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The 3 small-cap serial acquirers that took off big time

Inside the playbooks of Chapters Group, Judges Scientific and Teqnion

But first, mea culpa

I have to admit: I’ve been putting off this article. Blame the negative bias built up from watching one too many small-cap acquirers implode in the public domain (WeCommerce, Pluribus, Onfolio – the list goes on…more horror stories in our previous article). 

There are so many things that work against the concept. There’s barely any liquidity or research coverage. Companies that go public during the frothier times (e.g. the recent SPAC boom) tend to be saddled with an investor base whose attention span is short. On top of that, a volatile/declining share price can undo the credibility that otherwise stems from being publicly listed. 

Meet the Three Musketeers!

Thankfully, well-meaning fund managers have emailed me a few suggestions, which I dutifully researched and came up with a list of three: Judges Scientific, Teqnion and Chapters Group. The first two are industrial acquirers based in the UK and Sweden, respectively. The third one is a German VMS / enterprise software acquirer. 

Source: Google Finance. Market data as of COB 1 November 2023

As the table below shows, all three have delivered hefty shareholder returns, and hopefully will continue to do so in the future. 

Let’s dive in!

Case study #1: Judges Scientific: an acquirer of highly specialized instrumentation businesses

Judges is a UK based serial acquirer of niche engineering and instrumentation businesses with a c.20 track record. Think of it as a British cousin of Swedish industrial rollups, which we covered in a recent article – but with a much more global exposure. In-scope products include instruments for measurement, detection and calibration in high precision industrial environments. End users are higher education institutions, scientific communities, manufacturers and regulatory authorities.  

With 22 acquisitions under its belt, the company has developed a knack for identifying targets that possess world class products or IP, but are poorly managed commercially in the sense of capital allocation, pricing, go to market strategy etc. To quote Judges’ CFO Brad Ormsby, it goes after businesses “with high EBIT margins – that correlate with low competitive pressures…and technological moats”. 

As the chart below shows, Judges is an impressive capital allocator, with a ROIC mostly in the 20-30% range: a reflection of both its high-quality pipeline and strict acquisition discipline. It tends to pay 3-7X EBIT, financed with up to 3X leverage at 3-8%. This is a far cry from the +/-15% coupon facilities we see for startup acquirers, and speaks volumes to the depth of its relationships with mainstream banks like Lloyds, Santander and Bank of Ireland. 

Source: Judges Scientific

The operating model is heavily decentralized. According to one of the MDs featured in the promotional “Joining Judges” video, “they only get involved when we talk about budgets and capital allocation”. 

Most of its acquisitions incorporate a substantial earnout component. For example, the acquisition of Geotek, which provides “high resolution, non-destructive analysis of geological core” (press release) was structured as follows: 

  • Initial cash consideration of £45M

  • £35M earnout to paid in cash and new Judges stock

  • The said earnout kicks in at £6.4M EBIT, increasing pro rata until it reaches a cap of £11.4M

  • To put these figures into context, in the most recent financial year preceding the acquisition Geotek delivered revenue of £7.3M and PbT of £1.5M

So far, so clear: stay niche, don’t overpay. And then there’s the elephant in the room: shareholder distributions.

As a listed company, Judges has only ever raised £14M in new equity, with most acquisitions funded with a mix of organic cash flow, debt and share issuance (usually with a performance threshold). The Board has resolved to grow the dividend by 10%+ p.a., a target which it has comfortably exceeded. Of course, given the share price appreciation (more than 3X in the last, you won’t be buying Judges for the dividend yield of c.1%. 

Intrigued and want to learn more? I recommend this article:

Case study #2: Teqnion: a diversified industrial compounder

Teqnion was founded in 2006 by Johan Steene and Jonas Häggqvist. It is an acquirer of small industrial businesses based mainly in Northern Europe with an “eternal” investment horizon. 

Source: Teqnion

Astute capital allocation was part of the playbook from Day 1. In an interview with Matthias Riechert from P&R Investment Management, Johan admitted “we started out by persuading Jonas’ parents that they should trade in their shares they had in two trading companies or agent companies into Teqnion shares”. 

Another key, and recurring theme is patience, namely, the long lead time it takes to achieve scale. In the first decade of its existence, Teqnion grew from approx. SEK 30M to SEK 180M revenues. Not bad in relative terms, but not spectacular either, considering that on an FX adjusted basis SEK 180M is still below $20M. It’s only 2/3 through the second decade, with revenue up more than 7X, to SEK 1.4B. Teqnion’s ability to sustain momentum is truly impressive!

