June 7, 2022
Disclaimer: This is not investment advice. Information is provided 'as is' and solely for informational purposes, not for trading purposes or advice. Any reference to or omission of any reference to any company should not be construed as a recommendation to buy, sell or take any other action with respect to any security of any such company. The author may hold positions in securities discussed. Any forward looking-statement is subject to risks and uncertainties. Read further disclosure in the Terms of Service.
Today we are checking in with Fredrik Karlsson, who increased shareholder value by around 100x over 20 years in his previous role as CEO of Lifco. He is now CEO and co-founder of the decentralised serial acquirer Röko, which is preparing for an IPO.
His partner Tomas Billing also makes an appearance. Billing is the former CEO of the privately held investment company Nordstjernan and beat the market by circa 2x during his reign.
They are intensely competitive and got to know one another learning Russian as military interpreters and at Stockholm School of Economics, “doing group assignments at record speed, just dusting them off.”
Gustaf: Hey Fredrik - let us get right to it!
Tomas Billing’s first presentation outside of Stockholm’s finance district - as a newly minted 30-year-old CEO - said on an overhead slide: “What can Tomas Billing add to the Vansbro factory?”
The following slide said humbly: “Nothing.”
You were also a CEO at this time, and you have separately generated some of the best - if not the very best - return track records in the Nordics.
But ironically, the word “Nothing” still echoes in Röko.
But let us start from the beginning. You radiate competitiveness - did you ever compete professionally in any sport growing up?
Fredrik Karlsson: Gustaf, thank you for dropping by. I studied too much when I was young, so I mostly only had time for skiing and sailing but never professionally.
Gustaf: But you have won some races since then?
Fredrik: I am a three-time Swedish and Nordic champion in F18 catamaran [the world’s largest catamaran class]. I have also got an 8th place rank in the world championship, having won one leg. And I have won the Archipelago Raid here in Stockholm three times, thanks to a home advantage.
Gustaf: You did the Swedish business leader preparatory quadfecta: military service in the Interpreter School, studies at the Stockholm School of Economics in parallel with Engineering physics at the Royal Institute of Technology, and then becoming a management consultant at BCG.
Just over 30 years old, you become CEO, and the year is 1993. What appealed to you about the CEO role?
Fredrik: I was not very good at making slides as a consultant. I do not find slides rewarding; it is like writing papers in school. I wanted to do something measurable, like in sports. And the business equivalent is being a CEO - you go in with one set of financials and leave with another.
Gustaf: What did Carl Bennet see in you when you took over as CEO at Lifco in 1998? What did you learn from him?
Fredrik: Carl Bennet saw somebody who was result-focused, and that was what he wanted. I still remember how I presented my case to him: “I started at this German firm Mercatura, and the numbers looked like this, and when I left, they looked like this.”
I just showed him the financials. I believe I was the only one who showed it so clearly. And Carl is also extremely results-focused. Results are the only thing that matters. We found each other in that.
From Carl, I learned the power of simplicity. I was too academic when I was young. And when you are over-educated, you are inclined to do everything yourself because you think you are that good. But he emphasised that one should not go in and interfere after you have given people responsibility.
Gustaf: Bennet had taken Lifco private in 2000, and with the subsequent 2014 IPO, you became the first CEO to list the same firm on the Stockholm Stock Exchange twice. Did you make any changes to Lifco’s strategy in connection to the 2014 IPO?
Fredrik: Growth was not considered as important when we were private. It was enough to grow a little each year with high profitability. But then I understood that I needed more growth. So we recruited a dedicated M&A professional.
My role changed from being a turnaround manager in 1998 to becoming an acquirer and CEO appointer. That was important because you win the Champions League by picking the best players. Training cannot be your number one focus. And I transitioned into a role of acquiring strong firms.
I stopped working at Lifco three years ago, but otherwise, it is the same employee team line-up today, and they have made an excellent performance.
Gustaf: In 2019, you left Lifco due to a dispute over your compensation. Your family hopes that you will calm down, but in a month or so, you and Billing - chipping in EUR 8m each - raise EUR 270m and you close your first acquisition the same month. Today you have 18 firms in the portfolio generating close to a fifth of Lifco’s EBITA. What motivated you to go at it again with such determination? What is Röko?
Fredrik: Entrepreneurship is exciting and measurable; it is a competition.
Röko is a refinement of Lifco's business concept, another version of executing something similar. The acquisition strategy and criteria have been developed jointly between Tomas, Johan Bladh, Anders Nordby, and me. We have a more structured mindset than Lifco, where it was not as pronounced.
The acquisition model is based on only buying smaller family businesses that are asset-light with strong market positions, and always keeping the management as shareholders. At Lifco, we more often acquired 100%.
