From Diversified Conglomerates to Serial Acquirers.
19/03/2025
From the 1960s onwards, stock markets and investors in the USA started looking kindly at large diversified conglomerates. There were several large multidivisional companies which spanned a range of (often) unrelated industries. The key common feature they shared was management operated an internal capital market to determine capital allocation and potential capital investment.
For three or four decades, these companies grew strongly, getting a boost from falling interest rates and volatile but generally rising stock markets. Famous examples include Gulf and Western Industries, ITT Corporation, Litton Industries and Teledyne. The latter was very successful and its CEO, Henry Singleton was lauded by none other than Charlie Munger. Singleton is the subject of a very readable chapter in the book on unconventional CEOs called “The Outsiders” by William Thorndike.
Henry Singleton "Henry Singleton of Teledyne has the best operating and capital deployment record in American business." - Warren Buffett
However, Teledyne and Singleton was a rare success. Many of the conglomerates floundered in the 1990s onwards, as accounting frauds surfaced, stock market valuations declined, and the quality of conglomerate earnings was shown to be poor.
Academics observed this trend in Industrial Organisation era in the 1960s and 1970s and called it “The Age of Managerial Capitalism”. This had somehow replaced the previous small, owner-operated company era.
The main reason for this transformation was the separation of ownership and control. Large companies were increasingly managed by a new group of professional managers. These who were not founders and did not have a substantial equity interest in the company.
It was argued this new class of manager were not incentivised to maximise profits (as classic economic theory postulated) but to maximise growth. The salary of the professional manager was positively related to the size of the company. Other monetary and psychological rewards (think of plush offices, large HQ buildings Company Jet, general status etc) are all a positive function of enterprise size.
Incentives are very important. As the late Charlie Munger put it
“I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther…Never, ever, think about something else when you should be thinking about the power of incentives.”
If clever, hard-working ambitious people are incentivised to grow companies - guess what? - companies are going to grow, fast.
Many of the conglomerates grew rapidly by aggressive, equity-financed acquisition strategies. ITT grew revenues of $765mn in 1961 to $17bn in 1970. This was due to 350 acquisitions and mergers in 80 countries. The deals included strong, well-known businesses such as the Sheraton Hotel chain and Avis Rent a Car. ITT also absorbed smaller operations in auto parts, energy, books, semiconductors and cosmetics. Litton Industries, Gulf and Western and others followed a similar playbook
In the UK, companies like Hanson Trust and BTR were the fast growing companies which later became part of the elite FTSE100 Index. In the case of the UK companies, their strategy was clear. They used their highly-rated equity to buy companies which were trading on lower P/E ratios. Markets would value their combined earnings at the higher multiple. This was “proof”that the acquisition has been “value accretive” and EPS growth was achieved. The likes of Hanson Trust could carry on doing this for a long time, as long as their shares traded at elevated P/E multiples and there were suitable acquisition opportunities.
However, as the companies grew larger, the acquisitions had to become ever larger to have a meaningful effect on EPS growth. Hence, over time, acquisitions became risker and were more likely to fail or be opposed by anti-trust regulators and other policy makers.
Hanson Trust also became active in the USA with a landmark acquisition of Kidde in 1987. Lord Hanson was a feared corporate raider in US boardrooms. A character based on him, called Sir Larry Wildman, was featured in the film “Wall Street” which starred Michael Douglas.
A lot of the financial engineering relied on aggressive accounting. Some of the conglomerates were laid low by accounting scandals. More generally the markets grew sceptical about the conglomerates’ business models.
Fashions in management theories and business gurus changed and conglomerates were no longer in vogue. Instead, companies and investors started looking for companies which focused on one or two businesses. The emphasis was now on a few synergistic acquisitions rather than many unrelated ones.
Investors wanted focused companies and believed they could invest in a multi-industry portfolio directly rather than rely on the internal capital allocation of a diversified conglomerate to create a diversified exposure.
Conglomerates started at significant discounts to their Sum Of The Part (SOTP) valuations. Activists called for the conglomerates to be broken up and many disappeared. The first decade of the 21st century saw the end of some storied remaining names such as Tyco International and General Electric.
Some conglomerates have survived and prospered. Warren Buffett’s Berkshire Hathaway is perhaps the best-known example. There are a few others. However, the phrase diversified conglomerate is a pejorative and has been replaced by others, such as Serial Acquirers. Whatever they are called, they are quite common in other markets such as Sweden, Japan, Canada and India.
the investors Podcast defined Serial Acquirers as follows.
