Hey Graham Lynch Buffet,
Good question.
Let me start by saying that I am generally opposed to acquisition roll-up stories. The reason being is that there is invariably a transfer of value from the acquirer to the vendor.
And the reason this occurs, in my experience, is because executives driving acquisition-led strategies invariably make use of forecasts (forecasts of future market conditions, competitive landscapes, revenues, synergies, and therefore profits and cash flows) to justify their acquisition decisions.
And given that 95% of businesses are not good businesses, the executives running those businesses tend buy bad businesses.
Also, I have a deep distrust of forecasting.
Especially by people with vested interests and confirmation biases, such as a CEO trying to justify an acquisition.
However, there are exceptions: sometimes - but seldom - executives are able to buy good businesses or they buy businesses that make unambiguously good strategic sense.
And - this is the most important thing - they pay below intrinsic value for those businesses.
But to get back to the examples you cited, namely AUB, ONT and GXL, and why I endorse acquisitions made specifically by these companies, and not many others.
In AUB’s case, there is significant, multi-year precedent on which to draw. The company’s management team has a demonstrated track record at being disciplined in its acquisition strategy. When vendor expectations for broking businesses have been elevated, the AUB board has been happy to report to shareholders and say, “Valuations are too high. We haven’t been able to buy anything this year. We will wait patiently for the cycle to turn down, like we always have done.”
ONT is very similar. Again, there’s a proven acquisition track record. The CEO, who presides over the roll-up strategy is in the mould of a great value investor. He understands intimately the sort of asset he wants to acquire, and he knows the maximum he is willing to pay for it. In addition, the structural issues in the dentistry business (oversupply of dentists added to significant profitability pressures on dental practices following withdrawal in late 2013 of significant government payments, as well as unsophisticated vendors) make it a distinct buyer’s market.
GXL is similar to ONT in terms of the seller of a veterinary practice being relatively financially unsophisticated, and in most cases, GXL’s retail scale and purchasing power has resulted in substantial cross-selling revenue uplift. This all has lent itself to value-accretive acquisitions by GXL over the years. (Having said all that, for me the jury is not quite in on this year’s massive foray into the pet retail space. In principle, it sounds and reads well to become the number 1 player nationally in pet care retailing, by far, but I somewhat ambivalent about it at this stage.)
(SGH is another one like these.)
Back to why I am wary of TPI’s articulated acquisition intentions:
Firstly, I don’t think the sorts of assets TPI’s new CEO says he wants to buy, trade at discounts to intrinsic value. There aren’t too many “cheap” waste management businesses deals being done (at around 6x EV/EBITDA, TPI is probably the cheapest “deal” I know, based on some of the trade sale multiples I have seen transacted over the past 18 to 24 months (the average is about 8.5x EV/EBITDA, and I don’t know how TPI management creates value for shareholders by paying those sorts of valuation multiples.
Secondly, this new guy – and indeed the entire TPI board – are untested at buying astutely.
Thirdly, the type of asset that the CEO feels the need to acquire (and rightly so) are landfill assets given TPI’s low level of “internalisation” (10% to 12%). And quality landfill assets are very scarce. For that reason they don’t go cheap.
To circumvent this, Boucher has spoken of not necessarily buying landfill assets but by potentially entering into joint ventures with existing landfill owners. But I still fail to see why that will guarantee the avoidance of a transfer of value from TPI shareholders to the owners of the landfill asset(s) in question.
Finally, TPI is a capital-intensive business. OCF covers Capex by around 1.4x to 1.5x. Add to the landfill rehabilitation catch up that needs to be undertaken, and TPI will generate somewhat limited Free Cash Flow over the coming years.
This, I think, leaves little wiggle room for any misstep in acquiring badly, because the balance sheet will take some time to repair itself organically.
My whole investment thesis for buying TPI was not because I was a great fan of the business model, nor the industry structure.
While waste generation is perceived to be a largely non-discretionary activity, which should make collection economically resilient, and therefore an attractive investment sector, the fact is that the waste collection sector is more cyclical than people think. And, more importantly, it is also more competitive than people think.
I bought TPI almost purely because of the de-leveraging thesis.
This has now played itself out.
At the time of buying it, I thought 120c was a mid-scenario price, and 140c to 150c a “perfect scenario” outcome.
Well, a number of things prevented the “perfect scenario” from coming to pass, so I sold.
Now, I’m concerned that the process that got the company into a bit of a pickle in the first case, namely an acquisition strategy, repeats itself.
I will be happy to be proven wrong.
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