using the information below. Actual client results may differ from results depicted in this letter. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the loss of principal.

The discussion of Andvari’s investments and investment strategy (including, but not limited to, current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) represents the views and opinions of Andvari’s portfolio managers and Andvari Associates LLC, the investment adviser, at the time of this report, and can change without notice.

This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of Andvari.

The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Any or all of Andvari’s forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties, and other factors, most of which are beyond Andvari’s control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.

Imagine a company. It's not based in or anywhere near Silicon Valley. It's enterprise value is $7.5 billion and has revenues of $2 billion. It doesn't have a sexy, fast-growing tech business. It clears drain pipes and provides hospice care. Yet the shares of this company have achieved "tech-like" returns over the last decade.

Chemed, the owner of Roto-Rooter and hospice care provider VITAS, has many qualities that Andvari finds attractive in an investment. The main four are:

• Being in steady, recession-resistant service businesses that require little capital;
• Being a large player in markets that are still highly fragmented and populated with "mom-and-pop" competitors;
• Excellent capital allocation; and
• A long-tenured management team that is in alignment with shareholders.

ROTO-ROOTER AND VITAS

Roto-Rooter is the largest provider of plumbing and drain cleaning services in North America. It has a presence in 127 company-owned territories and 369 franchise territories. EBITDA margins are in the mid-20s. VITAS Healthcare is the largest hospice services in the U.S. with a presence in 14 states and the District of Columbia. EBITDA margins for VITAS are in the high teens.

Both VITAS and Roto-Rooter have grown annual revenues in the 5–6% range for many years. Both require little capital expenditures—capex as a percent of revenues has ranged between 2–3%. Both are recession resistant. The state of the economy has no bearing on the decision of anyone with a plumbing emergency or anyone with a terminal illness who needs or desires hospice care.

From Andvari's perspective, steadily growing, and recession-resistant businesses are great qualities to have in an investment. These businesses ought to deserve a premium valuation due to their greater ability to make it through an economic downturn and little need for capital to continue growing.

LARGEST PLAYER IN HIGHLY FRAGMENTED MARKETS

Roto-Rooter and VITAS are each the largest players in highly fragmented markets. Roto-Rooter has an estimated 15% of the drain clearing market and a 2–3% share of the same day service plumbing market. VITAS has about a 7% share of the U.S. hospice market. This positioning allows both ample opportunity to grow organically and by acquisition for decades to come.

Furthermore, because Roto-Rooter and VITAS have greater scale, and the competition for both are coming from "mom-and-pop" organizations operating on thinner margins, both can spend more on branding, advertising, training, and offering new services. This gives both Chemed companies a solid advantage over their competitors.

A HISTORY OF CAPITAL ALLOCATION 

Another quality for which Andvari always looks is a management team skilled at capital allocation. The first proof of Chemed's seriousness about capital allocation comes straight from its 2020 form 10-K (emphasis Andvari's): "Chemed purchases, operates and divests subsidiaries engaged in diverse business activities for the purposes of maximizing shareholder value. The Company's day to day operating businesses are managed on a decentralized basis."

In Andvari's words, Chemed views itself as a pure allocator of capital seeking to maximize long-term shareholder value. Furthermore, Chemed's head office does not meddle too much in how its subsidiaries run their respective businesses. Both qualities—excellent capital allocation and decentralized operations—could make Chemed a good candidate for a second Outsiders book.

More proof of Chemed's dedication to maximizing shareholder value is evident from the extraordinary action it took in 1999. The company announced they'd be cutting their dividend from a quarterly $0.265 per share to $0.05 per share. The dividend yield on their shares went from over 7% to 1.4%.

The reason for the dividend cut was to have more resources for internal growth and acquiring more Roto-Rooter franchises. Companies rarely cut their dividend. When they do it's usually forced upon them by awful capital allocation decisions from prior years. A company with the fortitude to make an unforced decision that is unpopular in the short-term, yet could ultimately create more value in the long-term, will always be worth Andvari's time to investigate.

ALIGNED AND LONG-TENURED MANAGEMENT

Chemed has a management team with long tenures and who are aligned with Chemed shareholders. Importantly, Chemed executives have significant personal wealth tied to the long-term performance of the company. Yet another important quality for which Andvari always looks.

• Kevin McNamara has been with Chemed since 1986. He has served as President since 1994 and CEO since 2001. He is a beneficial owner of shares worth over $93 million.
• David Williams has been with Chemed since 1990. He has served as CFO since 2004. He is a beneficial owner of shares worth over $43 million.

For long-term compensation, management is compensated based on a combination of: 3-year adjusted earnings per share growth and 3-year total shareholder return as compared against their peer group. This incentive plan combined with management’s already significant shareholdings means that management is well-aligned with all other Chemed shareholders (see also Andvari's "Quick Guide to Executive Comp").

HISTORICAL FINANCIAL RESULTS

Chemed's intangible qualities have coalesced into the production of excellent financial results. The chart below shows steady growth of revenues and adjusted EBITDA.

The next chart shows growth of revenues and adjusted EBITDA on a per share basis since Chemed's acquisition of VITAS (acquired February 2004). Given Chemed's large and continuing share repurchases, adjusted EBITDA per share has grown at an annualized rate of nearly 20% since 2003.

