Dynamic Portfolio Strategy: Rebalancing Using Divestitures

0:00Join me on September 25th for the M &A Science Fair. This is a hybrid event that showcases best practices and practical insights in M &A. It isn't your standard conference where you're sitting in on panel after panel. From fireside chats to breakout sessions, we'll be featuring impactful content led by M &A practitioners from Wifley, Sullivan Cromwell, Jamf, and Oakbridge Insurance. Together, we'll discuss everything from M &A change management to best practices with deal terms. Visit mascience.com to register. Again, that's mascience.com. See you in September. I'm Kisan Patel, and you're listening to M &A Science, where we talk with deal professionals and learn valuable lessons from their experience.

0:48This podcast focuses on stories, strategies, and what actually happened during M &A deals.

1:02Hello, M &A scientists. Welcome to the M &A Science Podcast, where we learn from the best in M &A to uncover proven techniques for enterprise value creation. If you're interested in learning more about how to optimize your M &A practice or want to get involved with our community of forward-thinking M &A practitioners, visit mascience.com and subscribe to our free weekly newsletter for the latest in industry trends, insightful content, and community events. If you want to keep up with us on the go, head over to LinkedIn and follow M &A Science. I am your host, Kisan Fatal, CEO and founder of M &A Science.

1:38Joining me today is Jerome Combs-Noak, strategy and corp dev at Dotmatics. Dotmatics is a life science software company that has completed 14 acquisitions to build a comprehensive platform of solutions aimed at accelerating the pace of scientific research. Today, we're going to talk about building a category leader through M &A and portfolio rebalancing through divestitures. Jerome, how are you doing today? Awesome. Thrilled to be here. Glad to finally have an opportunity to contribute a little bit to the pool of knowledge you're building with this podcast. Hey, thank you. I know you told me you've been a big listener and it's awesome to have you in the podcast.

2:14We're out here in California, Los Angeles on a sunny day. Appreciate you just taking time from doing deals like literally so. I've heard you between calls with attorneys trying to get something done now. So I really appreciate making this happen. Working on number 15, but I'm very well spent and really happy to be here. Kick things off a little bit about your background. Yeah, absolutely. Thinking about what it takes to be strong in corp dev and how I wanted to bring myself up and set myself up to be a good M &A science practitioner, I think there's really three skills you need. It's the quant skills, it's the strategic perspective, and it's the social skills.

2:48And the first part of my career was how do I build those skills in as thoughtful a way as I can and systematic a way as I can. Starting on the quant, Carnegie Mellon undergrad, computational science, then went into investment banking. And that's where I got my kind of foundational finance quant experience. On the strategy side, after banking, went to Columbia Business School and joined the Boston Consulting Group. Got a little bit more qualitative strategic experience. And then something that people don't necessarily think about in that early part of their career, but as you know, is incredibly important is the social side of it.

3:19And you kind of only really get that, or at least I only really got that through experience and repetition of doing deals and being able to talk to founders in different situations and empathize with what they were going through. I spent three years at a company called Standex, leading their M &A team through a series of acquisitions and investors. And then a year at Perkin Elmer, which is a life science instruments diagnostics company, doing five acquisitions there, deploying$6 billion in capital. And those were the formative deal reps that I think you need to hone your craft. And now finally at Thoughtmatics, for the first time, I'm taking all those skills that I've built over those experiences together.

3:52And we're building a category leader in life science software research, backed by Insight Partners. really excited about what we're doing, really excited to talk to you about it. I like how you break that down between quant, strategy, and social because I think it's so true and on point. Did you think about that though as a career path like that early? You're like, I got to build these three pillars of skills or do you sort of reflect back and say, hey, these are the three pillars? Be honest with me. I was probably naive early on in assuming that more of it was quant and that less of it was the qualitative and social aspects.

4:25I think I, to be really honest, had a naive view that a lot of these problems were more mathematical equations to be solved. Your first year in banking or your first real set of conversations with management teams and so forth, you realize that organizations are a lot more complex than what you can put in a spreadsheet. Strategy is a lot more complex than what you can solve with the math equation. And so it was a conscious, I think, second pivot or second effort, if you will, to start building out those additional aspects of the total skill set. Well, there you have it. Those of you listening there early in your career, think of it that way.

