How buy-and-build stocks deliver strong returns
Bunzl, DCC and Diploma became hugely successful through buy-and-build – rolling up dozens of unglamorous businesses. How does it work and what makes it successful?
Some of the best long-term investment opportunities in the stock market are firms that continue to develop by acquiring other existing businesses and helping them grow – known as the “buy-and-build” strategy. These investment opportunities often go unnoticed for years. There are a few reasons for this, but the main two are that the firms usually start out very small and they operate in deeply unglamorous areas. Even as the business grows and no longer fits the description of being small, the dull label turns many professional investors away.
These factors provide private investors with a tremendous advantage as it allows them to invest early in companies with great potential. And because few professional investors are interested, the valuations are often extremely attractive. Looking at businesses that have already followed this path gives an insight into the secrets of success and where to look for those that might repeat this trick in the coming years.
Buy-and-build: how it works
Bunzl (LSE: BNZL) is an old business. It has been listed since 1957 and is well-known and highly respected. The stock is a core member of the FTSE 100 and widely held by professional and private investors, who have enjoyed tremendous returns stretching back decades. It has many of the characteristics that a potential investor might be looking for: it is highly profitable, consistently grows, seems unflustered by economic circumstances and it has a strong balance sheet.
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Back in 1957, Bunzl was best known as the producer of cigarette filters. Given its high level of success over the years, a curious investor might wonder how it has generated such shareholder returns given the decline of smoking. Initially, in the early 1980s, the company started to transition from cigarette filters. This was gradual to start with, as it began to sell off manufacturing segments and focus more on the distribution element of the supply chain.
Over time, Bunzl diversified, and in 2002 it transitioned fully into the type of business it is now (though not quite at the scale it operates today). In that year, via the sale of Filtrona, it divested its last remaining business related to cigarette filters. Shortly after, a new American CEO, Michael Roney, arrived (he has since moved on to become the chairman of Next) and turned it into a serial acquirer of businesses. During Roney’s 11-year tenure, every five weeks on average Bunzl would typically make an acquisition of a small, privately held family business.
Bunzl focuses on supplying products that are essential to the running of a business, but not things that are used in production or sale. Examples include safety boots, food boxes, blue roll and sticky-tape dispensers. These staples are hardly glamorous, but they are essential and in-demand almost regardless of economic conditions.
This apparent simplicity of operations is a common theme among these sorts of companies since simple businesses are easier to understand and integrate into larger organisations. This is one of the characteristics that is repeated among successful buy-and-build operations. Other important traits include targeting a highly fragmented market, and the presence of many family-run participants that have long-standing relationships and contracts with customers.
Why buy-and-build is so popular
All these go together to bring about the most important part of the equation. Successful firms that undertake buy-and-build strategies do so by purchasing businesses cheaply. To buy cheaply means that the seller has to be willing to sell for a low price without feeling they have lost out. So the ideal type of business that can be bought cheaply tends to have a combination of five elements.
First, it is run by the founder, who is around, or at, retirement age. Second, the founder either doesn’t have children, or the children are not interested in running the business. Third, they have built up a business in a sector that is simple to understand and services a dependable market. Fourth, the business is based on long-term contracts and agreements. Fifth, the firm has managers unrelated to the founder who are capable of continuing to run it. When most or all of these characteristics are present, you have a willing seller and a dearth of buyers, which puts the acquirer at a great negotiating advantage.
Earlier this year, I was on a flight to Tenerife and sat next to a man who had recently sold his business. He had started in his 20s renting out forklift trucks. In time, this had evolved into a contract business whereby he would lease out forklift trucks for contracts lasting years, including provisions for servicing. This created a touch point with clients and fostered lasting relationships. Over time, the company had acquired more than 600 forklift trucks, which were contracted out for up to 15 years at a time. Thirty-odd years later, he was in his late 50s and understandably thinking about retirement. His children were not interested in the business and so his only viable option was to sell up.
