The loneliness of the small-cap acquirer

Large-cap rollups both public and private aren’t short of media attention – including this blog, which has profiled multi-billion dollar businesses like Constellation Software, Therapy Brands and Lifco. However, most software rollups are moderately sized. Few ever hit the $50M revenue mark, let alone the “IPO territory” $100M mark. Those that do, tend to be disproportionately owned by private equity, such as the names below. 

At the same time, for independent (non PE backed) rollups public markets may seem like a compelling source of capital, especially during periods of exuberance, like 2021. 

What defines success?

In this two-part series we profile 7 small-cap software consolidators: 4 that have struggled and 3 that have thrived. We analyze each company’s business model, track record – and why it has or hasn’t clicked with the public market investor community. We conclude the article by pointing out common trends. 

Warning: this is not investment advice! 

Why list in the first place?

The Rollupeurope proprietary database of software rollups contains c.130 names. Of these, only c.20% are listed. The median market cap (as of COB 15 Sep 23) was c.$870M. Not exactly small cap territory! 

As we discussed in an interview with Niklas Savas from Redeye, conceptually, there shouldn’t be compelling reasons to be listed as a serial acquirer. If you do it right, you become self-financing at one point, you shouldn’t need much external funding. Still, a listed business may benefit from:

1. Better access to debt financing

2. Credibility vis a vis targets

3. Currency for M&A and employee incentivisation

Our own experience is that 1) is quite true as even small-cap rollups manage to eke out favorable terms from banks vs. those available to privately held peers. 2) is at best debatable. Where 3) can spectacularly backfire, as we will see below. 

As for the reasons not to list at a small scale, lack liquidity would be top of our list.

In such a scenario, the consolidator faces the choice of either relying on cash flow to fund M&A, or to have a committed cohort of long-term anchor investors who will be willing to add equity if needed (e.g. Sator Grove / Mediqon). 

Our sample

We analyzed 4 companies: Avidly, Tiny, CSAM Health and Onfolio. It’s worth noting that the first company was taken private a year ago; and the second was subsumed by its majority shareholder on a similar time frame. 

We expect more M&A involving small cap consolidators both public and private as capital dries up and owners of these stranded assets demand resolution. 

* As of COB 15 September 2023 **Through COB 15 September 2023

Case study #1: Onfolio

Established in 2020 by the British teacher-turned-investor Dominic Wells, Onfolio is an serial acquirer of websites. It went public in August 2022 at $5/share, raising $14M to achieve a market cap of $25M. Since then, the stock has shed c.80%. 

Onfolio is very small, with Q2 2023 run-rate revenues of $5M. It’s lossmaking. Compare this to the pre-IPO projections of $10M revenue and $3M EBITDA (for 2022). 

Onfolio is not particularly well capitalized. It has a cash balance of $4M (out of the $12M raised in the IPO), compared to a deferred consideration of $2.4M. It’s remarkable that a company of this size – and lacking an organic growth story (revenues were down sequentially in Q2 2023) ended up being NASDAQ listed. 

As Onfolio admitted in its recent prospectus, today it faces two key questions: 

1. Can it reach profitability without issuing further equity and diluting shareholders? 

2. Do its acquisitions perform well after the deal has closed?

We would add a third question: corporate governance. Onfolio has non-controlling interest in four joint ventures. Using Onfolio JV I as an example:

• “As manager of JV I, the Company (i.e. Onfolio LLC) will receive a monthly management fee of $2,500, and 50% of net profits of JV I above the monthly minimum of $12,500”

• “In the event of the sale of a website that JV I manages, the Company will received 50% of the excess of the sales price above the price paid for the site”

• “During the year ended December 31, 2022, the Company purchased an additional 10.91% interest from existing owners for $52,500 in cash, bringing its total equity interest to 13.65%”

However:

• “The management fee to the Company described above was waived for fiscal year ended December 31, 2022 and through the six months ended June 30, 2023, due to lower operating results of JV I”

A lot to unpack

Case study #2: CSAM Health (Norway, eHealth solutions)

Update: CSAM has since rebranded to OMDA

CSAM’s beginning can be traced to the Oslo University Hospital. In 1999, the hospital’s employees proposed to enhance treatment workflow capabilities, security and interoperability between a multitude of highly specialised solutions. The outcome of that initiative was the Connected Healthcare technology, developed in 2005. The same year, CSAM Health was spun out. In 2014, a Norwegian mid market PE firm Priveq injected growth capital into CSAM, setting in motion its transformation from a consulting driven Norwegian business to a Nordic software company. In 2020, CSAM went public on OMX Nasdaq First North, raising NOK 1B+ (c.$100M) in debt and equity. 

CSAM’s revenues have roughly doubled in the last 4 years, to NOK 400M ($37M), boosted by continued M&A. Nearly 80% of its revenues are recurring. Blended organic growth was 11% in Q2 2023, above the long-term company forecast of 5-10%. 

What’s not to like?

Alas, the stock market hasn’t been kind to CSAM. In the nearly 3 years as a public company, its shares have shed half the value – to a point where its market cap is only $65M. 

What’s going on? 

Turns out, profitability and cash flow have disappointed. CSAM had yet to post consolidated profit. EBITDA margin was barely positive in 2022, rising to 8% in H1 2023. A far cry from the company guidance of 30% “in the years to come”. In CSAM’s words, the profits are “impacted by costs related to restructuring and reorganisation”. 

