Teqnion AB (publ) (TEQ) Earnings Call Transcript

I think I'll leave that to you. But of course, those tools are implemented more and more over the entire group, and we're constantly in a learning process on how to use these tools effectively. And on the M&A scene, over to you.

It's super interesting. I mean we've received a question a lot of times regarding how will we scale M&A I mean, for a couple of years ago, we were acquiring 3 companies a year, 3 to 5 companies a year. And we got a question of how would we ramp that up. And our answer, I think, has always been we'll figure it out. And hopefully, we get smarter, we get better. Maybe what we didn't anticipate was that we got this gift from GA that AI came. I think historically, if you look at peers, you would see that there's roughly 1 to 2 acquisitions per M&A FTE in the other serial acquirers. At Teqnion, I mean, depending on how you count FTE, I'm working close to full time, Johan is supporting. Jonathan is supporting a little bit as well. But we're closer to last year line FTE. And it's not because I have stopped sleeping. It's absolutely helpful that we have AI tools that can help us to do things that can run 10 things simultaneously while I'm sleeping to help out with things that would just take a lot of manual work and that would pick up things that we would never have picked up before. Then of course, we take very much [indiscernible] power approach where we try to use AI as a tool to support us. Basically, when I work with M&A, I think about them as a team of junior or associates. It's not to answer. You can make mistakes and we can't trust it at face value. But it makes a lot of the analysis that we that would have taken us a lot of time or maybe we wouldn't even have done them because it's too time consuming and not good capital allocation. But now when we have it, I mean, yes, we're spending tokens, not tokens that you really can see on the income statement as some of the real AI companies do. But yes, we're trying to really lean into that. And I think part of the result you can see as well.

Good. Then we have a question from Augusto on the e-mail. He says, amazing progress, keep it up. I'm aware you increased your M&A hurdles to 15% margins and up to SEK 40 million in profits. However, I don't think you ever acquired a company that large. How different is it acquiring a company in that range? Is sourcing different? Is growth profile different?

We have acquired a couple of companies that are -- they're not SEK 40 million, but they were just north of the earlier hurdle of SEK 30 million. How different is it to acquire a company that rate? I mean it's interesting. I mean we learn things all the time. Theoretically, you would think that if you acquire a very small company, it would go in the other direction, it would be easier. So if you buy a company that is half the average size, you would want it to take less than half of the time in order to make capital allocation good, right? But the -- what we've seen is that buying companies of smaller sizes usually just takes more time because they're usually, on average, not as good when it comes to administration structure process of the pieces that matters when it comes to M&A and business quality. And if you go in the other direction, going from, let's call it, SEK 10 million to SEK 20 million to SEK 30 million, SEK 40 million, they are on average better. So the processes are a little bit more professional. They usually have sell-side advisers that are, of course, more expensive, but also better. And it makes the processes, I would say, a little bit easier and more professional.

And more predictable.

And more predictable, Exactly, exactly. Is the sourcing different? Well, right now, we're in a very fortunate situation where we have strange too many, but we have more incoming leads than what we can take care of, which is really, really nice because then we just pick the best ones. And the sourcing from this one is just -- there's so many things that just comes in. I pick up my phone and we get things, most of the e-mail, but sometimes on the phone. And the growth profile, is that different or not? I think our biggest companies that we have acquired overall have a little bit better growth prospects, but it's not something that is significant. But I think that the robustness is different. There's less downside risk in them because they are less reliant on one person doing everything. They have more people usually to begin with spreading the risk out a little bit. They have more structure, they have better processes. They have, let's call it, just systems, hard and soft of different things.

Normally longer history, deeper relationships.

Yes. Exactly. [ Lou ] is another person that has written to us on the e-mail. He says, hope you are well. I'm taking the most recent report. A few questions are coming into my mind, and I was wondering if you could answer either here or within your call next Monday. One, what is the management perceive as a new mandate for acquisition starting January '25? I think we spoke a little bit about that. Yes. Question number two, you have changed your maximum earnings level to SEK 40 million. Are you searching for slightly bigger target? Are you finding bigger targets coming your way? Yes to all of those questions. I've been trying to communicate clearer and clearer to all sell-side advisers, brokers, investment banks, corporate finance advisers, whatever you want to call the helpers that we want to look for bigger things. I mean, with the help of -- that we are getting a little bit better, with the help of AI, I mean, we've shown that we can acquire 9 companies last year. We've done a handful this year. But then, of course, there will be some kind of bottleneck in how many companies can we acquire per person. So the natural next step instead of buying 100 companies makes SEK 1 million, a ridiculous example, it's, of course, easier from a capital allocation perspective to buy the same amount or maybe even fewer and go up a little bit. So it's both that we are receiving more companies of all sizes, but also that, of course, that we believe that it's better capital allocation and better for Teqnion shareholders to go up a little bit in size. And maybe just align expectations, we don't think that the majority of the companies will be of that size. We just want to let all of the sellers know that we are open to that now and mostly that we're lifting up the lowest level.

