Sometimes I think a company’s success starts very early in its history. It is either set on a good foundation, or it isn’t. I suspect a great deal of investors' energy is wasted on companies whose foundations were shaky at the start.
Today’s post is about a company whose founders laid a proper foundation. And it continues to support a value creation machine today.
That company is Halma, Plc, based in Amersham, England. It has been a public company since 1972, which the firm dates as its founding (though it has roots going back earlier). If I wrote a sequel to 100 Baggers covering the UK market, Halma would be in it. Here’s a look at just the last ten years, from the latest annual report:
Halma is a holding company with 44 operating companies and generated sales over £1.3bn in 2020 (fiscal year ended March 31). I’m going to pass lightly over what these companies do because I want to get to the broader DNA of why they’ve been so successful.
Briefly, Halma’s companies are involved in making the world safer, healthier and cleaner – all their businesses focus on these broad areas. This includes a wide range of niches: fire detection, water analysis, food safety, and more. The economics are perhaps what binds them - per an old Financial Times story (August 2004):
“A typical Halma business sells complex products, costing from £15 to £1,000, to an industrial customer in a niche market that is worth a few tens of millions of pounds annually. In products representing 30 percent of Halma's sales, Mr O'Shea [then CEO] says the company is the biggest in the world. In most of the other areas, it is one of just a few competitors.”
When I talked to the company, they maintained this was “broadly still true.” Halma likes niche markets with global reach that address broader areas of safety, health and the environment, and where demographics and a rising tide of regulation drive growth.
So that’s Halma. As I say, I’m passing lightly over the “what they do” aspect to get to the “how they do it” part. (You can read the latest annual report here, which I’d encourage you to do.
How They Did It
The “secret sauce,” as it were, simmered early. On the company’s website is a speech by David Barber, who co-founded Halma Plc with Mike Arthur. Barber was the CEO for over twenty years, and the Chairman until his retirement in 2003. The title of the speech is “Delivering Shareholder Value.”
Barber gave the speech in 1997. Halma, at that point, had delivered a 22.5% annualized increase in earnings per share for the prior 20 years. In the speech, Barber reflects back on what made Halma’s performance so great.
Here’s a few bullet points from the speech...
Keep control over your shares outstanding
Halma targets a growth mix of 6-7% organically and 6-7% through acquisitions. So, they buy up a lot of companies over time. They could’ve financed these in different ways, but early on Barber and his team decided not to issue shares:
“At the very outset with Halma we decided that since our overriding objective was to increase earnings per share, our best policy was not to issue any more shares. That sounds crazy to many people. The conventional view and the road most people choose towards success is to establish a high rating for their shares and then issue them.”
As Barber points out, if you have a company earning a 40% return on its capital and growing, you don’t sell it. That is a tradition that remains. Halma finances its acquisitions with internally generated cash flow. And its share count has barely moved over the last 20 years.
Barber also believes financing acquisitions this way is an important ingredient in Halma’s recipe for successful acquisitions…
The recipe for successful acquisitions
Barber notes that “a large body of academic opinion” argues that most acquisitions fail to add value. We’ve all heard this. But Halma has had great success with acquisitions. Why?
Barber warns us that the word acquisition covers a broad range of activities, which are in fact very different from each other.
The first distinction he makes is between “acquisitions which are funded by internally generated surplus cash and those which are funded by share issues.” He makes the following controversial claim:
“Because we have funded acquisitions this way, the vast proportion of the wealth created within Halma has in fact come from organic growth. Ignoring scrip issues, our total shares in issue over the 24 years from 1973 to 1997 increased by only 46%. Over that same period, our pre-tax profit increased by 22,000%. So the first distinction l would draw is that growth by internally funded cash is more akin to organic growth than it is to growth by acquisition.”
Perhaps that is a good way to think about it and an easy filter to apply to any company you are looking at. Do they acquire other companies mostly using internally generated cash, or do they borrow the money and/or issue shares?
Just off the top of my head, some very successful acquirers do it the way Halma does: Heico, Constellation Software and Brown & Brown. (And they also keep control over their share count. In Constellation’s case, it’s not changed at all since 2006.)
Barber’s other ingredient for success here is that the acquirer should just stick to businesses it already knows:
“If you buy a business which is a replica of one you already own and manage successfully, then you are in a good position to check whether or not you have a good deal. Having gone back to check our own figures, I find that this was the case for 70%of the individual businesses we have bought over the past 15 years. Where we do move into a newish field, we do so very cautiously and, wherever we can, we will buy small so as to reduce the scale of the risk.”
So again, an easy filter… Is the acquirer buying businesses that are basically replicas of what they already do? Or are they venturing into new industries all the time? The risk is lower with the former.
Focus on quality
Barber talks about the importance of having some kind of fixed vision about how you’re going to deliver shareholder value. That vision should be based on a mathematical model that makes sense and that you can check and use to guide your decisions. At Halma, one of the aspects of this mode was return on capital employed:
“One of the features of the arithmetical model… was the target of achieving a high return on capital employed. Although it took us about five years to get there, we have never fallen below this 40% level for the past 14 years. What we found was that once we had achieved and were enjoying this situation, we then became extremely reluctant to relinquish it.”
Today, the focus is “return on total invested capital,” or ROTIC. One of the joys of reading Halma’s annual reports is finding this return is a focus for the company. They talk about it and track it and it is a part of their incentive compensation. Here is a chart from the annual report:
But this is not all: The company tracks -- in the same fashion -- return on sales, cash conversion, organic growth and more. It’s all very refreshing. I wish more companies would do this kind of thing.
Anyway, when Halma looks to make an investment they want to make sure their return at least meets what the company does now. Basically, as Barber says, the focus should be quality -- not on the price of the deal, per se. “It's an old saying but a true one that you can never pay enough for a good acquisition and never pay too little for a bad one.”
On the quality score, Barber gives us a story:
“Imagine you… owned Microsoft with a price-earnings ratio of 40. In theory you could sell part of Microsoft and use the proceeds to buy a company we can call British Metal Bashing Limited with a P.E. of 12. The arithmetical outcome would be a huge increase in your earnings per share. You have certainly enhanced shareholder value in the short term but have you got a better company?”
I think we know the answer to that.
There are other interesting nuggets throughout the speech. You can read the full speech here. [Link]
To summarize, here are some basic things you might look for in order to find the “next Halma”:
Share counts that don’t increase much over time
Acquisitions using internally generated cash flow
Acquisitions in the same or similar businesses
A focus on quality (i.e., returns on capital)
Of course, the current Halma is alive and kicking and probably a good investment today. As of this post, we do not own Halma, but it is high on my “wish list.” If you know the company well and wouldn’t mind sharing notes, I would be interested in hearing from you!
Thanks for reading.
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Published September 9, 2020
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