Most Mergers Create Value – At Least in Sweden

Anyone who's been to business school knows - and I know his because I'm one of them - that mergers and acquisitions are an almost guaranteed way to destroy the value of a company. 

This is for a good reason – after all, academic research has for decades been telling us so. People tend to take things they see written in Harvard Business Review seriously. It’s also easy to come up with real-life examples of things gone wrong after overconfident management, with steadfast determination to grow their company, buys what in retrospect turns out to be a steaming pile of nothing but trouble. Bayer really wanting to get, and then getting, Monsanto comes to mind. Or Microsoft buying Nokia phones. Or, for that matter, Nokia buying Alcatel. Or Alcatel merging with Lucent years before that.

No wonder then that academia and, by extension, the wider public have a sceptical attitude towards corporate acquisitions.

Meanwhile in Sweden

For some investors, the experience with corporate acquisitions is completely different. Because, besides the high-publicity mega-merger, there’s also another way to grow by acquisition.

Acquiring small private companies is the core strategy of a surprisingly large number of Swedish listed companies. These are a group of companies commonly known as M&A compounders. They may own and operate hundreds of individual companies and buy a dozen or more per year. They all have some favoured parts of the economy they want their target companies to be in.

While each M&A compounder has its unique qualities, there are some common themes in their operations and acquisitions:

• Their operations don’t require significant capital expenditure (i.e., they are asset-light) but perhaps lack organic growth opportunities.
• Acquisitions are funded by internal cash flow.
• Targets are private well-run businesses (no turnarounds).
• Acquisition multiples are clearly below the acquirer’s trading multiples.
• Acquired businesses are not tightly integrated and often continue to operate independently under old management and old company name. Instead of explicit cost slashing, any synergies stem over time from shared headquarters functions and perhaps from sharing best practices across group companies.

Lifco: Acquisitions with Operational Independence

Consider Lifco. The Swedish company owns and operates close to 200 individual businesses worldwide, each specialising in one of a variety of business niches from dental implants to construction machinery. While Lifco groups the companies into three business areas (and to a further eight divisions), each company retains a high degree of autonomy.

According to the company’s annual report, “Lifco has a unique advantage in that the Group offers secure, long-term ownership for small and medium-sized companies. When we acquire a company it is not our goal to sell the business in the future. Nor do we strive to realise synergies and we have never relocated operations. The idea is that the companies should continue to operate as they did before becoming a part of the Lifco Group and thereby deliver steady earnings growth.”

For entrepreneurs, retaining operational independence after selling their company is an attractive alternative compared to, for example, selling to a competitor that would look to extract cost synergies from the combination. As a rule, I’d say “M&A synergies” and “operational independence” are mutually exclusive. Hence, this is an advantage for Lifco in acquisition negotiations.

Lifco was listed in 2014 through an IPO. The company didn’t raise any capital at that point and hasn’t done so in the time since. It has more than doubled its top line during its time as a listed company, mostly via acquisitions. Margins have expanded and earnings per share have grown more than threefold compared to what they were at the time of the initial public offering.

With a steady track record of growth via successful acquisitions, Lifco’s shareholders have, in addition to an annual dividend stream, enjoyed a very favourable share price development, as the shares have gone up more than 15x in seven years.

Bufab: Traditional Acquisitions with Swedish Flavours

Another take on the Swedish M&A compounder model is offered by the industrial parts provider Bufab. Compared to Lifco, Bufab is nowhere near as omnivorous in its acquisitions; it buys companies in its own industry. Nor does it buy companies at a pace of once or more per month, but rather just one or two per year. Synergies are also sought to a somewhat larger extent. In other words, Bufab’s acquisition model is closer to a traditional industry roll-up.

But where Bufab sets itself apart from traditional market consolidators are the Swedish flavours it brings to the deal. It doesn’t push integration to the acquired company but rather lets it dictate the pace. Synergies are sought, but from top line rather than cost, and the companies are left with a high degree of independence.

The headquarters doesn’t expect to know what’s best in each market, therefore a lot of decision-making is farmed out to the local company level. In its more than 40 years in business, Bufab has never had an unprofitable year. Like Lifco, it too has more than tripled its earnings per share in the past seven years without raising any additional capital. Shareholders have been rewarded with an eightfold rise in the share price since the IPO in 2014.

A Better Way to Acquisitions

Bufab and Lifco are just two examples of a whole slew of companies in a wide variety of sectors that are executing the Swedish M&A compounder model. It entails acquiring often and acquiring well, i.e. quality companies at reasonable multiples, usually with own cash flow.

Acquiring small companies frequently – many times a year in a lot of cases – means you get a lot of practice. You also have a track record to show to investors. Anything you’ve done many times over, you’re likely to do well – you have your criteria for acquisition and you don’t stray from them. You don’t overpay and you know how to integrate a company – or you don’t integrate, in some cases. And once you have a track record of excelling at something, investors are likely more willing to bake that into your valuation as premium versus some lesser-achieving competitors.

There you have it. Most mergers create value. At least they do for Swedish companies. So, the next time the financial press writes about massive shareholder value destruction after another large-scale corporate fusion has gone horribly wrong, with the included reminder that academic research says that this is practically unavoidable… well, you already know that there’s a better way.