The companies we bought in my later years at Lifco that had minorities performed very well. It has worked. And at Röko, we have chosen to focus on that model exclusively.
That sets us apart from other serial acquirers. Why? Because our old traditional companies have more or less been acquired in Scandinavia. So one needs to buy younger companies that have not had the time to grow as much, and then the management needs to stay involved.
We have had a healthy acquisition cadence since our founding three years ago. New firms meeting our criteria come for sale each year. And we estimate that 15,000 private SMEs are sold annually in Europe, of which 1,500 are potential targets for Röko.
Gustaf: You say that Buffett’s moats are important, but what are your two most critical acquisition target criteria?
Fredrik: We are sector-agnostic, meaning that we will not understand each firm 100% right away.
But, if a target has consecutive earnings growth, it must be doing something right. That is our most crucial acquisition criterion.
The second most important criterion is that we need management to stay on as shareholders. Most often, where there is robust financial performance, there are good managers in place.
Gustaf: Initially, your acquisition criteria included a 10% EBITA margin minimum - albeit somewhat flexible depending on capital intensity - and you said you would buy lower margin businesses than Lifco. But Röko’s margin profile is today just like Lifco’s, around 20%. Could you not help but buy quality?
Fredrik: I thought it would be challenging to find high-margin targets, but we discovered that there are enough of them.
Gustaf: Why have entrepreneurs wanted to sell?
Fredrik: There are two strong reasons. First, they do not want to have all their eggs in one basket. For example, maybe they are 35, have a family, and feel like they need to buy a big house and withdraw some money to decrease their personal risk. And at the same time, they want to continue running their firm.
Secondly, many entrepreneurs discover when they are around 50 that they do not have children that want to take over. They might feel alone, and as they cannot hand over the firm to the kids, they prefer to onboard a partner.
Gustaf: Why do owner-operators sell to Röko?
Fredrik: They are attracted to our long-term and decentralised model; they know we will not move the business. Their firm can continue to act independently, and it will not become integrated into anything.
If you sell to a PE fund, they will want to double the profit in around three years, which requires a lot of measures to be taken. But many entrepreneurs do not want to go down that route.
They have done well so far and would like to continue to get a little better every year.
And we make no other demands. Many people are happy to hear this.
We also allow their children to continue working at any level. Some transactions occur when one of the children has taken over as CEO, but the parents must distribute the inheritance.
In 60% of cases, the second-level management has also invested in connection to our entry. And they find the Röko model absolutely fantastic. We pay dividends, so they get a tangible return on their investment right away, all while they can continue as before.
And then, of course, we have the personal meeting. If you have a lot of experience, people take notice, which inspires trust.
The transaction certainty is also very high with Röko. Brokers love working with us. If they pick five potential buyers, the chances are that Röko, who consistently shows that they close in a good way, will be one of them.
We do the work before the LOI, only to confirm the thesis during the second phase. In that way, we do not surprise sellers with discount negotiation tactics later in the process. In three years, there has only been one case when an acquisition did not close after the LOI. And that was because one part-owner had been convinced by his partners to sign the LOI, only to change his mind later.
Our DD can be fast. We use financial and legal advisers and do the commercial side ourselves. Due to their heavy use of leverage, PE funds need to provide debt providers with a lot of information that we do not.
Gustaf: How do you finance the acquisitions?
Fredrik: The minorities can be seen as bank loans carrying a higher interest rate. Then we have regular bank loans on the group level.
We used earnouts a few times at Lifco and when uncertainty was high during Corona in 2020. And we can note that earnouts have always been expensive for us.
We have used earnouts when I have been a coward, and it has come at a cost. One can probably say that there are reasons why a seller would agree to an earnout.
Gustaf: How do you value firms?
Fredrik: We make it very easy by applying a standard multiple on RTM EBITA.
As we have some experience, we can identify potential problems early. We try to deal with these by asking questions before the formal DD process. In this way, the purchase price is not based on the wrong data, which is very important for ensuring a smooth process.
We always check the cash flow before bidding. Typical areas for investigation could be inventory that has increased sharply or if family members are not compensated at a market rate.
We usually do not underwrite improvements, so we do not have to make the models that PE does.
Gustaf: The last time we met, you praised your team within 10 seconds. How are investment decisions made? And, you have done two add-ons so far. What is your view on them going forward?
Fredrik: Our investment committee consists of me, Tomas, Johan Bladh, Anders Nordby, and soon Fabian Speiser, who will focus on continental Europe. Everyone has a veto.
The older Röko becomes, the more we can engage in add-ons. It might take a few years after you meet someone in your niche before they are ready to transact.
