Description

Addtech is a value-added distribution business based in Sweden and serving primarily Scandanavia. It has historically been a wonderful compounder with good growth and returns on capital, and I believe this will continue into the future. While not cheap, I believe the valuation, which has come down in the last few months, is reasonable and provides a good opportunity for a long investment.

1. Business History

The history of AddTech started with the founding of the company Bergman & Beving ("B&B") in 1906. For many decades, the company was focused on importing German  industrial products (Beving was German, Bergman Swedish). B&B had its IPO in 1976.

By 2001 it had become a conglomerate with ca EUR 1 bn of sales. At that point in time the founders felt that the business had assumed a complexity which was too hard to handle for one management team. As a result they decided to split up the business into 3 listed entities:

a)      AddTech – focused on distribution of industrial components

b)      Lagercrantz Group – focused on electronics distribution

c)      B&B Tools –  focused on tools and related engineering businesses.

AddTech today is largely a distribution business:

a)      85% distribution of third-party and own-label products

b)      15% manufacturing.

The name AddTech stands for "Value Adding Tech Provider". The company defines itself as a "middleman between suppliers and customers", adding technical and economic value for customers. I.e. their core competence is to find an appropriate technical solution to a technical problem and to realize it.

Its second core activity is M&A - today the group consists of over 100 subsidiaries.

Since floatation in 2001, AddTech has generated a TSR of ca. 20% p.a.

2. Business Segmentation

Segmentation by Trading vs. Manufacturing

When taking the breakdown between distribution and own manufacturing businesses further, AddTech segments its revenues as follows:

a)      50% Standardized industrial products (distribution)

b)      25% Modified Standardized products and sub-systems (distribution)

c)      10% “Own products” that are designed by Addtech, but manufactured by subcontractors with the Addtech brand name

d)      15% Niche production (manufacturing) i.e. actual manufactured specialized products i.e. valves under the Addtech brand name.

AddTech manufactures products only if it is necessary to have your own product to control a specific technological niche. An example are conveyor chains for the mining industry, where AddTech distributes standardized products, but also manufacturers its own products presumably to protect the spare-parts business.

In any case, differing from some of its peers, the focus for Addtech is clearly on technical distribution that depends on either a:

a)      Economic value-added

b)      Technological value-added

Segmentation by Business Area/Application 

Internally the company is organized around application areas. The company has assingned all subsidiaries to one of the following 5: 

a) Automation:                                           

b) Electrification                            

c) Energy

d) Industrial Solutions                                

d) Process Technology                                            

3. Organizational Setup

A particular aspect of Addtech is that it is run in a decentralized manner. For each of its many subsidiary businesses, there is an independent CEO with full responsibility for the P&L. This principle of entrepreneurial responsibility is a core value of the group and has first priority: while there are some attempts to structure the complexity of the group a bit and to carefully realize some synergies the HQ does not want to take on any operating responsibility.

So the right way to see the organization is as a collection of well run niche businesses with a keen focus on running them efficiently.

4. M&A Strategy

Another aspect of the business that is central to Addtech is its M&A.

Addtech makes a lot of industrial bolt on acquisitions of high quality niche businesses that fit into the “Addtech” mold.

As almost all deals are sourced through the subsidiary companies, there are strict guidelines for deal proposals.

a)      Only subsidiaries that have an EBIT/NWC of 45% or more and are profitable can make proposals. This is as those companies have the capacity to absorb an acquisition. (I thought that was a deal criterion, see write-up of your friend.

b)      HQ sets a framework i.e. qualitative test of strategic test that the acquisition proposal has to pass

Addtech also has strict price criteria for its M&A.  It first splits earnings into.

a)      Underlying earnings

b)      Value of growth.

As an example, if the company made an EBIT of 80m, 90m, 100m in the last 3 years, they would base the price on 90m and apply a standard multiple, e.g. 5x.

Any EBIT achieved above that would be paid for via an earn-out. The earn-out component will be at a lower multiple than the multiple used for the underlying earnings, e.g. 3 - 4x, thus lowering the effective multiple paid overall. 

b) The effective average EV/EBIT multiple paid since 2009 on EBIT as shown at the time of signing was 4,8x. The lowest multiple was 3,7x, the highest 6,5x.

This is surprisingly close to the formula we use here at FPE. What we are lacking is the ability for warm-calling.

B. Economic Characteristics

ROTCE/Cash Flow Characteristics

Addtech incentivizes its entire organization based on the EBIT/NWC criteria. This is based on a focus on a profitable return on growth.

Long-Term Compounding Economics

Addtech has generated a total TSR of approximately 20% p.a. since listing in 2001. Nevertheless, it should be noted that a significant portion of this growth has been a result of the acquisitions of the company.

C. Valuation

The valuation is as follows is noted above. 

D. Risks

1. Management Talent

One risk is part of the decentralized business model. Many of the managers at the subsidiary companies are skilled sales people. This means a long-term ability to develop the managers and value added sales personnel is critical.

2. Inorganic Growth

Given that much of the growth comes inorganically, there is a risk that Addtech will not be able to continue sourcing the quality of deals it has been able to do in the past. This would put significant pressure on the company.

AddTech has set itself a target of “15% earnings growth p.a.” over a business cycle. This may be at risk in case not enough fairly-valued acquisitions are finable.

Conclusion

Overall, AddTech is a strong industrial niche components distribution business. I believe Addtech is a solid quality business with a decent management, which combines to result in a business run for the long-term.

At current valuation, I believe it is attractive as a long-term compounder given its > 10% growth p.a..

Catalyst

Continued intrinsic growth of the business.