Next question here is as your floor for profitability has increased from 10% to 15%, is this a consequence of the management mandate? Are you seeing more difficult to improve margins, so you tend to acquire better margins at first?

It's not a mandate thing. This is something that we have decided that we want to acquire, let's call it, better companies. Is it because we -- it's difficult to improve margins? Part of the answer is maybe yes. It's a strange -- maybe it's not strange, but I feel that it's easier to improve on something that is above average in quality because they usually are used to improvement work. They usually have a mindset that they want to change and they are open to try things to make things better. I mean the reason why you usually don't want to do turnarounds because on paper or in Excel, it's super easy. But in the real world.

You have to turn around the people and their mindsets, and that's the part that takes time. And if you're already on the winning streak, you know that you have the confidence, you know that you're able, you know all those things. So it's much easier to tweak that into something even better than trying to change a mindset that doesn't believe in themselves.

Exactly. And I think -- just to add to that as well, we have seen, at least for us because there's so many cases, and you could say that the market for really, really small companies is inefficient when it comes to acquisition. I would say that maybe that's true, but also because we and the sellers are choosing each other not only because of money, but because of other things, relationship, culture, beliefs, et cetera. So what we have seen is that we're not paying higher multiples for companies that are of 15% compared to 10%. Of course, for the same size of revenue, 15% is more, so therefore, more money, but not in relation to the earnings. And given that conclusion, we really don't see a reason why we should not buy "better companies for the same price.

Next up, same person. What is the process and steps regarding acquisition on your end? I understand that Daniel is the go-to try to find them. Do you manage to do the valuation, due diligence all internally? Or are you taking external counsel?

Yes. No, just to simplify it very much is that Daniel finds them, does the DD and negotiate with them. He has been doing this for over 5 years. And he's a fast learning to begin with, and it's a very bright mind that handle fits perfectly well with the support that he gets from the other team members here in this corridor. We strongly believe in that way of doing the business because we own the responsibility ourselves on a very personal level. We are very, very thorough when it comes to doing these things because we don't want to make mistakes, and we don't want to pay for that responsibility on a third party. We are so, so confident that the best way of doing an acquisition process is to own every step of the way from the first contact to finalizing the deal and then start building a strong relationship by doing business together with the seller that we normally do for several years after an acquisition.

Yes. I think that I don't know why I say it, but maybe because I'm still thinking about the World Cup. I mean for Teqnion, what we do is that we acquire companies and we improve companies over time. That's it. That's our 2 core activities that should make us great and make shareholder value great over time. And we so much believe that we should be really, really good at that and not outsource our core competence because if we outsource our core competence, then what are we? And I mean, take a analogy, I mean, we're on the pitch. We should assist, we should score, we should catch balls that don't fall into our net. We can outsource things as diet, massage, I don't know what things football players do, but scoring goes, you don't take.

Lemonade mixers.

You don't outsource those key things. That's our view of it. And then, of course, other companies do other things. And for some of them, it works very well. The next question from the same person is, what's your plan when deal ramps up over time? As the free cash flow improves, this is more capital to deploy since we will need capacity in many forms to address that.

One thing is, of course, that we, over the last year, have increased the number of people that works here and the new team is in your words, is the best team we ever had. It's -- we have a fantastic driven team, both in the U.K. and in Sweden. And several of those people will probably, as the time goes by, be more and more involved in the acquisition part of our business as well, but time will tell. We -- as we normally answered this type of future-looking questions before is that we will, as we go along, learn along the way and find ways to do this and scale this in an effective way. We long for that the day that we have too much capital to deploy. So the bottleneck is that we have -- we have not enough people that want to run M&A. M&A is often looked at as something magical and very, very, I don't know, it's very intriguing for a lot of people to work with M&A, and we -- it doesn't take too many days between the inbox is filled with people that would like to work with us on the M&A part. I strongly believe that the best way to be a very good person working with M&A is that you've been operational. You have seen how you have to manage people in order to make a profitable business and you deeply understand the different levers, as you say, on how to pull an organization in the right direction and not only be extremely smart when it comes to read an Excel sheet or the financials. Yes.