Finally, Chemed shareholders have enjoyed exceptional cumulative performance over the last 10 years. Chemed has outperformed the S&P 500 and NASDAQ 100 indices. The company has also kept up with or outperformed several other tech and software businesses (like Salesforce and Autodesk) that are all wonderful in their own right.

ANDVARI TAKEAWAY

A decidedly non-tech business with annual revenues growing at "just" a 5–6% pace can still outperform an index of tech stocks. A combination of important qualitative factors are the necessary ingredients for success. Chemed's two service businesses will always be in demand regardless of the economy. Roto-Rooter and VITAS have low capital requirements. Both businesses are the largest in highly fragmented markets which gives them the opportunity to gain more scale through acquisitions. Finally, Chemed's management team are skilled allocators of capital and are well aligned with other shareholders given their large holdings of Chemed shares.

Chemed fits squarely within the framework of Andvari's qualitative-focused investment process. This unassuming and under-the-radar company is well worth a look for inclusion in any long-term investment portfolio.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of publication of this blog, Andvari clients had a position in Chemed. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

Andvari has recently discovered SDI Group, a company that could become the next great U.K.-based serial acquirer. Over the last decade, this small company has grown revenues nearly five-fold. SDI has done this organically and through over a dozen acquisitions. 

Andvari’s Interest in Serial Acquirers

Good companies with management teams skilled at capital allocation have historically greater odds of producing market beating returns. Andvari recently studied a short list of serial acquirers. We analyzed how long it took these companies to reach various revenue thresholds. Many grew rapidly through acquisition, while some grew at a more moderate pace. The one thing nearly all of them had in common was superlative performance during these periods, both in absolute and in relative terms.

Fitting the Mold

SDI seeks to buy and build niche businesses in the life science and technology markets. They have a variety of businesses in the digital imaging and sensing and control sectors. For example, SDI’s Synoptics Health manufactures ProReveal, a test to detect residual proteins on surgical instruments using fluorescence. SDI also owns Opus Instruments, a world leader in the field of Infrared Reflectography cameras for use in art conservation.

Acquisition Criteria

SDI has positioned itself as a sort of permanent home for niche businesses in the life science and technology markets. The company prefers to fund acquisitions from the cash flows of their existing businesses where possible. After acquisition, SDI implements financial controls and objectives, but otherwise allows the acquired business to run autonomously. The goal is to focus on the long-term and to “create an environment for the businesses to grow and develop with investment if required.”

Skilled Management

Regarding management, Mike Creedon has helmed the company as CEO since August 2011. Since then, Creedon has overseen the dramatic growth of the company. He has made over a dozen acquisitions. Annual revenues have grown from £7.2 million in 2012 to £35.1 million in 2021. Gross margins also grew from the high 50s to the mid-60s during this period. SDI’s share price has thus far reflected these excellent long-term results.

Andvari Takeaway

SDI Group appears to have the basic characteristics of a young serial acquirer that can produce excellent returns for shareholders (see our prior post on M&A wisdom from Halma plc). SDI’s management has proven to be capable over the prior ten years by acquiring good businesses at fair prices. Furthermore, with just £35 million in annual revenues, to say there is still room for SDI to grow would be a vast understatement. Based on Andvari’s study of other successful serial acquirers, it is certainly possible for SDI to grow revenues to £100 million within the next 7 years. If this turned out to be the case, we think it is likely shareholders will be quite happy.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of the conversation and as of the publication of this transcript, Andvari clients had no position in SDI Group. Furthermore, Andvari clients have not had a position in SDI Group in the past. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

The following article contains selected highlights from a live Q&A on August 10, 2021 between Douglas Ott, founder and CIO of Andvari Associates, and Catherine Corrigan, President and CEO of Exponent (NASDAQ: EXPO). At the time of the conversation and as of the publication of this transcript, Andvari clients had no position in Exponent. The transcript has been edited for clarity. Please read the full disclaimers at the end of the PDF transcript via the link below.

The complete 16-page transcript is available here or via Andvari's Client & Prospective Client Document Portal.

CATHERINE CORRIGAN – PRESIDENT & CEO OF EXPONENT

From a Family of Engineers

I come from a family of engineers and technical people. My father, he has a PhD in electrical engineering from Cornell. He had a career at Bell Laboratories. My older sister went into engineering. She’s a mechanical engineer at Penn and at MIT. My mother went back to school later in life and became a network software manager. The culture of my immediate family was really around technology, and science and engineering.

A Desire to Provide Immediate Solutions to Problems

At that point in time [having just completed a PhD], I would not have imagined myself in the seat that I’m in right now. It’s interesting. As you go through a PhD program, particularly on the engineering side, so much of what you see in terms of your faculty and your mentors, and what folks are doing there, they’re continuing on to do research. They’re going into postdoctoral fellowships, and then they’re becoming assistant professors, and then they’re getting tenure. This was the sort of traditional path. I applied for some of those and I followed that path. I had some opportunities along those lines, but it just wasn’t what I really thought I would be passionate about.

I really had a desire to be not doing basic research that might not see an application for 20 years or 30 years. I was much more interested in immediate solutions to problems that are happening right now. And really practical and applied solutions. I recognized I had a postdoctoral fellowship all queued up and I said, “Well, there’s this company called Failure Analysis [Exponent's former name] that looks sort of interesting.” They had come to campus at MIT to do some interviews. And so I did that interview, and the rest is history.