4:58Quant strategy and social and artwork experience you can gain to build those skills. You mentioned 14 acquisitions to date at Dotmatics. Can you tell me more about them? What's your magic? What's your unique approach to M &A? I should also be upfront about this. A lot of that pre-existed me. This was 2017 Insight Partners and the current CEO, Thomas Swalla, teamed up to buy a company called GraphPad. Without going into too much detail, enables, it's very broadly used by a wide range of researchers and scientists and statistical analysis that relates to the work that they're doing. They went into that with a deliberate M &A mandate strategy to acquire the very best software tools in different technical domains and bring them together in one place.

5:41And I think that having that top-down guidance in our core from day one early, from very senior leadership from our board members, was a really big part of it. Since then, we've done another 13 deals. The high-level outline of the strategy is finding the absolute best vertical SaaS businesses in different categories. That's thing one. And finding them is hard. It's a needle in a haystack, but we have a very systemic, robust way of doing that. Second aspect of it is having a differentiated strategy, both at the product strategy level, but then also in the way we actually add value to those companies.

6:17And let me talk about our our product strategy for just a second. Each acquisition we do brings a really deep specialty in a different scientific domain. What our customers need is they need to solve the specific technical problems they have in those domains, but they also need to bring that information and those different points in the workflow together in one place to get to the total answer that they're working on. So we've acquired the best tools in different categories. We've brought them together into a single platform. We've invested organically in a scientific data intelligence platform that kind of sits in the middle of that and connects those things together and enables comprehensive workflows, enables multi-dimensional analysis, and ultimately sets up for deeper, more innovative things that researchers are doing in AI that have previously struggled to succeed because, and I realize I'm jumping topics a little bit here, but a lot of AI efforts have failed because they don't have enough deep data sets on the a significantly broad set of dimensions that you need to solve these complex multidimensional problems.

7:19We have a platform now where we have the depth and breadth across a large number of data sets coming together in one place and in a very tangible way, accelerating the pace of scientific research. It sounds like the strategy is actually pretty tech-oriented. It's not just, hey, we're going to buy a bunch of verticals and just grow through that way by putting together a little team of a type of businesses. But you're actually tying these together on a single platform and allowing the data between these different applications to be consolidated, which is where you get a much bigger data set. You can start using AI applications with better results.

7:55It's like a consolidation of data amongst a portfolio of applications seems like the core strategy. It's that. And then in addition to that, having a very well-defined operating model where you're taking companies of different stages of maturity. Some of them are a PhD professor somewhere that created a really great piece of software. Some of them are further along with$5,$10,$15,$20 million in ARR. But in a very well-defined value creation playbook that we've developed over the course of these acquisitions, that we can apply to different companies at different stages and give them little tips and tricks and capability uplifts, if you will, to efficiently scale to the point that we're at now.

8:33So it's that value creation playbook capability in combination with a really differentiated strategy that adds real value to our customers and adds real value to the companies joining us. And the results of it on the scientific impact side have been pretty extraordinary. Since we're talking about M &A and so forth here, it's also been pretty extraordinary on the operating results side. Organically, having scaled this up to now close to 300 million in ARR with exceptional consistent organic growth, exceptional consistent profitability on that as well, that we then reinvest in developing the products and doing additional acquisitions and working towards the vision of having this truly comprehensive multimodal platform for science.

9:14Can we talk a little bit about how you value these companies? You don't want to give me secret sauce, but I'm running a SaaS company myself. And I got a big dream to turn this into an M &A platform. For those of you listening, want to help support one day. I'm just curious because when you look at it, you sort of had the strategy of like, hey, we can build ourselves in a market lead position. And you probably identified some initial acquisition targets and started getting that momentum going. But as you go through that, how do you look at that? Is it part of the strategy? It's like, we know what the end goal is going to be, what the value is going to be, so we can come in with strong valuation and pay a premium?