And I also think it's... we as human, we try to improve all the time. And I think that we are better compared to a year ago and 5 years ago. But the thing with humans is that we learn rather slowly. And I mean, secondhand information is super important. We try to read things and get better. But for some reason, evolutionary-wise, we learn better through first-hand experience, which is a slower, more anecdotal process. AI doesn't work in the same way. And unfortunately, people -- everyone says that you can make just one mistake, but don't make the same mistake twice. We try to live by that as well. But still, we're all humans, and that will happen because we are humans. AI is a little bit different. So I actually don't want to talk too much about AI because it sounds like we're becoming an AI company, but it's interesting. When it comes to acquisition, the first acquisition that I did with support of AI, it took longer compared to if I just did it myself. Then for the second, I think it took maybe roughly the same amount of time. And then over time, it just became quicker and quicker, and I built different artifacts that help me to analyze various things that catches things and do different checklists that I would sometimes miss and it reached 300 pages of lease agreements that -- and cross reference to other things that a human mind would not. So how would that ramp up? That's, I think, at least part of it, and that's what we're seeing at the moment.

We've got another question here in the Q&A from Benjamin. He's saying that our financial target #2 is that the EBITA margin should be at least 9%. That target seems a low bar now, especially as you're acquiring far more profitable companies now. Is it time to review that goal?

I think it's hard to answer that question because I don't -- let's put it this way. Every year, we look through our strategies on a group level, and we look at the financial targets and we talk about them and see if they're necessary to move them in a direction, and we're going to do that this year as well, and we will see what comes out of those discussions with the Board.

Yes. I think maybe just to add to that, and this becomes a little bit philosophical. We've made financial targets in a 3-tier way because #1 and #2 should always be in place. They put as a hygiene factor when we're off on 1 and 2, that's a red flag. So the focus should for us always be to at least double our EPS every 5 years. The first one is on stability. We want to ensure that we always can survive because with our survivors, there's no 5 years. So that is, of course, there. And then you could argue, is that the right KPI, -- should it be something else or not? But it's one way that we're looking at it. The second one is to ensure that we have enough buffer to being busy fools they are not creating value. Should it be 9%, should it be 12%, should it be 15% or 7%? I mean, we could argue that. But the key, which we strongly believe in is number three, that we create long-term shareholder value by increasing the EPS or actually free cash flow per share over time. If the margin is 9% or 15% or 20%, of course, it's helpful, but it can come, of course, from having higher margin. It can come from having higher revenue that translates into profit. And my view is that as long as we're above a certain threshold that we call 9% at the moment, but it could be a different number. It's not really that, that we're chasing. It's just more profit and cash flow per share as long as we are safe, which is 1 and 2.

Very good explanation. That's how we look at it, and I totally understand that you look at from a different way from the outside. But for us, it's EPS that's the main driver.

Yes. The next question comes from Pete on the e-mail and says, Daniel, congratulations on a great quarter. I just have a couple of questions for your earnings call, assuming you're doing one. One, working capital has been an outflow year-to-date. Do you expect this trajectory to continue as acquisitions increase or will it stabilize in H2? Are recent acquisitions more sensitive to cash collection compared to the longer-standing companies in the group? I mean the short answer is that we don't really do forecasts on that. And maybe the same amount of words is that we grow when we get into a position where we're growing organically and assuming that disregarding acquired companies, then, of course, the growth will take some working capital, but that will also stabilize. I mean if that will happen in H2 or not, we can't really comment on that. But I think you should expect that it will, one, normalize. And secondly that that number will sometimes be positive and sometimes negative in a quarterly basis, which is I get it. It's not much of an answer, but that's how it is.

Yes. Margins have declined in Teqnion west due to exceptional comparable quarter. Can you comment on what you expect the normalized margin run rate for West to be in the future?

I think that -- I mean, we're acquiring companies that are, let's call it, ballpark 20%, 25%, maybe just a little bit north of that in EBIT margin. So if you draw out the line long enough, it should go into that direction.

If we don't put too much cost on it.

Yes, exactly.