On Exponent's Culture of Scientific Excellence

Well, our culture around scientific excellence has been a constant throughout that time. That is a core value of the organization that has been in place and has been a foundation for the business. Our clients recognize that we are bringing the most advanced science, the most critical eye, that level of independence. That has always been there.

The company has certainly evolved over the course of time. When I started, I would say probably 85% or 90% of the portfolio of the company was this failure analysis, reactive type of business. And the nature of those engagements is very different than the engagements that we now have on the proactive space. The collaborative nature of our workplace has steadily increased over the course of time.

We have recognized the degree of differentiation that we have as a company, because of not only the critical mass of expertise, but our ability to form these interdisciplinary teams, literally at the at the snap of a finger in order to solve a client’s problem. So it’s this sort of culture of collaboration, this culture of bringing diversity in all its dimensions. Technical disciplines, years of experience. We need the industry expert who has 20, 30, 40 years of experience, but we also want the new PhD who worked on the leading edge technology, right? We can bring those together. And I really do think that that interdisciplinary collaboration that we’ve been able to foster in our culture over time, has been a big driver of the company’s success.

Exponent's Competitive Moat: Multiple, Premium Services Under One Roof

I would describe the competitive landscape as fragmented. We have competition in everything that we do. But there isn’t a single entity that’s going to have the depth and breadth that we cover. If I look at our chemical regulatory folks—we’ve got that group in both the U.K. as well as in the U.S.—they’ve got competitors in that regulatory space. But those competitors are not going to crossover into some of the reactive kind of work that we get into with chemicals.

Or if I look at our vehicle engineering practice, there are boutique accident reconstruction firms out there that are very good, that I would consider to be premium service firms. But they’re going to have a single discipline. Or maybe they’re just doing accident reconstruction and they can’t go next door to bring that human factors expert in, to be able to talk about that human operator error and operator distraction side of the equation, right?

If there’s an explosion of an oil refinery, we can handle the root cause of that explosion with our thermal scientists. But then we’re also going to look at the chemistry issues of what’s being discharged both into the air as well as into the ecological environment. And then further downstream, what are the health effects of that? And how do you monitor that? So it’s very much a soup-to-nuts kind of coverage that we have. Whereas if you went elsewhere, you you’d have to patchwork together maybe five different boutique firms.

We could be a much, much bigger company, if we decided to pursue more commodity-level professional services work. Lower costs, lower rates, lower margins: it’s just a race to the bottom. That’s not what we’re about. We want to solve the problems that only we can solve. I think our competitors have been just amazed at how much of a proactive portfolio we have been able to build. We charge the same rates for proactive work as we do for our reactive work. One person, one rate is our philosophy.

On Being "Defender-in-Chief" of Exponent's Reputation

One of my jobs—and I didn’t list this when you asked me what I spend my time on—but I am certainly the Defender-in-Chief of Exponent’s reputation. Our reputation for scientific excellence, for objectivity, independence, all of those things. The way the regulators view us, the way the scientific community views us are foundational to our success. Maintaining that reputation through the quality of the people that we hire, and through our quality management system to ensure we’re not making errors in our work, and all those sorts of things that we have in place, is incredibly important to maintaining that absolutely top-level reputation.

[End of transcript highlights]

GET THE FULL INTERVIEW

Access to the complete 16-page transcript is available here or via Andvari's Client & Prospective Client Document Portal. Please contact Info@AndvariAssociates.com to request access to the portal.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. At the time of the conversation and as of the publication of this transcript, Andvari clients had no position in Exponent. Furthermore, Andvari clients have not had a position in Exponent in the past. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

Doma is a recently public company that is taking on the most antiquated portion of the home purchase market: the title, escrow and close portions. Doma has some excellent qualities Andvari likes to see in a potential investment. It's founder-led and it's the founder's second act. Incumbent competitors are at a disadvantage having prospered too long based on inertia rather than innovation. Finally, the financials can scale extraordinarily quickly as Doma gains name recognition, takes market share, and expands into adjacent lines of business.

What Does Doma Do Exactly?

Doma has created a platform that "seeks to eliminate all of the latent, manual tasks involved in underwriting title insurance, performing core escrow functions, generating closing documentation and getting documents signed and recorded." The platform accomplishes this by using data analytics, machine learning and natural language processing. Looking at just the title portion of Doma's services, Doma can underwrite title insurance in mere minutes as opposed to the usual 3–5 days it would take one of its legacy competitors. If a lender uses all of Doma's services, the typical 40 to 50 day mortgage closing time can be shortened by 15 to 25%.

Second Act of an Already-Proven Founder

Max Simkoff founded Doma in 2016 and remains the CEO. However, this is not the first company he founded. Max previously co-founded Evolv in 2006 and sold it in 2014 to Cornerstone for over $40 million. Evolv used similar technology as Doma, but instead applied it to evaluate the skills, work experience and personalities of a company's employees and job candidates. The fact that Simkoff has experience creating a successful business based on similar technology increases the odds he will be successful in this second act.

Fat and Lazy Incumbents

The big four legacy providers of title & escrow services are Fidelity National Financial (FNF), First American Financial (FAF), Old Republic (ORI) and Stewart Information Services (STC). The four have 80% market share in the US. For the past few decades they have just coasted on the benefits they've accrued as they consolidated the market.

