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Deep Sail Capital began a new position in Vitec Software Group (VIT.B-ST), a vertical market software (VMS) serial acquirer. The business model is very similar to Canada’s Constellation Software, and Deep Sea sees years of strong growth ahead for Vitec. Their thesis is below.
Current Position: Vitec Software Group (VIT.B-ST)
Vitec Software Group [Vitec] is a vertical market software (VMS) serial acquirer. Vitec is headquartered in Umea, Sweden, and operates in Nordic countries, including Sweden, Norway, Denmark, and Finland. The company was founded in 1985 by a pair of research scientists, Lars Stenlund and Olve Sandberg. Initially, the company was an energy efficiency consultancy that offered services that included software applications for their clients. At first, the software was used as a lead generator for their consultancy services, but in 1995, Olav came up with the bright idea, “We shouldn’t sell this as a license. We’re going to sell it like a newspaper” Source; Lars Stenlund Interview). This created potentially one of the first Software as a Service (SaaS) models (note that Salesforce is generally considered to be the first commercially successful SaaS model, which launched in 1999; Olav beat them to it by 4 years!).
After that, the company has gone through a few major shifts; the most important was developing a strategy of growth by acquisition (serial acquisition). They did this in part because they realized that growing a single vertical in software is extremely difficult. Sales ramped slowly, but once you lock in a consumer, the churn is extremely low. The cash flow that a vertical software business produces exceeds the amount that can reasonably be reinvested into the business. So, to grow fast and efficiently, you need to take those excess cashflows and acquire other similar VWS businesses.
In 2003, they shifted from a singular focus on growing their energy efficiency VMS company to acquiring other VMS companies. This was around the same time that Mark Leonard of Constellation Software was implementing a similar VMS serial acquisition model in Canada. For anyone who follows this type of VMS software business, it will be clear to them that Vitec operates similarly to Constellation in a few ways, but there are some differences. The main difference between the two companies' operating models is that Vitec will invest more in existing companies than Constellation. Vitec was born by scientists; they are natural tinkerers, and they employ a Kaizen strategy to achieve incremental gains, which aligns with their willingness to reinvest in the business.
This higher reinvestment in the business results in a higher organic revenue growth rate (the Vitec organic growth rate was 14% vs. 8% for Constellation last quarter). The effect of this difference is that Vitec will have higher depreciation and a lower ROIC (Vitec is 7% vs. Constellation at 16%) due to the incremental capital that is invested in the acquired businesses. The upside from this incremental investment is that Vitec has been able to keep high margins by directly providing their consumers with incrementally valuable products at a faster rate (Vitec Gross Margin: 52% and Net Margin: 12% vs. Constellation Gross Margin: 35% and 8%). Outside of this major operating model difference, there are a few other smaller differences between the two companies. Vitec has a higher acquisition bar when it comes to culture fit and regional location than Constellation. Overall, many investors think of Vitec as Constellations smaller Norwegian cousin, and I tend to agree. Lar’s even commented on the similarities between the two companies recently, saying “But we’ve understood that we’re not really Constellation. Our approach comes from the industrial side; we are geeks”.
In 2021, the company’s founder, Lars Stenlund, who had been chairman and CEO since Vitec’s founding, stepped down as CEO, and Olle Backman took over. Olle was the Vitec CFO prior to the appointment and has shown a strong aptitude for capital allocation since his appointment. Olle’s key impact has been optimizing the cash flow better than his predecessors, putting more capital to use quicker. I have listened to a number of interviews with Olle, and I am equally impressed with him as with the Vitec original founders. From 2018 until 2021, Vitec completed 4 or 5 acquisitions per year, with an average size of $35 million SEK (~$3 million USD) in revenue. Starting in 2021, the company began to increase the size of its targets while continuing to focus on completing roughly the same number of acquisitions per year. In 2023, the company completed a total of six acquisitions with an average revenue size of $100 million SEK (~$10 million). This includes a mix of business categories and sizes ranging from Enova ($280 million SEK) to DL Systems AB ($14 million SEK). Olle has been able to scale these acquisitions effectively and, so far, has been able to improve both EBITDA margins and operating margins since 2021.
Below is how I view the company in terms of the 4 Pillars of Exceptional Investment.
Conclusion Vitec’s business model, end market, and management create an extremely attractive business. Vitec has all the characteristics that we look for in an investment, including substantial reinvestment options, a strong capital allocation strategy, and a founder’s mindset. We currently believe Vitec will consistently grow at a high rate while maintaining strong, stable margins for many years to come. At the current price, we view the shares as reasonably valued to slightly overvalued, but we think over time the value of the shares will compound at a high rate. We plan to own Vitec for many years to allow our capital to compound with its high growth.