In line with other Swedish serial acquirers, Teqnion’s financial targets are both clear and solid:

  • EBITDA margin 9%+

  • Net debt / EBITDA <2.5X

  • Double EPS every 5 years

In terms of valuation framework, Teqnion targets a 5-year payback. This translates into a mid/high teens ROIC. Once again, pipeline and discipline have been key to the consistency of returns. Teqnion made 4 acquisitions in 2022 (its target is 5/year) and remains heavily focused on Sweden, with only recent diversification into Ireland and the UK. 

I will finish this profile with a story about Daniel Zhang’s, Teqnion’s CXO, which offers a blueprint for people trying to break into this exciting industry. To quote Johan once more from the P&R interview [edited for conciseness]: 

One day in 2020 I received a cryptic text mentioning an idea for a new CFO from an unknown sender with a funny avatar. I replied in a text that question or idea should be sent via email and thought no more of it. The same day I received a long letter from Daniel that intrigued me and I then asked if he could come over to the office for a talk. After a three hour talk, I knew he was a warm, humble and brilliant guy so, I told him he couldn’t be the new CFO, but that I would love to work with him if he wished to join the team. He asked what his position and tasks would be, I replied that we would figure it out together as we went along. I offered him the position as CXO where the meaning of the X could be decided later. He jumped onboard.

Further reading:

Case study #3: Chapters Group: a decentralized VMS M&A machine

Chapters traces its origins back to 1998 when its predecessor company, Medical Columbus AG, was established to optimize procurement processes for hospitals. In 2016, new owners, including current CEO Jan-Hendrik Mohr, took over, leading to the divestment of Columbus’ legacy assets to GHX. Over the last 5 years, Chapters founded several acquisition platforms, expanding beyond its core DACH market to France, the UK and Ireland. 

Source: Chapters Group

Today, Chapters counts 30+ operating companies in the portfolio, with run-rate revenues approaching $100M. It has three core investment themes:

  • Corporate succession

  • Vertical market software

  • Services for the telco industry (Carma’s focus)

What’s the playbook? The way we understand it, there are 3 components.

  • Number one, have a clear delineation of responsibilities between HoldCo and operating subsidiaries. Chapters owns an 80% stake in its four privately held platforms (Nachfolgekapital, Ookam, Carma, mlog capital SAS). The remaining 20% is held by the management, which has an opportunity to convert into the HoldCo stock. These subsidiaries tend to be led by young, hungry search fund type people who are often recruited straight out of business school (see the Software Circle case study below)

  • Two, pursue an industry-agnostic but a geographically attuned acquisition strategy. Historically focused on the German speaking part of Europe, Chapters is now expanding across the continent. About time, considering how competitive the German software serial acquirer market has become, with domestic investors such as Lea, Forum, BID Equity and Bregal Unternehmenkapital. Chapters’ preferred targets tend to be lower mid market companies that are synergistic to the existing portfolios and have leading position in niche markets. On average, it pays ~6x EBITDA

  • Three, run a lean HoldCo focused on capital sourcing/IR; hiring subsidiary CEOs; and staking out new geographies. Jan has done a tremendous job cultivating a loyal investor base. He has affiliated himself with long-term, value add investors such as Mitch Rales, a founder of Danaher; Sator Grove, a Florida based investment vehicle that has invested into several software rollups; and MSA Capital, an advisor to Investmentaktiengesellschaft für langfristige Investoren TGV, a multi family office based out of Bonn, Germany. 

Chapters is not a strictly control investor, as demonstrated by the Software Circle case study. Chapters owns c.9% of Software Circle, with a big chunk of the remainder held by its long-term supporters like P&R, TGV and others. Previously known as Grafenia plc, a struggling printing and graphic design company based in Manchester, over the last years it was transformed into a VMS acquirer through a combination of: 

  • Recapitalization – a £23M equity raise completed in September 2023, with part of proceeds earmarked towards bond repurchase)

  • Hiring of new management – Roman Rothenberg and Shira Giat leading M&A – both were spotted by Matthias Riechert in London Business School

  • Speedy execution – 5 acquisitions completed to date

Further reading on Chapters: 

Lessons learnt

  • Delay going public as long as you can: ideally after you have established a repeatable playbook and a track record. It always takes longer than you think! 

  • Be specific about why you’re listing (reversing into an undervalued business, taking advantage of exuberant markets etc). Be prepared for a bumpy ride in case of thin liquidity and/or research coverage – both very likely outcomes

  • Align yourself with long-term capital providers that can step in if the markets turn sour

  • Keep the HoldCo lean and focused on sourcing capital, talent and establishing new platforms. Leverage visibility and listed currency to attract hungry, ambitious people to run the subsidiaries