The root cause of CSAM’s seesawing performance is its Buy-Integrate Build model. To quote from an excellent writeup by Global Quality Investing (CSAM Health – Serial acquirer run by Outsider owner-operators):

• “The acquired companies often start out with lower margins (<10% EBITDA margin) CSAM improves margins within 18-24 months”

• “Easy savings like consultants and superfluous perks are removed from the cost structure”

• “In addition to cutting costs, CSAM integrates the business by harmonizing quality controls, customer relationships, and support functions”

One can see how a high M&A volume executed in a relatively short period of time can wreak havoc on a bottom line. 

Expectations management seems to play a role, too. The goal stated by the CSAM management is to reach NOK 1B in sales by 2025, 2.5X the run-rate. Considering the resources available at their disposal, and especially the precipitous decline in share price, one wonders how they are going to achieve it.

Case study #3: Avidly (Finland, Hubspot agencies)

Avidly is a playbook example of a rollup that perhaps shouldn’t have been listed in the first place. Too small. Too misunderstood by the public market. 

But let’s take a step back. 

Avidly is a Helsinki based rollup of Hubspot agencies. It was formed in 2018 from a combination of 4 HubSpot diamond partners: Zeeland Family (Finland), Doidea (Sweden), Katalysator (Denmark), and Inbound Norway (Norway). It’s worth noting that Zeeland had first listed in Helsinki in 2007, albeit under a different name. In 2019, Avidly acquired NetPress from Germany as part of the company. 

The Finnish private equity investor Capman first invested in Avidly in 2018, and took control in 2020. Capman was really keen on Avidly as the only HubSpot rollup platform available in the Nordics. The fact that it was a micro cap listed on Nasdaq First North didn’t stop it. Capman negotiated a direct share issue and joined Avidly’s Board. It was not able to deliver a squeeze-out and take-private, so the rump remained listed. Capman recruited new management who did an excellent job (3 years in a row as #1 global HubSpot partner). 

Unfortunately, both trading volumes and share price remained depressed. As Juha Mikkola, the Capman partner that oversaw the investment explained in a candid case study, this had several adverse consequences:

• Shares could not be used as M&A currency. Targets were difficult to convince to join the platform even with cash offers

• ESOPs difficult to be based on share performance

There was a happy end however. In 2022, another Nordic PE firm called Adelis took Avidly private at a 49% premium. Even so the market cap was only EUR 33M (details), representing a revenue multiple of 1X. 

Case study #4: WeCommerce (Canada, Shopify SaaS)

Note the following is an updated extract from our August article: “What’s the endgame for Amazon and Shopify SaaS roll-ups?”

No company exemplifies the volatile fortunes of ecommerce tool consolidators better than WeCommerce. It first listed on TSXV, a junior Canadian exchange, in late 2020, just over a year after being founded inside Tiny Capital, the investment vehicle of two Canadian entrepreneurs, Andrew Wilkinson and Chris Sparling. 

WeCommerce beginnings can be traced to a Shopify agency established over a decade ago. As Andrew explained in an interview, the agency quickly ramped up off the back of selling Shopify themes to merchants, a novelty service at the time. In 2013, the business was sold – and later bought back, with the help of investors like Bill Ackman and Howard Marks. Thereafter WeCommerce acquired a major competitor and listed the business. 

Taking a step back, Andrew is a canny operator who claims to have parlayed a $58K lunch with Bill Ackman into his support for WeCommerce. Andrew’s rationale was seductively simple: “Just like with the iPhone and the App Store or Salesforce AppExchange, there’s this huge ecosystem of partners that will benefit alongside it”. 

Well, it didn’t quite pan out like this. 

Although WeCommerce had undoubtedly made headway on the M&A front (see below), investors were expecting a lot more – and marked down the stock after the pipeline failed to materialize. Additional factors that contributed to WeCommerce’s descent from C$1B+ valuation in January 2021 to a low of ~C$100M two years later were:

• Thin trading liquidity

• Lack of broker coverage

• Decline in profitability

At that point Tiny came to the rescue by contributing the rest of its portfolio into the listed vehicle to quadruple the business (link to press release).  Even though the enlarged business is approximately 4X larger, market reception has been lukewarm: the stock is trading at a 50%+ discount to the company assessed “C$5.12 per share attributed value”. 

To an extent, WeCommerce was its own undoing as its early success prompted the influx of Shopify SaaS copycats that pushed up prices for assets. However, given the performance of the acquired businesses one would also question their operational credentials. 

Conclusion

Public markets are not a natural fit for subscale consolidators with a limited track record. While the definitions of both “subscale” and “limited” can be debated, we would argue the cut off is at $50M+ revenue and 7-8 years, respectively. 

Here’s why:

• These companies tend to be disproportionately listed on junior markets which are less expensive and less onerous compared to main boards. The flip side is that trading volumes are thin and broker coverage is sparse to non-existent, making it difficult for public market investors to build meaningful positions. On top of that, the few brokers that do cover these stocks tend to be generalists that simply don’t have the time to immerse themselves in the nuance -> Avidly

• Small size = oversized HQ, which depresses consolidated earnings and in turn, limits ability to use internal cash flow to acquire

• Public market investors like synergies – but only if these can be unlocked within quarters, not years -> CSAM Health

• High leverage (since debt is relatively cheap) + depressed equity valuation + low FCF = limited dry powder for M&A…

• …which leads to such businesses over-promising and subsequently under-delivering on the acquisition pipeline and operational performance -> Onfolio, WeCommerce

• Then again, we caveat our analysis by pointing out that our verdict isn’t final and these companies may yet surprise on the upside, generating healthy returns for the investors that stayed the course

• Finally, we expect more M&A involving small cap consolidators both public and private as capital dries up and owners of these stranded assets demand resolution