9:47Or are we still being like, I'm Indian, man. I'm trying to get value in everything I look at. Is it more of that kind of still a strong value-based approach? And yeah, I'm just curious just fundamentally how you value it. I'll say a few things that I think might surprise people. I think it's more fundamental driven than a lot of people would assume software investing is. we do pretty rigorous and pretty real math in terms of looking at the momentum of a business. You know, being very, very precise and scientific in measuring our velocity and quality. Quality of velocity is something we could expand on, understanding the cost structure of that business in a lot of detail.

10:23And ultimately, what we want to make sure of is that there's these ephemeral concepts of this is a great product that's resonating with customers, but validating that and corroborating that with the momentum that you're able to see in the recurrence of revenue, the growth of revenue, and so forth, it's more fundamental driven than people realize where we are looking in a very precise way at the individual customer level. How long are those customers staying with this product? How quickly are we able to add new customers and grow there? Those indicators, those signals are really important to us.

10:59When you have a company that's consistently retaining its customers, that's consistently adding new ones through the strength of its product, and you're operating that company in a pretty disciplined way, you're able to, through not extraordinary math, get to fundamentally rooted valuation that actually still enable us to bid pretty aggressively on a lot of these relative to other software investors. the reality too is that sometimes sometimes you do the math and you can't but then that's fine too that tells us that wasn't the right asset for us i like how you break it down too of digging in and really understanding the real organic metrics with retention and acquisitions but i think that really tells like that strength of the business as opposed to just we're paying x on this multiplier of revenue or something like that yeah and by the way i don't think insight would mind me sharing this because they, and I'd encourage your listeners to go to their sites, they blog a lot about this, but momentum and retention are probably the two most important things in a SaaS company.

12:06You know, I'm going to chase somebody down to Insight after this interview to get them on the podcast so they can explain this on record. Absolutely. They'll correct my notes. I'll give you one a little more, probably something you have FaceTime with is when you actually pitch this to the company, what is the pitch for a company to say, hey, we're going to get acquired by dot madison why does that make sense i think there's two parts to the answer one is there really truly is and i sincerely believe this and our customers believe this and the founders we talked to believe this there truly is value that's created when you're taking all these disparate capabilities and bringing them together in one place and it's almost like one of those team building exercises where you each have one piece of the puzzle and suddenly the lights come on and you can see everything.

12:52I'm sure we've done variations in that team exercise. That really doesn't exist today in the life science world. It's incredibly fragmented. And at the same time, the drugs that are being developed now, it used to be you could drop something in a Petri dish and it worked or it didn't work and you had an answer. The drugs that are being developed now require a multimodal approach of chemists collaborating with biologists, collaborating with geneticists, et cetera, et cetera. And so I'm rambling a bit here, but the point is having that together in one place is distinctive, is different, creates value, enables the individual products to be elevated into this bigger context.

13:31And this is only going to become more true, by the way, as we move more towards data-driven AI-enabled discovery. And I don't think anyone's pushing us back on that. That's part one. Part two of the argument is each company at any stage of growth needs help in some way to get to the next stage of growth. And it doesn't matter who you are or what stage you're at. The challenges in step one are different than the challenges in step two are different than the challenges in step three. We have a sort of a little bit of a secret weapon in that Insight Partners, who's backed us up, they're one of the biggest, if not the biggest, software-focused investor across all these different verticals.

14:08they know those challenges really well. In addition to that, we've codified, and I'm not exaggerating, it's a 300-page playbook. You pick different pages for different acquisitions you do, but we have really good experience at different challenges that people face at different points. And then in addition to that, there's the shared service operating model that brings things to these businesses that they individually might not have the scale to support. And also, by the way, would really not be fun. Maybe this is the third point. Fun for a founder to support. I'll make up an example of like export control compliance or figuring out taxes in eight different jurisdictions.

14:46Founders shouldn't be focused on that. Founders should be focused on better products and servicing their customers and innovating. And we take care of a lot of the boring stuff that enables them to scale faster, more efficiently. Sounds like a good support from PE firm. It is. It's great. It's been a great relationship. And we've done a lot to internalize a lot of it. But despite everything we've done on that front, there's always something new and they're always there to help us. And it's been great. It's like that real core vision that you're really selling on that it seems like it's those other executives interested in combining companies.