It would have been crass to talk to a stranger about the financial particulars during our four-hour flight. However, I figured his business had been generating operating profits of between £1 million and £1.5 million per year off an asset base of perhaps £3 million. Based on my experience observing buy-and-build businesses in the past, I concluded that the acquirer would not have wanted to pay more than six times operating profits and probably aimed to pay as little as four times. Therefore, he must have sold his business for between £4 million at the low end and £9 million at the top end. Most likely it would have been closer to £4 million, since this would still have represented – to him – a premium to the value of the assets of the business.
For an investor in publicly listed companies, paying between four and six times operating profits looks very cheap. However, price is determined by buyers and sellers determining a mutually acceptable price. On the stock market, there are thousands of buyers and sellers, which continually fine-tunes the value of a company. This is not the case when a private business is sold.
Frequently, as in the case of my Tenerife-bound acquaintance, they want to sell the business and have to look hard for a buyer. Buyers are few and far between, which places the seller at a disadvantage and gives the buyer a strong negotiating position. This is a buyer’s market since the buyer has all the advantages.
However, the seller probably doesn’t feel aggrieved. From his point of view, he had a business with around £3 million in assets and, at the low end, would receive £4 million for them. For that £4 million, he no longer needs to work and can retire with a level of comfort of which most can only dream. The buyer, which in this case turned out to be a private buy-and-build operation (not one listed on the stock market), has bought a decent business at a low price. Both parties are happy with the outcome. The best buy-and-build companies are looking to make acquisitions of businesses that are very similar to those previously owned by my fellow passenger.
Along with Bunzl, there are a few other companies that were once small and relatively obscure but are now mature and well-regarded acquirers of simple family businesses. These include DCC (LSE: DCC), an Irish-domiciled business largely involved in the consumer energy sector. It has been listed for 30 years and has made nearly 300 acquisitions while providing very attractive returns to shareholders. Another firm of note is Diploma (LSE: DPLM), which since refocusing on its core competencies in the late 1990s has bought and integrated businesses in niche areas. It sells mission-critical, but relatively low-priced items, such as seals used in engineering. Any of these three companies has the potential to generate a good rate of return for investors. In the case of DCC, one can also make an argument that it is also uncommonly cheap. However, to generate truly exceptional profits, an investor needs to commit at an early stage, since the greatest returns can be enjoyed by businesses that are small, agile and cheap and have abundant opportunities for expansion.
How Marlowe consolidated safety certificates
Marlowe (LSE: MRL) operates in the testing, inspection and certification market (TIC) for the UK commercial real estate sector. Most commercial premises in the UK require periodic examinations to test for things such as health and safety, fire equipment, and air and water quality. Typically, each commercial premises has several different certificates that govern whether it is legal to be used. Historically, each certificate would be issued by a third-party certified professional who would inspect a property. That certified professional might be part of a small company, or simply a sole trader.
From the perspective of the building’s owner or manager, this can be onerous. Time and effort is taken up organising, paying for and recording the various certificates. Sometimes firms will have multiple sites. Each site will require various certificates and small businesses that service one site may not offer all the services required at another site. In these cases, keeping up to date becomes even more time-consuming.
Marlowe aims to consolidate this sector and become a one-stop shop for building managers who need to keep up to date with certifications. The benefit for a building manager is clear: rather than dealing with multiple firms, it can deal with just one. From Marlowe’s point of view, as well as buying simple, cheap businesses that are easy to understand, it can also drive growth. If it has a contract with a firm for one service at one site, it will also be able to offer that company additional services at other sites and thus lower the administrative burden for the customer.
Marlowe has existed in its present form since 2015. It was founded by Alex Dacre, who had experience working in acquisitions at other listed firms, and is backed by Michael Ashcroft, who is the largest shareholder with around 18% of the equity. Over the years it has made many small acquisitions, sometimes with the price of the businesses acquired being less than £1 million. Over time, it has built a breadth of service offerings as well as geographic scale.
Unfortunately, the group has performed poorly in recent years as the strategy became less focused on the consolidation of UK TIC businesses and more on acquiring technology-related companies. The technology division was intended to sit alongside the TIC business to help customers with risk management by bringing together record-keeping along with the certification. Dacre successfully built a valuable technology business within Marlowe, but this strayed from its original strategy. Management oversight was stretched too thinly, so in early 2024 all of the technology business was sold to Inflexion for £430 million. Dacre left the business to move to Inflexion to pursue opportunities in keeping with his skills.
