Investment letters

Over decades — even centuries — these bastions of business have used their resilience and built up competitive moats yielding exceptional free cash and healthy balance sheets. Their secret is spending this cash wisely on opportunities to unlock new pathways for organic growth. They filter out noise and have a clear strategy for pursuing their long-term goals.

TURNING M&A INTO LONG-TERM SUCCESS

Mergers and acquisitions (M&A) can highlight the qualities that separate compounders from the rest of the pack. Compounders grow predominantly using in-house resources, but M&A can serve as a valuable litmus test2 for their investing prowess.

Leveraging their free cash flow, compounders seize on opportunities to fuel future organic growth, but only when synergies align.

Leveraging their free cash flow and balance sheets, Compounders seize on M&A opportunities to fuel future organic growth. Their size enables synergies which smaller peers can only dream of attaining. Their abundancy of cash provides them the optionality to buy into new growth avenues independent of the state of capital markets. These are two ingredients crucial to success in M&A.

There are many pitfalls in M&A. It can be often inconsistent and procyclical. Assets can turn out to be too big to integrate. The risk of overpaying is high. Compounders are savvy investors and know how to deal with the complexity of M&A.

Take, for instance, the 2023 acquisition of luxury brand Aesop for US$2.5 billion in cash by L’Oréal, the company’s largest deal to date. Cash-strapped Natura was under pressure to sell their crown jewel Aesop. Cash-rich L’Oréal seized the opportunity.¹Much like L’Oréal’s previous acquisition of skincare company CeraVe from Valeant, also financially challenged, we see the potential for significant synergies. CeraVe sales shot up more than 7x in the six years following their acquisition.²

Both deals were driven by an opportunity to globalise another highquality brand through L’Oréal’s worldwide distribution footprint. By expanding into new markets, this beauty behemoth continues to boost sales and establish fresh avenues for organic growth.

Another example comes from our Comgest Global Compounders strategy: Microsoft’s US$26 billion acquisition of LinkedIn in 2016.³The tech titan’s US$100 billion pot of cash was more than 70 times greater than that of Salesforce, which was also in the running to acquire the social media platform. Since the acquisition, Microsoft has leveraged LinkedIn’s network to expand their cloud services customer base. By 2023, sales at LinkedIn had tripled to US$15.7 billion.⁴

BUYING WISELY

Marathon runners want to ensure that each new acquisition fits into their long-term strategy. They usually avoid exceptionally bulky – that is to say, risky – M&A activity. This is often referred to as “transformational M&A”, which is aimed at creating radical growth over a short period of time.

Marathon runners have no need for transformational M&A

When companies fail to generate value and growth in their core business, they may try to renew themselves through transformational M&A. Why would a successful company want to transform? For this reason, marathon runners have no need for such a makeover.

In 2016, Comgest sold its’ stake in the German pharmaceutical and biotechnology company Bayer. Why? The company’s decision to buy the American agrochemical and agricultural biotech business, Monsanto.

The deal should have transformed Bayer into a global leader in agriculture and life sciences. Years later, the deal mired the company in debt and lingering poor reputational issues, which have had long-term ramifications.

HOME-GROWN GROWTH

M&A is not a prerequisite to be considered a compounder. Many can generate organic growth without M&A.

Danish pharmaceutical giant Novo Nordisk illustrates this fact. A decade ago, the company edged out French rival Sanofi when the primary treatment for type-2 diabetes shifted to the hormone glucagon-like peptide-1 (GLP-1). Ultimately, Sanofi lost the innovation race.

Novo Nordisk, now the market leader in GLP-1⁵and a global leader in diabetes medication, spends substantially on R&D, which has opened up an entirely new market. The rise in type-2 diabetes has coincided with an increase in global obesity rates and GLP-1 has also proven to be an effective anti-obesity drug. Marketed under the name Wegovy, this drug is a gamechanger across adjacent industries. Unfortunately, the sad reality is that the market is only expected to grow.

PATIENCE AND CONSISTENCY

These marathon runners epitomise Comgest’s sustainable, quality growth approach. They are built – and building – on consistent organic growth and patience, not “make or break” decisions. Compounders have solid financials built around strong moats. They know how to spend their cash wisely and have the scale, experience and culture to seamlessly fit newly acquired businesses into their long-term growth strategy. When choosing companies for our Comgest Compounder portfolios, M&A can help uncover some of the qualities that we seek for investors willing to go the distance.

For more information, visit our webpage on Comgest Compounders strategies.

Product Specialist

Wolfgang Fickus is a graduate of the University of Cologne (Germany) with a degree in business administration (Diplom-Kaufmann) and studied at the London Business School. He also holds a CEMS Master’s in international management and is a CFA^® charterholder. Wolfgang began his career in 1995 at Paribas Asset Management Paris as a European equity fund manager. In 2000, he moved to WestLB where he worked as an analyst for European technology stocks before becoming the Head of Mid- and Small Cap Research in 2005. Wolfgang joined Comgest in September 2012 and is a Product Specialist / Investor Relations Manager.

REFERENCES

1 Source: Comgest analyst and Company Reports↩︎

2 Source: L’Oreal and company meetings.↩︎

3 Waters, Richard. Bidding war drove up Microsoft’s LinkedIn bill.The Financial Times, 2-Jul-2016.↩︎

4 Iqbal, Mansoor. LinkedIn Usage and Revenue Statistics (2024), Business of Apps, 18-Apr-2024.↩︎

5 Novo Nordisk 2014 Annual Report↩︎

IMPORTANT INFORMATION

Past investment results are not necessarily indicative of future investment results. Forward looking statements, data or forecasts may not be realised. This material is not intended for the US market. This material is for information purposes only and it does not constitute investment advice. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. The portfolio holdings referenced herein may not be held at the time you receive this publication and are subject to change without notice. All opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Certain information contained in this article has been obtained from sources believed to be reliable, but no liability is accepted by Comgest in relation to the accuracy or completeness of the information. The information contained in this communication is not ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with MIFID II.

Comgest S.A. is a portfolio management company regulated by the Autorité des Marchés Financiers and whose registered office is at 17, square Edouard VII, 75009 Paris.

Comgest Asset Management International Limited is an investment firm regulated by the Central Bank of Ireland whose registered office is at 46 St. Stephen's Green, Dublin 2, Ireland.