These legacy providers have had little incentive to invest to the extent Doma has. Trying to catch up to Doma now would mean spending upwards of $65 million over many years. And even if they were successful in catching up in terms of technology, they'd still have to lower their fees to match Doma's level. This is a "high risk, low reward" proposition from the perspective of the incumbents.

One great piece of advice that applies to life, sports, and investing: "Go to where the competition isn't." Looking at the competitors Doma has, it's as if they don't have competition. From Andvari's perspective, we like situations where there is little to no true competition as it increases the odds of success.

Growing Revenues and Capturing Market Share

Another great thing about Doma is they operate in a large and steadily growing U.S. residential real estate market. In 2020, there were nearly 6.5 million homes sold. There were also 12 million mortgage originations with 40% from purchases and 60% from refinancings. Virtually all these mortgages required the services (title insurance, escrow, and closing) that Doma can provide.

Scaling the Business

As the disruptor in their small, $23 billion section of the nearly $320 billion home ownership market, Doma has grown and can continue to grow quickly. They will do this organically, through acquiring other small title agencies and plugging them into their platform, and by expanding into adjacent services like appraisal and warranty. It seems highly likely that Doma can meet their goal of doubling revenues in the next 3 years. In the process, their market share will go from 1–2% to nearly 5%. Given their tech advantage, it also seems highly likely Doma will eventually be as or more profitable than their legacy competitors.

Andvari Takeaway

Doma has some great qualities that Andvari believes can make for a potentially good investment. This company is founder and CEO Max Simkoff's second act. He built and sold a company before which makes it more likely he can do it again, perhaps with even greater success. Doma has created a much better service that is both cheaper and higher quality. Finally, the incumbent competitors have been lazy and it seems inevitable they will cede more market share to Doma.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari clients do not currently have a position in Doma. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

EverArc Holdings, the special purpose acquisition company (SPAC) co-chaired by Nick Howley and Will Thorndike, announced last month it will acquire Perimeter Solutions for $2 billion. Howley founded and led TransDigm, a company which has delivered a >35% IRR since 1993. Thorndike, aside from being the well-known author of The Outsiders, is a founding partner of successful private equity firm Housatonic Partners.

As they write, Perimeter is a "leading global manufacturer of high-quality firefighting products and lubricant additives." Given the success of both Howley and Thorndike in their respective careers, and the acquisition criteria they laid out, Andvari believes EverArc found a quality business.

EverArc Acquisition Criteria

EverArc laid out five criteria they wanted in a business:

• Recurring and predictable revenue streams
• Long-term secular growth tailwinds
• Products or services that account for critical but small portions of larger value streams
• Significant free cash flow generation with high returns on tangible capital
• Businesses in industries with potential for opportunistic consolidation

It's hard not to think a business that meets all these criteria would not be the epitome of a great business. Andvari has written about several of these criteria in the past. Flavor and fragrance makers like Robertet Groupe and McCormick are examples of businesses with products that account for critical but small portions of larger value streams. MSA Safety ("A Picks-and-Shovels 100-Bagger") falls into this category as well and also sells products that protect the lives of people like Perimeter. Constellation Software and HEICO are good examples of companies with significant free cash flows operating in industries with high potential for consolidation. 

Revenues: Growing and Recurring 

Andvari believes Perimeter and its Fire Safety segment (which accounts for 80% of total EBITDA) meets EverArc's criteria. Fire Safety revenues are recurring and predictable and the segment has secular growth tailwinds. The following charts are from a recent webinar presentation by Perimeter's CEO Eddie Goldberg. 

Spending to suppress forest fires has steadily increased over the decades. Acres per fire has steadily increased. The length of the fire season has also increased over time. Andvari then looked at data from California Dep't of Forestry and Fire Protection ("Cal Fire"), a state that has been plagued with costly fires in the last several years. Fire suppression expenditures in California have increased over a hundredfold in the last 40 years.

Small, But Critical Component

With the federal government regularly spending over $1.5 billion a year on suppressing fires, Fire Safety's retardant products are a small but critical component to these efforts. EverArc writes that fire retardant "consistently represents only approximately 2–3% of suppression costs in the US." This feature should allow the Fire Safety segment to operate with above average margins and a greater ability to raise prices.

Attractive Financials

Lo and behold, Perimeter indeed has extremely attractive financials. EBITDA margins are in the 40% range. Capital expenditures as a percent of revenue is ~2%. Even more interesting is EverArc's statement that Perimeter’s products enable value-based pricing. This means Perimeter can price its products based on the economic value it offers to the customer and not just the cost of the product. Nick Howley's TransDigm has expertly used value-based pricing as a way to continually raise prices on the thousands of different aerospace parts they sell to their customers.

Extensive Qualification of Products

Also similar to TransDigm, whose parts must undergo extensive testing and qualification by the Federal Aviation Administration, Perimeter's Fire Safety products must also undergo "extensive performance, safety and environmental testing." The Wildland Fire Chemicals Test Procedures section of the Forest Service website has a very long list of the tests that must be performed. Only after a fire chemical has successfully completed all the required tests will it gain listing on the Forest Service Qualified Products List (QPL). A chemical’s presence on the QPL is what allows federal agencies, states, and others to purchase it. This constitutes an effective barrier to entry for would-be competitors.

Potential for Consolidation?

