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What investors prize
Most investors focus on organic growth, even for a company whose whole premise is being a near-perfect acquirer and operator. Companies in the market overwhelmingly grow organically, serial acquirers are few and far between, and investors are trained to look for the next Google. Added up, acquisition-led compounding is probably worth trillions of dollars, only it is a rarer kind of opportunity.
Some shrewd investors understand the math perfectly and still value the stock lower, because they expect other investors to prize organic growth. For anyone who does not plan to hold forever, discounting for what the crowd may think is rational.
Buying stalled companies
Picture a document promising the chance to deploy $5 billion to $7 billion a year for the next 20 years into shrinking companies at a 65% levered IRR. That would guarantee an incredible run of compounding. Roughly 80% of the companies Bending Spoons bought were growing when it bought them and kept growing afterward, and negative organic growth is no obstacle either. Because most buyers avoid companies whose growth has flatlined, a refreshed supply of them keeps arriving.
Room to scale
An acquisition strategy also scales further than almost any organic one. A new startup that reaches one or two billion dollars in revenue has beaten nearly everyone, while Bending Spoons is already at $4 billion with room to pass $5 billion.
Why do acquirers often overpay?
In 1986, the economist Richard Roll proposed the hubris hypothesis: managers of buying companies overestimate their ability to find value, so they pay more than a target is worth. Studies of takeovers since then have often found that the stock of the buyer does not rise on announcement, and sometimes falls. Roll's explanation is one reason investors treat acquisition-led growth with suspicion.
How do serial acquirers compound over decades?
Constellation Software, a Toronto company founded in 1995 by Mark Leonard, buys small businesses that make software for specific industries and has completed hundreds of acquisitions. It keeps the acquired businesses running with their own teams and reinvests their cash flow into more purchases. Berkshire Hathaway follows a similar pattern with a wider range of industries.
Why do stalled companies sell so cheaply?
In the Gordon growth model, published by Myron Gordon and Eli Shapiro in 1956, a business's value equals next year's cash flow divided by the discount rate minus the growth rate. When growth falls toward zero, the denominator grows and the value falls. Buyers who pay for growth therefore pass over flat businesses, and the prices of those businesses drop. The model remains a staple of valuation textbooks.
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