Dynamic Portfolio Strategy: Rebalancing Using Divestitures

Approaching deals in a software-oriented environment

A lot of our M&A strategy pre-existed me. In 2017, Insight Partners and the current CEO, Thomas Swalla, teamed up to buy a company called GraphPad. Without going into too much detail, GraphPad is widely used by researchers and scientists for statistical analysis related to their work. 

They approached this with a deliberate M&A strategy: to acquire the very best software tools in different technical domains and combine them in one place. Having top-down guidance from senior leadership and our board members from day one was a really big part of it. 

Since then, we've done another 13 deals. The high-level strategy is finding the best vertical SaaS businesses in different categories. Finding them is hard—it's a needle in a haystack—but we have a very systematic and robust way of doing that.

The second aspect is having a differentiated strategy, both at the product strategy level and in the way we add value to these companies. 

Let me talk about our product strategy for a second. Every acquisition we make brings a deep specialty in a different scientific domain. Our customers need to solve specific technical problems in those domains, but they also need to combine that information at different points in a workflow to reach the total answer they're working on.

We've acquired the best tools in different categories and brought them together into a single platform. We've invested organically in a scientific data intelligence platform that connects these tools, enables comprehensive workflows, allows for multidimensional analysis, and ultimately supports deeper, more innovative research in AI. 

Many AI efforts have failed due to a lack of deep data sets on the broad dimensions needed to solve complex problems. We now have a platform that brings together the depth and breadth of data sets, accelerating the pace of scientific research. That's the product strategy.

It's that, and in addition, having a very well-defined operating model where you're taking companies at different stages of maturity. Some of them might be PhD professors who created a great piece of software, while others are further along with $5-20 million in ARR. 

Over the course of these acquisitions, we've developed a very well-defined value-creation playbook that we can apply to different companies at various stages. This allows us to give them tips, tricks, and capability uplifts to scale efficiently to where we are now.

So, it's that value creation playbook capability combined with a really differentiated strategy that adds real value to our customers and the companies joining us. The results have been pretty extraordinary. On the scientific impact side, we've seen significant progress, and it's also been extraordinary on the operating results side. 

We've scaled up organically to nearly 300 million in ARR with exceptional, consistent organic growth and profitability. This allows us to reinvest in product development, make additional acquisitions, and continue working towards the vision of a truly comprehensive multimodal platform for science.

Preserving brand integrity in M&A go-to-market strategies

Two comments on go-to-market. A big part of any M&A strategy is finding companies that fit well with how you grow those companies. For us, product-led growth has been a significant part of that. 

When you find absolute leaders in different categories, especially within specialized user groups where people communicate closely, you have opportunities for strong product-led growth in your go-to-market motions. This has been typical of most of the companies we've found. 

We try to preserve that strength and not do anything that could disrupt it. Additionally, we have a more traditional enterprise sales team that engages at the enterprise level. 

What you end up with is a terrific and unique situation where the products speak directly to individual users while the enterprise platform sales team communicates with the organization. These two elements work together, reinforcing consistent organic growth.

It leans more on individual product sales motions than the classic conglomerate approach, and that's by design. The strength of our products is a big part of what differentiates us and enables successful sales. 

The enterprise sales team focuses on key accounts, leveraging product strengths to expand within those accounts. This collaborative approach allows the sales team to become an extension of the platform. The enterprise sales team focuses on key accounts, identifying opportunities to bring in additional products.

But I want to emphasize something that many acquirers might miss: if you have a great brand with a successful sales motion, the worst thing you could do is eliminate it and replace it with something else. It might seem obvious, but many acquirers do this. 

Many instrument players or horizontal software players in our space have well-defined enterprise sales capabilities and often try to supplant what's already working well in other companies. 

What we do differently is focus on preserving everything—the brand's aura, the successful sales motion, and possibly jumping ahead to a different topic on integration philosophy. 

We are very careful, and we may take longer than expected, before bringing in the enterprise sales team. This cautious approach ensures we don't break the existing model. We must be confident in that model before complementing it with our enterprise sales capability.

