Growing through Multiple Roll-ups

Looking at business through a different lens

As Warren Buffet says, "I'm a better investor because I'm a businessman. And I'm a better businessman because I'm an investor." I found that to be really true, and it's my experience that my knowledge of business has helped me invest better, and my knowledge of investment has helped me manage our businesses better.

We learned a lot from 2010 to 2015. I used to read 2000 pages of 10Ks analyst reports, and earning calls, and  I used to deep dive into companies to understand their economic characteristics, what made them great, what made them good companies to be able to predict which companies are likely to do well into the future. And then, invest in them. 

When I studied roll-ups, I found that many of them that did well, the underlying businesses, were buying the companies that lent themselves well to a decentralized investment strategy or bringing the businesses together.

They had the tremendous competitive advantage to roll up the next business, but in every case, they had a clear reason for earning the right to acquire. Many other companies engaged in acquisitive activities and wasted shareholder capital because they were putting businesses together with no real purpose, and they hadn't earned the right to be an acquirer.

You earn the right to be an acquirer by managing the businesses better than they were previously managed.

• You could drive more growth out of them
• You could drive more profitability out of them
• You have something to bring to these businesses that will make them better in one way or the other.
  

We revised our strategy and our investment playbook around that, and we tried to buy companies that are intrinsically very good businesses and we tried to run them a little bit better than they were run previously.

I was personally comfortable with it. In my life and my business career, I found that people drove outcomes in business. So if I could predict how somebody thinks, how the management team of a company thinks, and how they're likely to behave in the future, through looking at what I've done in the past and M&A was part of their past. They added a lot of value through that; then, I could look into the future and underwrite that into my price at which I'm ready to buy the company.

And then we were able to buy companies that the market thought was expensive, but we thought they were really cheap because we were underwriting capital deployment that was going to be accretive into the future. 

Distinguishing good acquirers

We usually look at both and invest in both. For example, you look at a company like Salesforce, a very strong acquirer. They would have a base of customers and then append products that would add value to and make the customers more sticky, and they would leverage these customer relations further and provide them with more products that they needed. 

So, every time they bought a company, it looked very expensive, what they paid for it versus the company's revenues and profits at the time. But then you expose this product to the large customer base of Salesforce and their revenues would go up a lot, so then it would become cheap. 

And then this is one strategy that's allowed Salesforce to compound at a very high rate for a very long time. And it's not very different from a strategy that a company like Microsoft employed for many years. 

Then you look at other acquirers. Let's say you look at TransDigm, where the companies would keep running independently. So they didn't necessarily have a lot of synergies with their products, but they developed expertise in running these companies in a way that allowed them to extract more revenues. They had best practices through learning from 50 different acquisitions that every time they bought a company, they just present the playbook they run to make that company more efficient with higher revenue and profits, and they had earned the right to be an acquirer. Every time they acquired, it would add value to their shareholders. 

Whereas a lot of other companies would just buy companies to grow their revenues, they really would not add any value to the shareholders, customers, or companies that were acquiring themselves. We don't invest in those, but we invest in the former. We're looking for their capability to drive synergies off the revenues and an element around the operational efficiency.

Identifying the right segment and deal size

We were studying companies and you're investing passively into businesses on the stock market. You're looking for companies that have certain characteristics. So, you want a lot of predictability because you're not managing the company every day. So, you want to be able to model in your head and on a spreadsheet what this company will look like in a few years?

We found that software companies had a very high level of predictability. A lot of them had pricing power because they were very important to their end customers. They had a low churn rate enabling us to have a much easier business to manage because of the revenue than if you start from scratch. 

That made us really focused on software, and then we started studying and investing in a lot of software companies and thought that maybe we could do that on our own. So then, we started looking at where we can add value in the marketplace. Is there a gap that we could fill where we would earn the right to be an acquirer and make good acquisitions that would add value to our shareholders and to the whole constituency? The companies that sell to us, the employees are the companies that sell to us, and everybody else.

In the vertical market software, there are about 30,000 of those companies, and most of them tend to be in the two to $20 million range because the vertical markets themselves are small. Then there are a few bigger companies, a thousand of the 3000 or larger companies. 

The larger companies are, to a certain extent, usually easier to manage. So if you have a significant revenue base, you leverage one R&D budget across many more customers, and they're usually in bigger verticals that tend to attract venture capital and private equity a lot more. So we didn't feel that we would bring tons of value there.

But the small and mid-sized markets have to be operated a lot more efficiently to bring value. And we felt within Valsoft that we would become a good exit strategy for these companies by learning how to operate those properly. 

