Let’s examine the growth of Flexigroup

One of the features we like in a company is the capacity to grow earnings over time. We generally prefer organic growth to growth by acquisition, but this is not a universal rule. Acquisitions come in different flavours, and it’s helpful to be able to tell them apart; the potential for value creation can vary significantly from one type to the next.

At one end of the spectrum are acquisitions whose purpose is to somehow “strengthen” (in other words enlarge) the enterprise. The investor case for these transactions usually includes reference to scale, strength, diversification, and the sometimes nebulous concept of “strategic fit”.

All too often, this type of acquisition transfers value from the shareholders of the acquiring company to the shareholders of the target. This is particularly the case with acquisitions of listed companies, where the target shareholders may receive a takeover premium.

For any acquisition where you can’t identify a concrete mechanism through which the combination will generate genuine business value, it may be best to assume that it won’t. This is especially the case where the acquisition relies on debt funding to boost the reported EPS for the merged business.

Roll up, roll up

Further along the acquisition spectrum, we have roll-ups. In this type of transaction, a listed company that trades on a high multiple, may look to buy smaller businesses at a lower multiple. A dollar of earnings bought at, for example, a 6x multiple might then be valued at 10x in the share price of the acquirer. It may be that no incremental profit or cash flow results from the transaction, but the same dollar of earnings is viewed as being more valuable in the hands of the acquirer.

This type of acquisition can deliver returns for acquiring shareholders. However, there can also be an element of circular logic: if the acquiring company’s trading multiple were to fall, the value previously “created” by this approach could suddenly disappear. Accordingly, roll-up strategies pursued by companies on lofty “growth” multiples need to be viewed with some caution, particularly when the prices paid start to creep up.

The other end of the spectrum

At the other end of the spectrum are acquisitions that have a clear ability to deliver business value: actual dollars of incremental profit and cash flow that would not otherwise exist. This might be due to genuine synergies arising from the combination, such as the ability to avoid duplicated costs, or where an excellent management team improves the performance of a business that has been poorly run. Subject to the price paid, this type of strategy can deliver meaningful value growth to the acquiring company.

Growth – organically and through acquisition

With this framework in mind, let’s consider Flexigroup (ASX:FXL) – a company we hold in our Funds – which generates growth both organically and through acquisition. FXL has a number of moving parts in its business model and balance sheet, and a full understanding takes some analysis. However, for today, we will focus just on the profile of FXL’s acquisition strategy.

Over the years, FXL has made a number of acquisitions, including: the 2008 acquisition of Certegy, a provider of interest-free payment plan services; the 2011 acquisition of Paymate, an online payment business; and in 2012, the acquisition of Lombard, a retail point of sale financier, which offers interest-free funding and Visa cards.

This is a fairly steady program of deals. However, the acquisitions have generally been of modest scale, which means that integration risks have been manageable. More importantly, FXL has been able to demonstrate value accretion from these acquisitions, through healthy improvement in the performance and earnings delivered by the acquired businesses.

Recently, FXL announced the acquisition of Once Credit, an interest-free financier and credit card company that is very similar to FXL’s existing Lombard business.

Key points

In considering the merits of the Once Credit acquisition, we see a number of positives. Some of the key points include:

1. Scale

FXL is paying $45m for Once Credit. Compared with its own market capitalisation of over $1b, FXL is not, at this scale, taking on large integration risks, particularly given its previous success with similar integrations.

2. Funding

The acquisition is fully funded by a $45m equity raising – FXL is not relying on corporate debt to improve the accretion numbers.

3. Synergies

FXL has articulated several sources of incremental value, including being able to provide Once Credit with better access to low-cost funding to enable growth in its receivables book (critical for this type of business), as well as eliminating duplicated costs that are shared with Lombard.

4. Price

While not as cheap as the Lombard acquisition, the price paid for Once Credit appears to reflect reasonable value. It seems fair to assume that the income stream FXL is acquiring is worth more than the cash it is paying out.

Often, we greet acquisition announcements with a sense of trepidation, but the profile of this transaction, combined with FXL’s track record of success and its strong management team, lead us to think that the Once Credit transaction is something that FXL’s shareholders can applaud. Indeed, when asked, we were happy to subscribe additional capital to help fund the purchase.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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