In practice, this approach means that cross-selling opportunities don't typically emerge as part of our day 60 plan for an acquisition. Instead, these opportunities often arise around six to twelve months into the acquisition. It may seem counterintuitive, but the core principle is preserving what's great about the original products.

The same principle applies to product integration and many other aspects of our approach. Let me take a step back and talk about our integration philosophy. 

• Step one is buying great businesses. 
• Step two is having a well-defined playbook where we work within the confines of that business while bringing in our expertise. We're really good at go-to-market strategies and PLG (product-led growth). We bring a whole bag of tricks to these individual businesses. 
• Step three involves joining those businesses with our broader product strategy, and finding common workflows, users, and connections between them and other products.

However, we don't force everything into a single product. We allow them to continue as symbiotic products, pushing them to be interoperable with our common data platform. The key point here is that it takes time before we can bundle and sell these tools together.

Some practitioners might see this as a drawback, but it’s actually a strength of our strategy. But what’s great about it is that it has allowed us to preserve high NPS scores, strong community feedback, and appreciation for our products without breaking them.

Our developers continue to focus on the same customers, creating new features for them rather than re-platforming the technology to accommodate the needs of the larger organization. While this approach may take longer to develop a comprehensive, interoperable portfolio of tools, our tools are best in class and beloved by their customers.

Additionally, outside of go-to-market and product strategies, we are more traditional regarding shared services and back-office functions. We integrate these more quickly because we know we can do so without disrupting what's working well with the customer or the scientist or risking the departure of key engineers once restrictions allow them to leave.

Another positive outcome of this approach is our exceptional track record of retaining the talent that comes along with us. This talent has been a significant differentiator for us, providing deep expertise across various categories.

Approaching valuation

I need to be a little careful—I don't want to contradict what Insight Partners wants me to share about our valuation methodology. But I’ll say a few things that might surprise people. 

Our approach is more fundamentally driven than many assume software investing to be. We do rigorous and real math to assess a business's momentum today. We're very precise and scientific in measuring ARR velocity and quality, understanding the business's cost structure in detail. 

Ultimately, we want to ensure that we’re validating the product's resonance with customers by looking at revenue recurrence and growth.

It’s more fundamental than people realize. We look very closely at the individual customer level: 

• How long are customers staying with this product? 
• How quickly are we adding new customers and growing? 

These metrics are the proof points that show the quality of the product and its category. It’s easy to get caught up in stories about game-changing technology. There are hundreds of those, and I'll admit, I'm not smart enough to tell you which ones are real and which aren't. 

But when you see a company that consistently retains its customers, consistently adds new ones through the strength of its product, and operates in a disciplined way, you can arrive at fundamentally rooted valuations that allow us to bid pretty aggressively compared to other software investors.

The reality is that sometimes, after doing the math, you realize it's not the right asset for you—and that's okay too. That’s the point where you know it wasn’t the right fit.

Momentum and retention are probably the two most important things in a SaaS company.

Strategic pitch for acquisitions

The answer has two main parts. First, value is created when you bring together disparate capabilities in one place. It’s like a team-building exercise where everyone has a piece of the puzzle, and suddenly, the lights come on, and you can see everything clearly. This kind of integration doesn't exist today in the life sciences world, which is incredibly fragmented. 

It used to be that you could drop something in a Petri dish, and you had an answer whether it worked or not. Meanwhile, the drugs being developed now require a multimodal approach—chemists collaborating with biologists, geneticists, and others. 

Having all these elements together in one place is distinctive and different and creates value. It elevates individual products into a bigger context, especially as we move more towards data-driven, AI-enabled discovery.

The second part of the argument is that each company, at any stage of growth, needs help to get to the next stage. The challenges in step one are different from those in step two or three. 

We have a bit of a secret weapon with Insight Partners, who back us and are one of the biggest software-focused investors across various verticals. They understand these challenges really well. 

Additionally, we've codified a 300-page playbook, which we tailor to different acquisitions. This experience helps address the challenges companies face at different points. 

Another key aspect is our shared service operating model, which brings resources to these businesses that they might not have the scale to support individually. For example, founders shouldn’t be bogged down with things like export control compliance or figuring out taxes in multiple jurisdictions. 

Founders should focus on better products, serving their customers, and innovating. We take care of the boring stuff, allowing them to scale faster and more efficiently.