We would provide something valuable for these entrepreneurs that have those companies and that want to move on or the companies need to go to their next step. So we would buy them and we would help them make that transition. 

They're in a different phase of their life cycle, sometimes, they're operating in a saturated market. So they deploy money in R&D, sales, and marketing, but there are no new customers to grab because everybody's vented. 

They all have software solutions, so you must get them from your competitors. But these competitors have sticky solutions just like you do. So the company has reached a point in its lifecycle where it's blocked from growing, and it's mature.

And in a mature company, you tend to lose your best employees. It tends to be less fun to work there when there's limited growth. So we come in, we'll buy these companies, give them money and expertise to buy their competitors, acquire their growth and then create a dynamic company with a much bigger customer base to which they could sell more product. 

And then we'll buy other adjacent products that serve that vertical and create a dynamic mini conglomerate around the company we initially acquire. We found that that brings a lot of value to the employees and the owners of the companies we acquire and our shareholders and employees at Valsoft.

Platform play acquisition

We're usually going to enter a new vertical with a platform company. In vertical market software and software in general, you're building one product and you're selling it to many customers. 

So if you have a lot of customers, the same R&D budget gets levered across a much higher revenue base. If you start with a very small company in a new vertical, you're starting weak. You have to start with a company with a little pedigree in a vertical. 

You enter strong, have staying power in the vertical, and then you look to buy companies with interesting customer relationships and bring those into your platform. 

Then, you could buy companies that have interesting products and you could sell those to the bigger base of customers. And there's a lot more you could do. So that's our strategy, but we usually manage all the companies we buy independently in a decentralized fashion. Meaning we keep most management teams in place and whatnot. 

We need all the companies we buy to be mission-critical to their customers. We need them to have a certain level of strength in their customer base. Meaning they've been around for a bit of time and shown that they bring a lot of value to their customers.

We bought a company this year that had been around since 1955. This company is small. Think about what's happened over the life cycle of this company for seven years, and yet it's remained independent and successful, and it's weathered every attack upon its domain. So there must be something about this company that's special.

Creating revenue synergies

First of all, we have to buy the company at a price that makes sense. We underwrite each acquisition on a standalone basis, and we underwrite it to the unlevered IRR that we will get from this acquisition.

The amount of information we've gathered on successful and unsuccessful acquirers is our IP. The IP of our investment group is what's allowed us to be successful across two roll-ups so far, and the third one coming.

Many acquirers will say their stock is trading at 15x EBITDA, and they could buy companies at 10x EBITDA, it's accretive to their shareholders, and they're making a good deal. Unfortunately, those always fail in the long term because your stock trades at a moment in time. 

This could vary very widely. And when you're purchasing an asset, this is a long time, the long-term investment you're making with your shareholder's capital. So you need to make sure you're making a good deal standalone. 

You need to look at the IRR of this investment on a standalone basis, modeling a very conservative terminal value because the further out you're modeling, the less certain it is because the world changes a lot in 5 to 10 years.

The market is hot, so we buy, and then our stock trades up. But you know what? Now it's not trading up anymore. If you're on the road at 3%, now your debt will move to 8% when you refinance it. And what happens to your investment, then? Did you make a good investment with your shareholder's capital?

We operate by the philosophy that opportunity will come back, but the destruction of capital is permanent. So you need to be really careful in M&A. 

We do it because we need to have a lot of looks. So we have 60 people full-time in M&A, always looking all around the world for good opportunities for us to deploy our capital. And at any moment in time, we have over 20 due diligence projects ongoing. The reason we do that is to be able to really be selective in which companies we invest. 

If you're looking at three companies and you're looking to do M&A, the pickings are slim. You don't get to choose your opportunity effectively. So for us, we want to make sure that if we do M&A, we'll do good M&A for shareholders, and we have no problem not doing any.

Approaching target companies

My job at this point is more like a risk officer. At the end, when we write a check, we're making a good decision. Our investment partners do a lot of our M&A activities. 

We're one of the few companies with a decentralized capital allocation strategy. So we have investment partners that each run their investment organization. They each have a portfolio of assets and are responsible for the returns, growth, and deployment of capital for that portfolio of assets.

They are the ones that speak to owners. They make deals, and occasionally I get involved when it's a bigger deal and I want to know more, but generally speaking, our investment partners, investment directors are the ones that are making the investment decisions.

Difference from PE firms

The smaller the company, the harder it is for a PE firm to run. So it's rare we see PE firms coming in the sub-20 million markets because often, putting one of their management teams and the way they run business, there will not be enough scale to warrant the effort when you have 5 billion to deploy.