“Serial acquirers, also known as acquisition-driven compounders, strategically purchase small, profitable businesses, often family-owned, to foster growth and enhance shareholder value.”
We will look at some of these companies in the future in this Substack
The most important function for such companies is capital allocation. As a gross simplification, we can say there are two key roles for senior management, running the operating businesses and capital allocation. These require different skills yet the same people are required to excel in both. Warren Buffett at Berkshire Hathaway has completely split the two roles. He gives the CEOs of the operating companies considerable autonomy but insists that most investment and capita allocation decisions have to be made by him and his team at the Omaha HQ.
Companies must allocate capital rationally, taking capital out of declining businesses and allocating it into growing profitable ones. If they cannot find enough investment opportunities to deploy capital they should return it back to shareholders.
The old school conglomerates failed in this regard. They were obsessed with growth and did not return money to shareholders but did ill-advised or questionable acquisitions or made ill-judged investments. Diversification became “diworsification”. Even worse, managements who pursed size over profitability grew large empires and wasted money on fancy headquarters, large central bureaucracies, company aircraft and the like.
As implied above, Singleton at Teledyne was an exception. When the market rated Teledyne shares highly he grew his company aggressively through acquisitions. When market sentiment changed and the rating on Teledyne Shares dropped, Singleton quickly turned the strategy 180 degrees and started shrinking his company by divestments and aggressively buying back shares.
Investors in serial acquirers look for decentralised companies (low HQ staffs and costs), disciplined capital allocation in tightly defined sectors and well defined challenging criteria for acquisitions. As noted above Berkshire Hathaway is a good example. Operations are decentralised and managers are left alone to run their business. HQ does not interfere in their business and indeed does not have the resources to do so. Despite have $1trn of assets, the HQ staff is less than 30 people.
We will look at some serial acquirers going forward in this Substack. In the meantime, below is an excellent video with a Fund Manager (Guy Gottfried) explaining his analysis of a serial acquirer which was the largest position in his portfolio.
Annex 1
We asked Perplexity AI the following question.
“Why are serial acquirers attractive investments?”
This following was the good answer that Perplexity AI yielded.
Successful serial acquirers are decentralized operators of niche businesses.
They run a decentralized acquisition process that allows them to acquire many (niche) businesses without the system breaking down in bureaucracy, centralization, and control. Thus, they can compound free cash flow per share as they acquire more. The gold standard of serial acquirers is Constellation Software (Canada); it averaged 70+ deals per year between 2017 and 2020.
The beauty of serial acquirers is that the more extensive the collection of acquired businesses, the more resilient their earning streams, as they diversify into more customers, geography, products, and suppliers. Operationally, they also gain bargaining power against suppliers and pricing power against competitors, enjoying scale advantages.
The theory sounds great, but only a few can do it right.
It requires executing a complex process of
(i) forming a disciplined and decentralized acquisition process, then
(ii) operating acquired businesses independently, and at the same time,
(iii) facilitating a supportive system and culture to foster these two processes.
The other complex thing is that these acquirers must identify and acquire niche businesses that the more resourceful ones can’t, limiting the bidding wars.
The good news is, by design, if you focus on acquiring small niche players, the selection criteria deter larger businesses from taking an interest, especially if they are not decentralized, and you build domain expertise in a specific field, which larger ones would find a distraction of its core.
How do we identify exceptional serial acquirers?
Serial acquirers can be categorized into roll-ups, platforms, accumulators, and holding companies.
Roll-ups focus on one specific industry vertical, such as SiteOne in landscaping or Waste Connections in waste services.
Platforms operate in multiple verticals, such as Danaher (life science + water), where they can be more tightly integrated (less autonomously).
Accumulators and holdings are generalist acquirers that can operate multiple verticals, and businesses can be unrelated with little synergies, such as Constellation Software (Accumulators) and Berkshire Hathaway (holdings).
Exceptional serial acquirers are like exceptional businesses. They can consistently reinvest excess cash into buying free cash flow generative businesses at reasonable prices. As the cycle of reinvestment continues, the entity becomes more resilient and diversified.
To determine which acquirers, have the ingredients to execute successfully. I created a framework to help me sift through mediocre ones.
1. Portfolio Companies & Industry - the first is analysing individual portfolio companies for their resiliency and cash flow predictability, their industry for long-term growth, and whether it is ripe for consolidation.
2. M&A Framework - the second is analysing the acquisition process, the pipeline, the acquisition price/hurdle rates, discipline (track record), and the competition.
3. Decision Makers - the last is determining if the CEO and Senior management has skin in the game and a track record of delegating the acquisition decision and managing businesses autonomously.
19/03/2025