At the end of 2024, Marlowe is again focused on its core areas. Ashcroft is acting as executive chairman on an interim basis while the firm appoints a new CEO. There is plenty of scope to raise operating margins while driving revenue growth, and the opportunity for acquisitions of good, cheap businesses is rich.
Kitwave: a profitable niche in food wholesale
Kitwave (LSE: KITW) is a food wholesaler covering impulse-buy products, alcohol and groceries, with 32 depots and 550 vehicles across the UK. Its niche is smaller deliveries that large wholesalers are unable to fulfil cost-effectively. Its typical customers are not supermarkets or businesses with large catering needs, but rather sellers of small amounts of food and drink, such as convenience stores, pubs, cafes and operators of vending machines.
The business was founded in the late 1980s by Paul Young as a single-site confectionary business in the northeast of England. It grew steadily for the next 20 years until it received an investment from NVM, a private equity business that wanted to use the existing operation to consolidate its particular area of wholesaling. Young then expanded it steadily with the aid of David Brind, a chief financial officer from NVM. Private equity usually has a fixed investment horizon and so in 2021 Kitwave was listed on Aim, London’s junior market, as a means for NVM to sell its stake.
Brind stayed with the company and remains on the board today, while Young retired from the board in 2023, at the age of 66. He has since begun selling his holding, but retains just under 5% of the business, worth around £12 million. Following his retirement, Ben Maxted, who has been with the company since 2011, was appointed CEO.
Since listing, Kitwave has completed four acquisitions of smaller businesses. Each of these deals have been between £10 million and £30 million and are in the range of valuations typical for what we see in quality buy-and-build businesses. While the absolute number of acquisitions is lower than some of the other firms adopting this strategy, the board has stated that it sees a considerable opportunity to make further value-accretive acquisitions. Additionally, by consolidating the sector and combining operations, the company should be able to remove costs and drive efficiencies, which is a further route to profitable growth.
Importantly, management talk about an acquisition blueprint that lowers the risk of making a bad acquisition. Kitwave follows a repeatable strategy that it has honed over the last 13 years to acquire and integrate new businesses. In total, since 2011 Kitwave has made 14 acquisitions that have demonstrably added value. The company’s CEO is young (he turns 41 this month), yet experienced in generating value for shareholders. This should give potential investors confidence that the business is still in its early days of consolidating the wholesale market.
How the buy-and-build stocks stack up today
Businesses that can serially acquire small, privately owned companies while maintaining a disciplined approach are rare. Well-known ones have delivered tremendous returns for early investors, and continue to look like good investments even though they are much larger today.
Of the three that are constituents of the FTSE 100 today, DCC is both a shrewd operator that has delivered very good returns and is also notably cheap.
Bunzl continues to operate well and is now a global business. Complexity and size don’t appear to have dampened its ability to find good acquisitions. However, it is well known and liked by investors, and as such appears fully valued.
The architect of Diploma’s strategy retired from the business in 2018 and the sailing has been less smooth since. His immediate successor left the business just four months after starting. Since then, the current CEO has courted controversy among shareholders because of the large scale of his compensation package. The rump business remains good, but the shares look expensive.
Among the two smaller companies, Kitwave is on the best footing. It has never had a misstep, yet it is a small stock with an enterprise value of around £340 million, so it has not so far seen much investment from professional investors and remains underappreciated by the market. The result is that the shares look very good value for a company that is already generating real value for shareholders, on a price/earnings ratio of around 12 and offering a dividend yield of 3.5%. Kitwave is probably best placed to be the next great buy-and-build business.
Marlowe has had issues and there will be question marks until a new CEO is appointed. Nevertheless, the shares also look cheap: the business is making more than £20 million in operating profits, against an enterprise value of around £260 million. Marlowe has great growth potential and its current cheapness could help it to produce even greater returns for those able to stomach the slightly elevated risk.
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Jamie is an analyst and former fund manager. He writes about companies for MoneyWeek and consults on investments to professional investors.