We run into them less, and also, in our field, we provide a very attractive exit strategy for owners. As far as Valsoft is concerned, we keep our businesses forever. Very rarely are we ever going to sell a business. Only if it's the best thing to do for the business. 

Basically we buy, we hold the business, and we invest in the business with a 40-year horizon. We make investments that might not pay off for five years, and we buy businesses that we expect to stay around for a very long time.

That's a very different strategy than a company and a PE firm that will buy a business to sell it in five, six years. You're going to make very short term investments. You're going to make cuts and staff, you're going to run things very differently than we would, given our model.

We have a Valsoft system, a playbook that we apply. And we have best practices on how to manage these companies. In addition, we have leadership summits that we run to educate all our CEOs on how to better run their businesses.

Also, a lot of that we learned from our own experiences. Sometimes running a company is a  very lonely experience. You're at the top of the company, everybody listens to you, and you don't have the peers to run things by. And we bring these companies together and give them a network of peers to help them. It makes their lives and their careers more interesting. 

People make decisions based on what makes their lives better, not necessarily what puts the most money in their pockets. Many owners care about money, but they also care about their employees, future, and careers within the acquirer. So there's a lot of things we bring that private equity doesn't necessarily bring to the table.

Financial structure

We sold a few businesses, I was around 27 to 28 years old. We got together with our partners. We were retired for six months and hated it. So we wanted to work–the sense of purpose that work gives you is important. And we're going to put this company together and our advantage will be our time horizon. We will do things that other people, given their capital structures, cannot do.

We started these investment activities. A lot of the things we do, other people can't do because we start everything with our own money. So it was all our own capital. We started this world, buying these businesses within Valsoft with the intent to keep them. And then these businesses would make us money and we would buy other businesses with them.

And then we got an external investor in February of 2022 that came into Valsoft. Valsoft now makes its cash flows, so there's no need for incremental capital. The company's cash flows are enough to fund our acquisitions.

Eventually, we'll take Valsoft public. We'll retain a substantial stake in Valsoft, and it will keep deploying this long-term capital allocation strategy, where we seek to build value for our shareholders for the very long term. 

The goal is not to sell it. The goal is to bring it to the public eventually. Whoever wants liquidity could have it. They will retain most of the stake and keep working at deriving shareholder value.

The same capital discipline that we bring to the acquisition side, we bring to the investment side internally into R&D projects, sales and marketing efforts, new product developments, and all that. So whether we allocate capital internally or externally, we look at it with the same return criterion.

Challenges in building an M&A muscle

We own this other company called Valnet, another company sponsored by the Valsoft group with the goal to deploy caps, but towards websites. So we own brands like Screen Rant, Moms.com, Hot Cars, and GiveMeSport in the UK, some very large web-publishing brands.

Early on in the development of this company, I tried to do the similar playbook I'm deploying at Valsoft, which is buying independent companies, managing a decentralized fashion, and making a good investment, but it didn't work. 

It didn't work because these companies needed to be very well-managed to have staying power because the competition is so fierce that they are constantly attacked. And unless you have the remarkable editorial ability or remarkable ability to drive advertising revenues and then redeploy that great editorial and video content, these businesses tend to do poorly. So they would do good for the first year and then in the second, and third year they would die or not do well.

So then we switched to the acquisitive strategy and started developing Valnet's competitive advantage. We developed a network of freelance content writers, and we had 4,000 freelance content writers around the globe that could produce content for our properties in a very cost-effective, scalable manner.

Then, we built the advertising engine that would power our properties to be world scale. So every time we buy a company, we could generate a lot more money than we did from the companies because of the ad relationships we had and the strategies we had around them. Then, we started buying companies that were much more established and already had stay power and brand authority. 

So then we would buy these companies, we would plug in our superior content strategy, and our sperm monetization strategy. And then we would increase the viewership through our content, increase the monetization through our ad strategy, redeploy the capital we make into superior content, and then the business would start growing really nicely.

Screen Rant became one of the biggest publishing groups in the world. We have many other such success stories at Valnet, but the initial lesson learned was: you have to earn the right to be an acquirer. If you haven't, you need to invest internally in your business to be strong enough to give you that.

The number two lesson learned is you have to buy businesses that have staying power because often, when a company goes through the acquisition process, it will be mismanaged for a little bit. You go through some team members that don't adapt well to the new acquirer, and the integration process can be tumultuous. So you need to buy companies that, on their own, have staying power, and they're not fickle. 