The PE firm has been a great support. Despite everything we've done on that front, there's always something new, and they’re always there to help us. It's been a great partnership.

It ultimately gets other executives interested in combining companies, which is the biggest thing. These are science-driven companies, and it’s worth mentioning our core values: science-driven, customer-centric, and better together. 

We live by those values, and they influence how we approach these deals. People realize and experience that when they work with us.

One last thing I’ll mention, which I'm sure every guest of yours has said: reputation is so important. We're working on our 15th acquisition now, and we’ve done a surprisingly small number of LOIs to get there. 

When we issue an LOI, we deliver on it. We also have a process that makes it easy for people to opt in. Our initial question list is only six questions, and we focus diligence on what truly matters. Making the process easier helps everything else fall into place.

Portfolio rebalancing and its challenges

This isn’t related to my current company, but rather a different one—very different in fact. So, now that I've removed my plug for Dotmatics let’s discuss portfolio rebalancing. 

This is a very different situation. Dotmatics is a relatively new company with a singular focus on strategy. When I joined Standex and Perkin Elmer, both companies had been listed on the New York Stock Exchange for over 50 years. They are great companies with storied histories and do really good work. 

But inevitably, after that amount of time, there’s some drift in different business units. Unless you actively think about a mechanism to prune those elements back to a core strategy, you’ll end up with these odd-shaped things that don’t align well with the company’s goals. 

In both instances, the central strategy and corporate development function provided the perspective and impetus for the necessary pruning. It's important to note that there’s not really anyone else, except maybe the CFO or an external activist investor, who will actively do this. And that’s not how you want these things to be instigated. 

I’d encourage your listeners in corporate development and strategy roles to think about this because if you're not actively thinking about it, nothing happens.

It’s easy to put it on the back burner and just do business as usual, but you’ve got to be proactive when evaluating your portfolio. And it's not just about putting it on the back burner. There’s also a bias against selling because it can seem like admitting defeat. 

Management teams often assume their job is to take the assets they have and do the best job running them. While that’s partially true, their real job is to realize the best value they can from those assets. This includes serving customers and employees well, which depends on the asset being owned by the right entity that’s well-positioned to grow and develop it. 

There’s a negative connotation around divestitures as if they are a form of failure. Additionally, people focus on goals like EPS, EBITDA, and quarter-over-quarter growth. When you look at the world through that lens, you might miss your first obligation to total shareholder returns. Unless you’re actively thinking about it that way, you might not consider divesting. 

These are the reasons why people avoid portfolio reviews, and they’re also hard to talk about internally. At any level, the official line is that "we love all of our children equally." Plus, it’s a lot of work to execute a divestiture. The good news is that when done right, you can realize a lot of value for your shareholders. 

It also refreshes and reawakens a stronger sense of identity, purpose, and focus, allowing the remaining portfolio to reach new heights. Importantly, the company that gets spun out is presumably with an owner who’s focused on their strategy, allowing them to achieve new heights and a new purpose that they weren’t able to before.

When and how to rebalance a company’s portfolio

There’s usually no impetus unless someone is actively thinking about portfolio rebalancing. But you're right—if I were to give another answer, it would be when a conglomerate’s stock is trading at a discount. 

You look at the individual components of a business, see what they’re worth, compare that to where your stock is trading, and often realize you’re trading at a discount. This can lead to frustration and the impetus to act. 

My strongest recommendation is to acknowledge this and be proactive about it, rather than waiting for the investor base to come to you with their version of the solution.

Getting buy-in and alignment from the board and key stakeholders

The first challenge is that different people will have different perspectives on how to measure shareholder returns, and how they view the company's strategy and its identity. The way to approach this is by asking calibrated questions, such as:

• Why are we in the businesses we’re in? 
• What gives us the right to own these businesses? 
• As a CorpDev professional, you can ask, what should we be looking for in our next acquisition? 
• How do we think about excess capital and what do we do with it?

These questions help reveal the core principles people believe in regarding their obligations to shareholders and their approach to creating returns. Once everyone starts responding similarly, you can develop a framework.