Andvari does not have a great sense if there is an opportunity to consolidate parts of the fire suppression industry. Whether the industry is fragmented is a question a potential investor will have to answer through their own efforts. However, a good place to start would be looking at the QPLs of the Forest Service.

For example, in the category of long-term retardants, there are only two companies that have qualified. One is Perimeter's Phos-Chek brand and the other is Fortress's product. In fact, Fortress touts that its product is "the only new entrant in over two decades to achieve placement on the USFS Qualified Products List (QPL)." For Perimeter to have such a long-held position in this product category is a strong signal of business quality. However, this might not leave room for consolidation opportunities.

On the other hand, the QPLs for Class A Foams and Water Enhancers have a longer list of products that compete with Perimeter's products. There might be consolidation opportunities in these two categories. There might also be opportunities for Perimeter to acquire makers of equipment used to store, transport, and disperse firefighting foams.

Andvari Takeaway

Perimeter checks off many boxes in terms of business quality. Its products are small, yet critical parts to the end product or service. It has secular growth winds at its back. The financials of the business are excellent. Finally, we believe Co-Chairmen Howley and Thorndike will be excellent stewards of capital. Whenever Perimeter becomes publicly listed in the U.S., Andvari believes it is a company worthy of addition to any investor’s watch list.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari clients do not have currently have positions in EverArc Holdings or Perimeter Solutions. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

For the first half of 2021 Andvari is up 2.9% net of fees while the S&P 500 is up 15.3%.^[i] Andvari clients, please refer to your reports for your specific performance figures. The table below shows Andvari’s composite performance against two benchmarks while the chart shows the cumulative gains of $100,000 investments.

ANDVARI HOLDINGS

Andvari's largest positions continued to lag the market and remain a drag on performance year to date. The holdings that worked well in 2020 are not working as well so far in 2021. However, just because a company's share price has declined does not mean that the value of its business has also declined. We are extremely bullish on the long-term prospects for our holdings that have lagged the market this year.

LATENT VALUE

Andvari's second largest holding has now lagged the market over the last twelve months and over the last three years. Still, we remain confident there is tremendous potential for the company and its shareholders. There is enormous latent value that has yet to surface.

This is a company with a market cap of $1.4 billion, revenues approaching $150 million, and over $250 million of cash on its balance sheet. Importantly, over the last several years this company has upgraded the quality of its management team and its board of directors. The management team now includes a handful of former Danaher employees. The new directors on the board have experience leading business units with billions of revenues.

It is hard to overstate the significance that the managers of our company have Danaher on their résumés. Danaher is a company that has built enormous wealth for its shareholders over the last 37 years. From 1995 to 2020, Danaher shareholders enjoyed a total cumulative return of 7,801% versus 880% for the S&P 500 index. Danaher did this by using its cashflows to acquire dozens of companies and instituting a culture of continuous improvement.

Knowing what Danaher was able to achieve gives us confidence in the latent value of our investment. It took Danaher eight years (12/31/85 to 12/31/93) to grow revenues from $100 million to $1 billion. During this phase of Danaher's growth, their shareholders vastly outperformed the market. Although nothing is certain, the odds are skewed in our favor that our holding, run by former Danaher managers, can grow quickly over the next decade and deliver outstanding returns to shareholders in the process.

LAUNCHING ANDVARI PARTNERS LP

After starting Andvari in 2011 with just $3.5M of "friends and family" money, it is a pleasure to share some exciting news. Andvari’s first investment fund, Andvari Partners LP, has been launched.

The philosophy underpinning the fund strategy is identical to Andvari's existing approach. We intend to invest in nearly all the same names we currently own. Just fewer of them. Owning fewer names and managing fewer separate accounts is something we have long sought. Our progression towards fewer names has been careful and measured given the significant retirement assets we manage.

We strive to invest in the way we think will lead to the best, long-term outcome. High concentration mixed with our qualitatively-driven selection process and our long holding periods is how we get there. The new structure gives us the increased freedom to make that happen. For more information on Andvari Partners LP, please contact us (info@andvariassociates.com).

ANDVARI TAKEAWAY

Andvari remains steadfast in our investment approach and philosophy. We wrote last quarter about continually looking to be invested in fewer and better companies. These are companies that can compound our wealth at above average rates for decades rather than several years. When the market ignores the latent value of one of our holdings for too long, we usually view this as an opportunity to add to that holding.

This is exactly what we have done over the last six months. We have added to this already sizeable holding. With the effects of the COVID global pandemic subsiding, our holding will find it easier to do business and close new sales. We also expect our holding to put its cash pile to work by announcing a large acquisition in the next 6–12 months. These both will be catalysts for future increases in its share price and the intrinsic value of the business.

As always, I love to hear from clients and interested parties about anything on your mind. Please contact me with your thoughts, comments, or questions.

Sincerely,

Douglas E. Ott, II

DISCLOSURES AND END NOTES

^[i] Andvari performance represents actual trading performance of all, actual clients beginning on 4/12/13. Performance from 12/31/12 to 4/12/13 is actual performance of proprietary accounts, namely the accounts of Andvari’s principal, Douglas Ott. Andvari believes including Ott’s performance figures for the first 4 months and 12 days of 2013 is fair as he managed those accounts similarly to Andvari’s first clients. All performance, including the initial proprietary period, are net of management fees (assumed to be 1.25% per annum, paid quarterly, as currently advertised), net of brokerage commissions and expenses, time-weighted, and includes all cash and other securities. Performance includes realized and unrealized returns and excludes the effects of taxes on incurred gains or losses. Andvari does not certify the accuracy of these numbers. Performance data quoted represents past performance and does not guarantee future results.