And we also see over time, I mean, just going back to what you just said about the financial targets, it's the EPS that we're chasing in the long run and maybe the margin -- EBITA margin will change according to something else. But as it looks right now and what you also is shown on the white part page, you see what has happened with the most recent acquisitions when it comes to EBITA margin and where we're targeting right now.

And then on an individual company level, we have one company Techno West, for example, where they are in rather advanced discussions with their key client where if everything goes through, it might take a year or maybe 2. It's a really big international conglomerate on the other side. If that happens, they will probably bump up the revenue in the subsidiary, let's call it, GBP 20 million, GBP 30 million. The margin on that will be not high. But it's -- based on the discussions, it's basically a case where we get, let's call it, a fixed amount of margin that is more or less free for taking up a little bit of responsibility. Great for earnings, great for earnings per share. good for our return on capital. But on the KPI margin for that company, not great. But however, that's not really what's important. You pay salaries with profit or what profit is, not margin.

I have a question here from Leo Williams in the chat. He says, "Hi, guys, I've read that there is an emphasis on keeping the owners of acquired companies on at least 3 years to health and position. I'd love to hear how those conversations look at the juncture where they considering retiring, et cetera, and what the process is of finding the right replacement.

Yes, that's a really relevant question. That's one of the key pieces of the puzzle that you need to manage in order to make a successful serial acquirer, I guess, finding companies and acquire them to a reasonable price is doable, finding the right type of people to operate these companies that we acquire is a tougher nut to crack. We love spending a lot of time with the seller after we finalize the deal, make sure that they continue to have a place within that subsidiary. hopefully, just do business as usual even after that, we own the shares. Nothing should be happen. And over the time that comes, we work with them normally in the Board of that subsidiary and make sure that we have a strategic plan going forward with or without them depending on if they want to retire or not. And the retirement plan is normally discussed very early on in the process of us getting to know them always before we actually finalize the deal. So we -- both parties are very -- we are very certain of what's going to happen when it comes to that transition. And then how we find a new person, hopefully, we find someone that is able to run the business that is already in the business. And then we have a time to transfer the mandate over to that individual over the years where we still have the owner in operations or we together with the previous owner can go out on the market and find a capable person. And we both have the -- from a technical perspective, we have the experience on how to search and find the right type of individual. And from the owner's perspective, they have all the knowledge of what's necessary in order to operate just this particular subsidiary. So we work with that together to find the right type of individual that is giving the fantastic mandates to run this good business going forward in the Teqnion Group. It's -- I have the deepest respect for this type of search, and we have found really good people, and we also made mistakes in this because you are -- in these type of businesses, you definitely need to be entrepreneurial driven to some extent. You need to be a true leader. You need to have many, many hats in order to make sure that you grow the business going forward. And hopefully, we find someone that is very eager to be a part of the big journey of the Teqnion Group. So they also, over time, can help us and support other subsidiaries. And that is something that we implemented maybe in -- for the first time in a really true way last year, and it so far looks really, really well. that a subsidiary CEO also starts to help and support the Boards of other subsidiaries to make sure that they perform well.

Yes. I think we're also in a fortunate situation. I mean, perfection when it comes to acquisition or when it comes to recruitment, it doesn't really exist, but you could try to find something within a proximity to perfection. And we're in a fortunate situation where we receive hundreds of IMs every year. I speak to maybe 100, 200 vendors per year. And as you know, we only buy, let's call it, 1, 2 handful per year. So I mean, as soon as we feel that it's not the right fit, we try to just -- we just stay away because there's so many other things that we could chase after. It's not a problem for us. We can, of course, make mistakes just as -- I mean, it's a dating process. You could find a partner, you could marry the person and then you find out, well, this wasn't really right, that happens as well. But we just try to be very, very picky with that. So to your question of how does it work when the vendor maybe wants to retire, if we feel that there is -- if the person is going to retire the same day and it's super important, and it's difficult to recruit, we just don't go there. That's the luxury of being in our position. We don't need to solve something. We only want to solve the easy problems.

Are we ready to wrap this hour up?

Let's do a couple of quick ones.

Okay.

Kit has a question. It's a little bit long, but basically, it's wondering, if you look at the note when it comes to the business combinations and how much EBITA we buy and then compare that to actual numbers over time, how does that compare? I think a quick one is that, of course, in the disclosures, we put in the numbers that you should put in according to the accounting rules. The companies that we acquired before they sometimes look a little bit different compared to when we own them. Just as an example, because they are privately owned, some of them have properties in the company, so they don't pay any lease. We usually don't want to own the properties. They go out to do a leaseback, so that adds cost. A lot of the owners, let's call it, that it's 3 owners, they don't take any salary or very close to due to tax reasons, it's better to take dividend or something similar. But then, of course, in the real world, you need salaries and exceptionally -- especially if we recruit someone else to replace or 3, 4 other people to replace the 3 people, then you would have that up as well. So there are -- it's not really apple-to-apple.