15:17Ultimately, I think that is the biggest thing because these are science-driven companies. It's also probably worth mentioning our values, our core values, science-driven, customer-centric, better together. Living by that, exercising that and how we approach these deals. and people realizing and experiencing that when they're with us. Maybe the last thing I'll say on this is, and I'm sure every single guest of yours has said this, reputation is so important. We're working on our 15th acquisition now. We've done a surprisingly small number of LOIs to get there. When we issue an LOI, we deliver on it.

15:51We also have a process that makes it easy for people to opt into our process. Our initial question list is six questions. We really are able to focus diligence on things that we know matter because we've done it enough to not ask you questions about things that don't matter. So making the process easier is also obviously lubricating everything else we talked about. The reputation is everything. I think that should be like taught the golden rule. I probably should have said that first. I probably should have opened that. Business. Hey, can we talk about portfolio rebalancing? I know something that you mentioned that you had experience with and love to hear a little bit about it.

16:24Changing gears in a pretty orthogonal way here, but... Yeah, this is in this current company that your experience was with, a different company. Very different company. Switching gears. Switching gears. Totally different. But this is actually where we first started chatting. It was all around this. And you're like, hey, this is a pretty cool experience. And I'm like, this sounds like a podcast interview. Portfolio rebalancing. Very different situation as we talked about. So Dotmanix, relatively new company, singular focus on this strategy. Standex and Perkin Elmer, when I joined them, had each been listed on the New York Stock Exchange for over 50 years.

16:55Great companies with storied histories and doing really good work. But inevitably, after that amount of time, there's sort of some drift in different business units. And unless you're very actively thinking about a mechanism to prune those elements of drift back to a core strategy, unless you have a real discipline and mechanism to do that, you're going to have these odd-shaped things that are out there. So I think in each of those instances, we, and by we, I mean the central strategy corp debt function, provided that perspective, provided that impetus to do that pruning. And I should say too that there's not really anyone else except for maybe the CFO or perhaps an activist external investor, which is not how you want these things to be instigated, by the way, that's going to actively do that.

17:41I'd encourage your listeners, many of them in those corporate strategy seats, to be thinking about that. If you're not actively thinking about it, nothing happens. I think you're right. It's easy to just put in the back burner and do business as usual versus you got to be proactive when you think about where your portfolio sits and evaluate it. And it's not just putting it on the back burner and not thinking about it. I think there's a bias against selling because it seems like it's admitting defeat. And then management teams, there's sort of this implicit assumption that their job is to take the assets they have and do the best job they can running them.

18:18And while that's kind of true, it's actually not exactly true. Their job is to realize the best value that they can from those assets. And we can also talk about serving customers well, serving employees well. Those other objectives are also dependent on that asset being owned by the right person that's, or sorry, right entity that's well positioned to grow and develop that asset. There's a negative connotation that investors are a form of failure. There's that implicit thinking. And then the other thing that's working against you is people focus on, I call them the not first principles, but a level below that, like goals around EPS, goals around EBITDA, goals around growth, quarter over quarter.

19:00And when you're looking at the world through that lens, you're often missing your first obligation to total share of the returns. And unless you're really actively thinking about it in that way, you don't come to the conclusion that, oh, maybe we should think about an investor. I like this. These are the reasons why people don't do like a portfolio review is because there's a bias against selling. They fall in love with their kids or the business lines and that they look at selling a business as counter to growth. Two other things I'll say. It's hard to talk about internally and at any level, right?

19:32The official line has to be, we love all of our children equally. And also we'll get into this at some point, I'm sure, but it's a lot of work. It's a lot of work to actually execute an investor. The good news is when you've done it, you can also realize a lot of value for your shareholders, but then also refresh and reawaken a stronger sense of identity and purpose and focus that then enables you to reach new heights with the Remain portfolio. And importantly, the company that got spun out also is presumably with an owner that's focused on their strategy, focused on what they're trying to do, and thereby able to achieve new heights and new purpose that they weren't able to before.