Driving value from synergies

For us, in every acquisition, we build a business acquisition thesis the day we buy the company. And then we have integration reviews weekly, for a period of six months. After six months, we have a business acquisition review going over the results of the integration. And did our original six-month plan pan out? Two years later, we had another business acquisition review.

And this is something we do diligently for 60 acquisitions. We run and include a large pool of team members in these business acquisition theses and business acquisition reviews to sort the lessons learned. Where did we miss out on this one?

We constantly get better. If you're running one company, you're learning from one set of experiences. If you're running 60 companies, you're learning from 60 different sets of experiences. If you're able to have a good strategy to share that knowledge, then your knowledge should compound much faster than the knowledge compounds at independence. And you should become stronger and stronger over time. This is something that's true for everybody that acquires businesses, and learning from that for your future acquisition activities is very important.

Getting the right people

It's tools, processes, and people. First of all, if you're not using Dealroom, you don't know what you're doing, and you have no chance. Then your process. Chrome is your process for continuous improvement and success. So you have to have the right process to be successful.

The most important thing overall is if you have the wrong people, no matter the quality of your tool, you could be using Dealroom, but without the right people, you won't be successful.

We have a culture here, and we call it meritocracy. Our goal is to be fair. We don't run. Our culture is not a family, so not everybody is welcome no matter what. Our culture is a sports team. So we're going out there to win. We're going to a marketplace, an environment where people compete with us every day and come to eat our lunch, and we're out there to win. 

To deserve to be a team member, you have to earn your spot on a roster and deliver for the other team members because they all want to win together. So that means the spoils must go to the people that deliver. For people that don't bring enough to the team, you have to move on because they're just not the right person at the right time for that team to win and be fair in a company. An investment organization is tough. It's much easier to say than to do.

Sharing learnings

We have two leadership summits that we run every year. We're bringing the leaderships of all our new and existing companies together and share explicitly over three days. It's a nice offsite environment where people come,  there on a bit of a vacation, but they learn at the same time. People who have gone through certain interesting experiences will share that with everybody else. And then people are going to share the results and performances of their businesses, and other people are going to ask questions.

There are these official forums. Then we have groups, where leaders are encouraged to post and contribute to the community within their groups. We have investment seminars once a month, where we go over a lot of the deals. We look at the following:

• Did we bid the right amount on this business? 
• Did we underbid? 
• Did we overbid? 
  

We'll do many of our business acquisition thesis, and business acquisition reviews during these monthly investment meetings. These things take time, but they bring tremendous value because the rest of your month becomes much more efficient. You can allocate your time units a lot more efficiently with this information. 

We have a huge and quality group of people, which is a community effort. In the leadership summits, there will be ten different people contributing data or 20 different people contributing. We only put the schedule together and invite people; then it doesn't come from the top. Valsoft is decentralized, so we have a lot of CEOs within our business that would have the ability to do my job. So it's a very deep bench of talent here, and my role is to predict the things that could hurt us and sail the ship in a way that will prevent us from going there.

Constantly look at deepening the moat that's around our business. What trends exist that could make us less competitive? And what do we need to do to become more competitive five years from now?

These seeds need to be planted today to be successful in the future. Look at the biggest market caps in 2000, and how many of those are still the biggest market caps today? Or look at the biggest market caps in 1980. How many of those were still the biggest market caps in 2000? The answer is usually none. 

Companies constantly die, and the job of a CEO is to make sure your ship is strong and you foresee these events and capital allocation. How you orient the capital allocation of your company is a very important job for a CEO, and too many CEOs are poor at it, and I try to be good at it.

Often CEOs rise through the ranks of the companies because they're professional organizers or great leaders. And I think those skills are necessary, but as a company scales the capital, what you do with your money and how effective you are at deploying is very important.

Advice

Before you get into M&A, remember that most M&A is destructive to shareholder value. If you saw deal-making in 2021, it was at an all-time high and 2021 is also a generational peak in valuations. 

Most companies bought companies at all time highs, so a lot of that M&A is going to end up being destructive to shareholder value, and a lot of that is going to lead to these companies being weaker as a result of those M&A efforts rather than stronger.

I read a lot about the trends and who was successful at them. Rather than start with a blank sheet of paper, start with who was successful at it and identify patterns in the behavior of these companies. Read about that and make sure you're not acquiring just to grow. 

You're acquiring because you will do something with this company that will make your overall company stronger and better, and improve the forward trajectory of your company. Acquisitions for pure growth are usually not good either, so put some thought into it. It's not always obvious. 

When you look at M&A now, it's very low. Right now is probably the best time to start buying because the prices are lower, and there are less buyers out there than there were in the future. So now it's probably a good time to start looking for M&A, especially if you have cash.