This framework has three dimensions. First, there is the strategic focus: Which industries do we want to be in, and why do we believe we have the right to operate in those industries? 

Second, there is the financial angle: Understanding the economic contribution of the different businesses in your portfolio. Here, it’s essential to look beyond EBITDA or EPS to quality metrics like margins, returns on invested capital, and growth rates.

A technical exercise I’m excited about is creating a dynamic portfolio model. In this model, you toggle business units on or off. While removing a unit might reduce your earnings and EBITDA, you might find that your growth rate, margins, and other metrics improve for the remaining company. 

When you correlate these improvements against the multiples companies trade at, you can expect to see a positive movement in your multiple. Additionally, when you divest a business unit, you gain cash that can be redeployed, which also directly benefits shareholders. 

One of the main problems is that unless you're actively doing this mathematical exercise, you might not realize that a cash-generating business is actually weighing down your growth and other metrics, leading to a trading discount.

Finally, different investors self-select into different strategies that align with specific business units once they're spun out, which they can’t do when you're a conglomerate. This leads to a trading discount because it's harder for thematic investors to get excited about parts of your company when it’s bundled with other unrelated business units.

When you're a conglomerate, it's harder for thematic investors to buy your stock based on their excitement about a specific piece of your company. Without investors who are excited about specific things in your company, it's hard to maximize share price. 

So separating it out enables that kind of investor interest. Otherwise, each investor feels like they're compromising in some way.

Key factors in considering divestitures

The third factor would be feasibility, which sounds obvious, but let's discuss it for a minute. You need to think really hard about the entanglements between different business units. By entanglements, I mean situations where employees or functions are supporting multiple business units. 

When you separate those, it's like surgically removing conjoined twins to some extent. You have to consider whether each unit will do well on its own and whether you'll need to create additional capabilities for one or the other or have a transitionary period between them.

The difficulty of doing that is much higher for closely intertwined businesses with many entanglements, and it's less so for businesses that operate more independently. 

When laying out options, you should consider three dimensions: strategic focus, how additive they are to financial results (including quality metrics), and feasibility. Ideally, you prioritize divesting non-strategic, non-additive, and highly feasible assets. Sometimes you get two out of three, but those are the dimensions to focus on.

For listeners of this podcast, many are likely operating in specialties like negotiating transaction service agreements or setting up the functions needed to separate these businesses. 

There’s a whole world of work involved, but the prize at the end is having a company that can focus on a more singular set of objectives, grow, and financially perform better based on everything we've discussed.

Executing a divestiture for portfolio rebalancing

It's really a lot of work. You know it's going to be a lot of work, and then it's invariably even more than you thought it would be. There's no fun way around that. What you try to do, as best you can is approach it with a few tips in mind. 

Executive sponsorship is huge. You need very strong alignment, if not a mandate, from the board of directors, and the leadership team also needs to be very aligned with that.

You need to think early and hard about the operating model for both the remaining company and the company being spun out. Have an early definition of what that looks like so that different functions know what they’re working towards. That helps people understand the task in front of them. 

The hard part is that there are many interdependencies between the pro forma operating model for the company that’s separating and the acquirer of that company, so you may get different answers, but having a strong hypothesis early on is key.

This might sound like a cop-out, but I’ll say it: get external help. Some companies specialize in advising on these sorts of carve-outs. They’ll still miss things, and you’ll still have to be very involved, but at least you can benefit from their experience and the reps they’ve had.

Another point is the hesitation to involve functions early on. Before you know you're doing it, keep a small team, but once you know it’s happening, you’ll need the expertise of people within those functions to uncover the entanglements. 

You can’t sit in a boardroom and know where all the hidden traps are in separating a business. That would be my high-level advice to someone going through it.

Best practices in executing divestitures

The points I mentioned earlier are key. Defining the operating model early and involving the necessary functions is crucial. There's often hesitancy to bring too many people into the fold, but in my experience, you’ll need those functions involved.

It’s important to frame the divestiture as a positive move for both companies. The best divestitures occur when each company is in a better position to pursue new opportunities after the split. The people involved in the process need to recognize that this is in the best interest of the customers, employees, and everyone else involved. 