20:10Focus and achieve greater grounds for reasons to actually do this, make divestitures. What's the critical point that a company actually does it? They actually go through the exercise. They review their portfolio and look at rebalancing. The share stock is like plummeted down so much. Thing one is there's not much of an impetus unless someone's actually actively thinking about it in this way. But you're right. Actually, if I were to give another answer, it would be that you'll often observe conglomerates trading at a discount. And this is like classic sum of the parts analysis type stuff. But you look at the individual components of a business.

20:47You see what those would be worth. You look at where your stock is trading. You look at where more focused peers of yours are trading. A lot of times when you have this amalgamation of business units, it's harder to tell a persuasive story to the street. you find yourself trading at a discount, people get frustrated with that. That often leads to the impetus to act. And as a management team, my strongest recommendation would be to acknowledge that and be proactive about it and not wait for the investor base to come back to you with their version of the solution to it. Yeah. I like that point around looking at your business against the market and seeing where that's sitting, the story, and then investors, obviously, the financial performance or other indicators.

21:30I know you had first-hand experience with this. Can you walk us through the process? Because, you know, obviously there's like board, key stakeholders. How do you get all this buying alignment? What did that look like when it actually materialized? The first challenge you have to solve is a lot of different people will have a lot of different perspectives on this and a lot of different perspectives on how they measure, how they think about generating shareholder returns, how they think about the strategy and identity of the company. And the way I suggest approaching this is asking a lot of questions in a calibrated way, such as, why are we in the businesses we're in?

22:08What gives us a right to own these businesses? As a corp dev professional, you have the right to ask, what should we be looking for in our next acquisition? How do we think about excess capital and what we do with it? There's a series of questions that what we're actually trying to figure out are what are the core fundamental principles that people believe about their obligation to shareholders, their mission, their approach to creating those shareholder returns. What you want people to say is ultimately build up to a version of we're focused on total shareholder returns. But you need to first get everyone to say that and also to answer the questions in the same way before you can start to talk about divestors.

22:47Once people are responding in the same way, you can then start to begin to develop a framework. And I think there's three dimensions to this. One is around strategic focus of which industries do we like to be in? Why do we feel that we have a right to operate in those industries? But what is it about us that does that? There's the financial angle of it, which is the economic contribution of the different businesses in our portfolio. And here, by the way, you can't just be thinking about EBITDA or EBS, the absolute dollar of contribution, but the impact on quality metrics such as margins, returns on invested capital, growth rates, and so forth.

23:28And what you want to do as a technical exercise is, and this is one of the things I'm most excited to talk about, is creating a dynamic portfolio model where you have each of the different business units and what they're contributing. But when you toggle a business unit on or off, when you toggle a business unit off, your earnings go down, your EBITDA goes down. But, oh, this is interesting. Our growth rate is now a lot higher for the weighted average remain co. Our margins are a lot higher for the weighted average remain co. And, oh, that's interesting. Our EBITDA is lower, but these other metrics are higher.

24:01And, oh, that's interesting. when you correlate those improvements and those operating metrics against multiples that companies trade at, we can reasonably expect to be entitled to a higher multiple. Entitled is probably the wrong word, but we can reasonably expect to trade, to see a movement in the multiple we're trading at. And then in addition to that, when you do a divestment, you give up some amount of earnings, but you also get some cash that you can redeploy into other things. And, oh, by the way, actually, that cash is also in a very direct way worth something to shareholders. So one of the main problems that people have is unless you're actively doing that mathematical exercise, you don't know, you might feel good that, I think there's another implicit assumption that if a company is generating cash flow for me, I like owning it.

24:50You might not realize a different form of dilution in how it's weighing down your, it's an anchor to growth, it's an anchor to other operating metrics that are causing you to be punished as a company. The last financial point I'd make is that different investors will self-select into different strategies that align with those business units once they're spun out, which they're not able to do when you're a conglomerate. And that also leads to a trading discount. The point I was trying to make here is that when you're a conglomerate, it's harder for thematic investors to buy your stock based on an excitement that they have in some piece of you.