Another question is, I know you've been consciously discontinuing unprofitable business for the last few quarters. How far along in the process are you? Are they more of an ongoing process?

Well, it's going to be there forever. We never want to enter any unprofitable business, then sometimes people make mistakes. Sometimes they will change that things become unprofitable while they were not in the beginning. So it will always be there as a process to tidy up and clean up for things that should not be there. But then, of course, I think the biggest jobs have been done. We -- as you know, we closed down business, and that's not part of what we should do going forward as long as we maintain.

No. There's so many things going into this question also because we will definitely try to make sure that all our coworkers are confident and want to deliver customer value and be proud of that and make sure that they can do sales with high margins and make more money. Some of it will, over time, not be good business, and then we have to do less of that and more of others. That will -- as Daniel mentioned, we will always be -- it will always be here, and we will always have to address that. What we are -- I want to fall back on what you said about EPS. I mean that should be our KPI that we should be measured on, and that's the one that we're chasing. We want to deliver shareholder value over time, and we're going to do everything we can in order to reach that.

Yes. Two quick ones from Doug. Historically, Q3 has always been a quarter with strong margins. Why? The short answer is really that it's a mix of which companies that have delivered during the Q3. It's also a little bit by chance. I would not expect if you draw out the time line 20 years with the same type of companies, you will not see the same accentuated seasonality as you've seen. Doug is also wondering why is working capital consuming cash if organic sales are negative. The key component there is that the organic growth measures companies that we have in our group for at least 12 months or actually 13 months and above. And -- so during the last 12 months, we have acquired a number of companies that have performed quite well as we talked about before. These companies are growing. Okay. Let's do the last one as well. Jorge, positive organic growth versus flat figure in Q2 '26. I think the question is when will we get that organic top line growth?

As soon as it will drive EBIT as soon as we will make sure that we earn good money on all the business that we do.

Yes. We're getting closer and closer to that number. And as you've seen, the negative organic decline have been shrinking, but I wouldn't really draw a flat or a straight line into that as well, either. Stable or higher margins as demand is increasing versus current sales, the pressure will be on having companies working at the same or high capacity and with more higher margin product split. I'm not entirely sure if I understand the question. But I mean, we are, as you see in the backlog, we have increased the backlog this quarter quite a bit. And maybe just to give some color on that, across the board, the backlog looks good. It looks a little bit better across the board. And then there's 3 companies that have really bumped up that increase. So it's not evenly distributed. Three of the companies have done exceptionally well when it comes to order intake. And for those companies, I would absolutely expect revenue to be up and profits to be up. For one of the companies, the delivery is not expected to be until 2027. So -- and for 2 of them, I think it's going to be later this year or something like that. So it's not -- it's across the board better, but 3 companies really did really well in that regard.

Yes. Last one, just listen to the interview you did, I think that's referring to a podcast. And I just want to say thank you for transparency, especially on the topic of your partner. You're welcome. I also really like the details you provide on the subs. Teqnion is becoming a better company with each new acquisition, and it's clear that your role in the process. Teqnion is the second biggest position in my portfolio. So to see that it's in capable hands is really important to me. Thank you. So it's a long question. I'm going to be short. What did you learn in McKinsey? What did you learn afterwards pre-Teqnion? And what have you learned at Teqnion? I think -- just to make it really, really simple and real life, of course, isn't this simple in my mind. I think at McKinsey, I really sharpened the tool of analyzing things. I think I became really compared to earlier, much better when it comes to analysis and getting a good business sense. My time between consulting and Teqnion, I think I got a chance to try to apply that into the real world into change management, taking it from Excel to the real world, translating that to P&L. And I think at Teqnion, I have the opportunity and have been challenged to do more of both. Then of course, the real world isn't really that simple, but that's what I could come up with in 10 seconds.

And we wrap things up.

Yes, do you want to say something as a closing remark?

I just want to say to all of you that took the time to listen to us. Thank you very much. I hope to see you again in October when we will be back. And until then, have a great time.

Thank you very much. Take care. Bye-bye.