The indexes are listed as benchmarks and are total return figures and assumes dividends are reinvested. The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. The Russell 2000 Index is an index of 2,000 U.S. small-cap stocks. It is not possible to invest directly in an index. Because Andvari client portfolios are non-diversified, the performance of each holding will have a greater impact on results and may make them more volatile than a more diversified index. Andvari also engages or may engage in strategies not employed by the S&P 500 or the Russell 2000 including, without limitation, the use of leverage.

One may request a list of all securities mentioned or recommended for the preceding year as of the date of this letter. You may contact Andvari using the information below. Actual client results may differ from results depicted in this letter. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the loss of principal.

The discussion of Andvari’s investments and investment strategy (including, but not limited to, current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) represents the views and opinions of Andvari’s portfolio managers and Andvari Associates LLC, the investment adviser, at the time of this report, and can change without notice.

This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of Andvari.

The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Any or all of Andvari’s forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties, and other factors, most of which are beyond Andvari’s control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.

To understand the possibilities for new, emerging serial acquirers, Andvari has studied the financial history of the great serial acquirers. The greats are companies like Danaher, Roper, HEICO, and Constellation Software, all of which have acquired dozens of companies over the decades. 

In our small sample size, we focused on how quickly these serial acquirers have been able to grow their revenues. In nearly every case, and in spite of the risks involved with M&A transactions, Andvari found that these companies outperformed the market for each period of their revenue growth.

QUANTIFYING PERIODS OF OUTPERFORMANCE

Our basic question is how quickly have the great serial acquirers grown from $100 million in revenues to $500 million? From $500 million to $1 billion? Below is a table of Andvari’s findings. We chose the first fiscal year end during which a company achieved a particular revenue number as the start or end date as the case may be.

WHAT IS BASELINE GREATNESS?

The findings are instructive as to what is possible. By knowing what is possible, it will be less likely for Andvari to dismiss an emerging serial acquirer on concerns the current valuation multiple might be way too high. 

For example, Danaher took just 2 years to go from 100 million to 500 million in revenues while it took 6–8 years for most of the others. For the longer term view of growing revenues from 100 million to 2 billion, Danaher, Constellation, and Open Text achieved this feat in 11–12 years. Other companies in our list took (or will take) 20 years or more to go from 100 million to 2 billion. 

With a baseline for what is possible for revenue growth, how did shareholders of these companies fare? Any management team can grow their company via acquisitions, but it’s a special management team that doesn’t destroy value along the way in this process. Below we see the returns of each of these well-managed companies compared to the S&P 500 during each phase of their revenue growth.

With few exceptions, shareholders of these serial acquirer companies outperformed the market in all revenue growth phases. The companies that underperformed the market all shared one trait: proximity to the dot com bubble.

• Roper underperformed in their 100 to 500 million phase. This was from 1993 to 2000.
• Ametek underperformed in their 500 million to 1 billion phase. This was from 1984 to 2000. 
• Open Text underperformed in their 100 million to 500 million phase. This was from 2000 to 2007.
• Watsco underperformed when they grew revenues from 500 million to 1 billion in less than 2 years from 1997 to 1998.

ANDVARI TAKEAWAY

In Andvari’s ongoing quest to outperform the market over the long term, we are always on the hunt for small and mid-sized companies that can become the next great serial acquirer. 

Occasionally, Andvari might find a company we believe to be a nascent serial acquirer and also looks very expensive. Having studied the history of older serial acquirers, we appreciate that growth can come much more quickly than anyone can imagine. We also understand the historical returns shareholders have achieved with these types of companies. 

Armed with an understanding of the range of outcomes a serial acquirer can achieve, Andvari hopes to never immediately dismiss such a company based purely on traditional valuation metrics. The potential returns are hard to ignore.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari clients currently have positions in HEICO and Constellation Software. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

The picks-and-shovels investing theme is a favorite of Andvari’s. The theme takes its name from the California Gold Rush. Prospectors were not guaranteed to find gold but the people selling the picks and shovels earned a good living. Suppliers of goods and services that are essential to the creation of another finished product are fertile grounds for prospective investments. MSA Safety is one company that fits the picks-and-shovels theme—and several others—and has turned into a 100-bagger over the last 33 years.

Originally named Mine Safety Appliances, the company was formed in 1914 after a spate of terrible coal mine explosions. Dozens or even hundreds of miners died in these tragic accidents when an open flame lamp ignited methane gas or coal dust. The Monongah Coal mine was the site of the largest coal mine disaster in U.S. history in 1907 with 362 deaths. Thus, MSA enlisted Thomas Edison to help create an electric cap lamp to replace the open flame lamps used in mines. Over the next 25 years, MSA’s lamps helped reduce mine explosions by 75%.

LIFE SAVING, MISSION CRITICAL PRODUCTS

Although not literally selling picks and shovels, the MSA product range includes breathing apparatus products, fixed gas and flame detection instruments, portable gas detection instruments, and firefighter helmets and apparel. These products are all essential to the safety of miners and others working in hazardous environments. Also, these products are often mandated by government and industry regulations. The life saving, mission critical qualities of MSA's products enables high margins and affords them the ability to more easily raise prices.