Clear and deliberate communication post-announcement is vital. If the messaging isn't handled well, it can jeopardize the deal by spooking customers or suppliers, and it becomes harder to attract the right potential buyer. You need people to feel tied to and invested in the outcome, and there are various ways to achieve that.

Internal alignment, clear messaging, and clarity on each entity's end result will help you navigate the hard work of actually executing the divestiture.

This might sound corny, but for me, and hopefully for others involved, it’s important to embrace the transformative impact you’re creating. You’re setting up two different companies to succeed in entirely new ways. You need to find excitement in that because a lot of it will be hard work. That excitement can help you and the functions involved push through the challenges.

Remember, every function involved still has its day job. It's a lot of work. It's crucial to have the perspective that this effort enables bigger strategic things to happen. Part of your leadership role is to communicate that effectively.

Divestiture success metrics

Two things: The obvious one is the share price, but that's not always immediate. One of the early career lessons I learned is that just because the math says something is the right answer, it doesn’t mean everyone will agree, and the share price will double overnight. 

What often happens in divestitures is that different investors in your stock have different viewpoints about the business units. When the cards are revealed, some investors may be excited, while others may not. 

Despite your communication strategy, some will trade out of the stock. In the long term, you’ll have a more focused company with stronger metrics, trading at a higher share price, but that might take a quarter or two to materialize. You need a board that understands and is prepared for that. 

I’ve seen situations where, after the initial divestiture, there’s some short-term rotation of investors, but a quarter or two later, your investor base starts asking, "Have you thought about divesting this other unit?" 

Once people realize the benefits of these actions, there can be a positive pull. It’s important to remember that you’ll see different reactions from different portions of your investor pool.

Example of portfolio rebalancing and its challenges

Standex International, a conglomerate that had been listed for over 50 years, had various niche industrial businesses in different domains. In some domains, we had strong competitive advantages, doing things nobody else knew how to do. We had differentiated brands and were getting returns that reflected that. 

In other business units, however, our competitive position had eroded over time. What was once a differentiated position had been competed away by others entering the space, or technological advantages had dispersed, allowing others to do similar things.

These business units were still contributing positively to overall results, but when you disaggregated growth or looked at metrics like margins, they were dilutive. Through the modeling exercise I described earlier, we decided to sell one of those business units.

To make this tangible, Standex had an industrial cooking equipment business that made the speed ovens you see at Subway—the ones that toast your sandwich. It was once a novel product, but as time went on, competitors emerged, and today you can find similar units at lower costs. We decided to divest that business unit.

This is where the success on both sides comes in. Another company, Middleby, specializes in that vertical. They valued those storied brands, had a better distribution system for selling commercial equipment, and could leverage unique value-creation strategies specific to their focus on that space. 

The business was worth considerably more to them, based on the value they could realize from growing and combining it with their existing operations than it was as an isolated business unit within Standex's broader conglomerate.

The challenges are significant, and while you can look at charts and do case studies, the reality of executing a divestiture is really hard. Managing internal communications and messaging is tough, especially in a way that doesn't create fear among other business units, suppliers, or partners. There’s a huge communication challenge here that shouldn't be understated.

Another challenge is managing the investor base. Different investors have different ideas and theses about your stock. Some might see the lower margins in a business unit as an opportunity, not a drawback. 

Any action like this might attract opposition from some investors. However, once things have settled and you’ve delivered on the new opportunities, you'll start to reap the benefits from the shareholder community.

So, the three main challenges are communication, the sheer amount of hard work, and achieving master alignment—getting diverse views on the same page.

But above all of that, the most important factor is clarity of focus and strategy. You need to be clear about why you occupy the spaces you do, why you believe you have a competitive advantage in those markets, and whether that advantage is strengthening or weakening over time. 

This clarity should guide your dynamic financial modeling and your understanding of how the operating model will benefit post-transaction.

And there’s a simple but critical question: Are we the best owner of this asset? In the case of Standex, we weren’t the best owner for the industrial cooking equipment business—Middleby was. 

They were better positioned to maximize the value of that asset, while Standex could focus on the rest of its portfolio and deliver exceptional results with a more focused strategy. It’s been a great success story for both companies. These are the key takeaways, and they really drive the success of a divestiture.

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