EXEMPLARY FINANCIALS

MSA’s financials are quite good despite them being a manufacturer of physical products. This is because MSA’s products are: (1) essential to safety; (2) are highly-engineered; (3) are mandated by regulations; and (4) are a small part of the total costs borne by the end users. MSA’s revenues are also more stable compared to the industries to which they sell. 

LEADING MARKET POSITIONS AND VALUE-CREATING M&A

There are two other factors contributing to MSA’s success. One is that most of their products occupy the #1 position in their categories. Having the best brands allows MSA to charge more and raise prices more easily. The other factor is MSA’s excellent track record of value-creating acquisitions. Although not quite a serial acquirer like Constellation Software or Halma, from 2010 through 2020 MSA has acquired 5 companies for a total consideration of $716 million. It’s acquisition program has succeeded because MSA has stayed inside its circle of competence. They’ve only acquired manufacturers of mission critical products that help protect the lives of people working in dangerous environments.

ANDVARI TAKEAWAY

Although MSA does sell to cyclical industries Andvari categorically dislikes—mining and oil and gas, for example—it would be wrong to totally dismiss MSA as a potential investment. It has many attractive qualities that we look for. It’s products are highly engineered, have leading positions in highly regulated markets, and are non-discretionary purchases that protect the lives of people. Whether it's miners, firefighters, or chemical plant employees, none of them can do their jobs without products from MSA. This all adds up to a company whose shareholders have enjoyed a 100-fold return since 1988.

Further Reading

• Hutchings Museum - Mining: Electric Light & Hats
• National Museum of American History - Electric Lamps
• When Everybody Is Digging for Gold, It’s Good To Be in the Pick and Shovel Business
• MSA Safety March 2021 Investor Presentation

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. In the instance of MSA Safety, Andvari and its clients have never owned shares prior to publication of this educational blog. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

McCormick, the seasoning and spice company, is an outstanding business with several of the qualitative traits we seek. Spices are a small, but essential part of end products that consumers often grow to love. It has dominant positions in its markets and its CEO is highly aligned with shareholders. The combination of these traits have enabled McCormick shareholders to outperform the S&P 500 over the long term.

SMALL AND ESSENTIAL

According to McCormick, spices are typically 10% or less of the cost of a meal, yet provide 90% of the flavor and satisfaction. Andvari has written about this concept before in “Robertet Groupe: Accounting for Good Taste”. Being a small part of the total cost while also being an essential component gives a company pricing power. This allows the company to more easily raise prices over time, an especially important quality in times of inflation.

MARKET DOMINANCE

Further, the majority of their products and brands are #1 in their respective categories. Market dominance generally leads to higher margins and more stable revenues due to less intense competition. Andvari likes to see this in all companies.

Dominance of McCormick’s type can often come with the price of increased scrutiny from the Federal Trade Commission (FTC). This can be both a good and bad thing. Good because it’s a high-value indicator of a company’s strength but bad because the company may be forced to divest assets to restore market competition (see “The Fertile Ground of Forced Divestitures”).

RELIABLE SIGNALS OF STRENGTH

In the case of McCormick’s proposed $605 million acquisition of Lawry’s and Adolph’s consumer brands in 2007, the FTC alleged McCormick would control 80% of the $100 million U.S. market for branded seasoned salt. To complete the deal, McCormick had to (1) sell it’s Season-All business to Morton and (2) abstain from acquiring another seasoned salt brand for 10 years. Despite the divestiture and 10-year ban, McCormick’s share price continued to produce savoury returns with its consumer segment leading the charge.

VALUE-CREATIVE M&A IN A HIGHLY FRAGMENTED MARKET

McCormick has created value through an effective M&A program. It has acquired dozens of brands and products in the flavors, spices, and condiment categories. It has stuck to acquiring businesses it knows well, one of the key reasons why it's M&A efforts have succeeded (see “M&A Wisdom from the U.K.”).

Despite a robust M&A program, McCormick still only has a 20% market share. A highly fragmented market like this gives a company a very long runway for both organic and inorganic growth. As of 2017, the company’s SVP of Corporate Strategy & Development said they had a list of 1,000 assets it could potentially acquire under the right conditions. Significant opportunities for growth reinvestment are two other qualitative factors Andvari likes to see.

ALIGNED CEO

Finally, McCormick’s current CEO is Lawrence Kurzius. He was CEO and President of Zatarain’s for 12 years when McCormick bought the company in 2003. Since then, Kurzius steadily acquired and retained McCormick shares as he climbed through the ranks of leadership.

In 2016 Kurzius took over as CEO of the entire company and now owns 5.8% of McCormick’s voting class of shares. These shares are worth roughly $100 million. Kurzius has skin in the game, has an excellent track record, and it's highly likely he will continue to maximize his and shareholders’ wealth over the long run.

ANDVARI TAKEAWAY

Whether a company sells spices, software, or rents out space on cell towers, Andvari always seeks out the qualitative factors that increase the likelihood of earning above-average returns over the long run. We like to see a company selling a highly valuable product that’s just a small part of the customer’s total cost. We like market dominance, value-creating M&A, and consolidation of fragmented markets. We like highly aligned CEOs. In the case of McCormick, the returns to shareholders from this recipe have been extremely satisfying.

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari may re-evaluate its holdings in such positions and sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

David Barber is the co-founder and now retired CEO of Halma plc. For the 20 year period preceding David’s 1997 speech on delivering shareholder value, Halma shares had returned 22.5% per annum.

In his speech, Barber described the reasons behind the success of Halma. Although there are several, Andvari focuses on the criteria Halma used in its highly effective M&A program. When nearly everyone agrees most acquisitions destroy value, we can learn much by studying a company with a track record of creating value through M&A (see our prior post, “The ‘Permanent Home’ Advantage”, on the same topic).

Barber’s guidance can be boiled down to four, key recommendations:

#1: USE INTERNALLY GENERATED FUNDS

Barber says the first factor that will improve the odds of an acquisition creating value is whether one funds the deal with surplus cash or by issuing shares. The idea here is if the acquired company was purchased at a fair price and performs well, the value creation will be greater if shareholders weren’t diluted in the process. Simple and logical.

#2: FIND A REPLICA

Next is whether the acquisition target is a “replica” of one already owned by the purchaser. Anyone selling a business likely has more information than the buyer. The owner also wouldn’t be selling unless they thought they could get the better end of the deal. Thus, to reduce the risk stemming from a disparity in information, the buyer should be as much or even more of an expert in the field of the seller. The buyer of businesses should therefore be looking to purchase other businesses that are replicas of the ones they already own.

#3: PURSUE BOLT-ONS

The third way to reduce M&A risk is by seeking to acquire “bolt-ons”. Barber defines a bolt-on company as one that “when purchased can then be readily integrated into an existing Group company.” This necessarily means the target will be of a smaller size, which also usually means lower complexity, both of which increase the odds of generating value.

#4: DO NOT SACRIFICE EARNINGS QUALITY

The last predictor of value creating M&A is if the acquired company will improve the quantity and quality of earnings. From Barber’s perspective, “quality of earnings is paramount” and “you can never pay enough for a good acquisition and never pay too little for a bad one.”

ANDVARI TAKEAWAY

Thanks to the combination of sensible M&A criteria and a focus on quality, niche businesses with high returns on capital, Halma provided extraordinary returns to its shareholders. Furthermore, thanks to Barber cementing the strategy and culture into the business, shareholders have enjoyed great results even after his retirement in 2003.

A great deal of M&A is value destructive, but not always. Companies with excellent management and sensible M&A programs have beaten the odds. HEICO, Constellation Software, Roper, Danaher, Ametek, Teledyne, and Waste Connections are just a few examples of other companies that have similarly successful M&A programs. High-performing, serial acquirers that can compound returns for decades are exactly the sort of companies for which Andvari is continually on the hunt.

Further Reading

• David Barber’s 1997 speech on delivering shareholder value
• Halma plc Investor Relations website
• “Do Shareholders of Acquiring Firms Gain From Acquisitions?”
• “Do M&A Deals Create or Destroy Value? A Meta-Analysis”

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IMPORTANT DISCLOSURE AND DISCLAIMERS

Investment strategies managed by Andvari Associates LLC ("Andvari") may have a position in the securities or assets discussed in this article. Andvari may re-evaluate its holdings in such positions and sell or cover certain positions without notice.

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. This document contains information and views as of the date indicated and such information and views are subject to change without notice. Andvari has no duty or obligation to update the information contained herein. Past investment performance is not an indication of future results. Full Disclaimer.

© 2021 Andvari Associates LLC

For the first quarter of 2021 Andvari is down 5.2% net of fees while the S&P 500 is up 6.2%.[i] Andvari clients, please refer to your reports for your specific performance figures. The table below shows Andvari’s composite performance against two benchmarks while the chart shows the cumulative gains of $100,000 investments.

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Compounding capital at high rates—especially in a taxable account—is a challenge with smaller turnaround investments. If and when the turnaround succeeds, the investor must sell their position and look for the next opportunity. Capital gains will be realized and the next opportunity might not even be immediately available, both of which reduce long-term performance.

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To achieve results different than the average, one must actually do something different. One underappreciated way in which companies may differentiate themselves from their peers is in their approach to communicating with shareholders. The way a company tells its story might just be a sign that something special is going on.

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The article which follows is a high-level summary of a deep dive we recently initiated into the history of the desktop publishing software market from its founding in 1984 until the 2000s. These are the software programs used to edit graphics and to lay out pages for documents ranging from brochures to newsletters to magazines. We work through the enduring lessons highlighted below, which are still applicable to investing today and to all businesses. But we certainly encourage our readers to 'go deeper' via our PDF if they are so inclined.

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SS&C checks off many of the qualitative boxes on Andvari’s list. Bill Stone, the founder, is still running the business after more than 30 years. He still owns 13.3% of SS&C which now has a market cap of $16.5 billion. He has an extraordinary track record of capital allocation (including demonstrating talent as a serial acquirer, which we value). He is an intense operator and has created a culture that retains and attracts highly motivated people.

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If Warren Buffett was 30 years old, all he’d be doing is buying software businesses. They have every attribute of a business he loves. They have incredible moats around them. You can raise prices every year. Your customers don’t leave. You can deliver value and that value is paid for and expected to be paid for.

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