For example, we talked about add-ons within Dental at Lifco for years, and finally, we hired an external consultant who just went around and met companies. It took 3-4 years before something happened. It is a long-term job.
That can also be seen among the established serial acquirers. They have processed a lot of companies, which is why they have a continuous flow. We are still a bit too young, but it will come with time.
Gustaf: What happens after a transaction?
Fredrik: The significant change is that they need to start reporting to us monthly.
But we only buy good businesses, so there are no material changes needed. It is more of a process of getting to know one another personally.
Questions arise as time goes by, and we may have some thoughts. For example, every time we meet a particular firm, we may tell them that we think they could benefit from employing more salespeople. And to another firm, we may say that they probably can increase prices.
We are only trying to convey one message at a time.
Gustaf: What are some common cases where you act as a sounding board?
Fredrik: Currently, we tell CEOs that we are experiencing inflation and that they have to increase their pricing. CEOs understand the dynamic but find it hard. They want support in their decision-making, which we are happy to provide. And maybe, they can blame us when communicating their pricing to customers.
Pricing is also essential when getting to know a new business in a non-inflationary environment. Instead of conducting market research, you can increase prices to see which customer groups tolerate it. Then you can think about what other things that are possible for this subset of customers. It is a great market analysis to make.
Similarly, a common exercise is to discuss plans for big customers that are not very profitable. It is great for the CEO to have a partner for these difficult decisions. And you would proceed by increasing prices and ending the customer relationship that way if necessary.
At Lifco, for example, a subsidiary had one customer that represented 80% of revenues. That customer wanted to implement a 100-page agreement with price reductions set for each year. Together with the CEO, I made some calculations to see if we could become profitable on the remaining 20% of revenues were we to lose that customer. There was a six-month notice period during which we would have the time to scale down operations, and yes - it was possible.
We told the customer: "In Sweden, we have The Sale of Goods Act, which has its foundations from the Viking Age, to balance buyers and sellers. If you want us to even look at your 100-page agreement, you must first pay our lawyer costs. We are happy to send an order confirmation based on Swedish commercial legislation if you want to order. You will get a price. Take it or leave it.”
It was a prominent American firm, and they were caught blind-sided. Something similar had never happened to them before. The head of procurement flew in but soon understood that we delivered high quality and that they basically had no other option. So they are still today a customer of the subsidiary.
In general, if a firm wants to grow, the first thing we check is the margin. There is hardly any worse thing than increasing revenues without also increasing profits. It only ties up working capital and increases personnel costs. Revenues are only troublesome on their own.
If a subsidiary wants to develop a new product or onboard a big customer, we tell them that the investment needs a higher than average EBITA margin. Otherwise, the cash flow will suffer. And we need the cash flow for acquisitions.
Gustaf: What advice would you give other CEOs?
Fredrik: You have to be very careful about which issues you have an opinion on at the subsidiary level. You can have an opinion on a maximum of two things at any time. Since you are not allowed to have many views, you have to choose very carefully.
And there is usually increased motivation if you remove a layer of middle managers if you have several. There are delays in the communication between salespeople and customers if salespeople first must talk to sales managers, who in turn must liaise with a CEO.
Communication gets faster, and the salespeople find it more motivating when they can speak directly with the CEO. And the customer feels that they are dealing with someone who has authority.
Gustaf: How do you get managers not to complicate things?
Fredrik: By not complicating things myself.
Speaking of which, my son is studying Industrial Engineering & Management and is doing product estimate calculations, with one model more complicated than the other.
If you have to deal with such complex calculations, you do not have a sufficiently profitable company to begin with! I tell my poor son that what he is doing is useless, which is not very motivating.
Suffice to say, I no longer comment on his economics studies.
Gustaf: What does your monthly reporting include?
Fredrik: Income statement and balance sheet. Simplicity permeates Röko's culture.
If you have a big organisation you need to make the goal easy to grasp. We only focus on increasing profits.
An example - although a bit simplified - would be Jack Welch, who started by using simplicity, and everything went very well at GE.
Then when he became chairman, he hired Jeff Immelt, who he thought was better than himself. And Immelt wanted eight goals instead of one and complicated things.
But of course, there were a lot of factors at play. Immelt also acquired at expensive valuations only to divest at low valuations and had a bit of bad luck - whereas Welch had fortune on his side.
But in general, increasing complexity does not go well.
Gustaf: How would you structure a bonus system if you did not have minorities?
Fredrik: It would be based on a combination of profit and capital employed. For example, if the firm increased EBITA by $100, maybe the CEO would get 10%. But if his capital employed increases by $100, he gets a penalty of $2.5, so he ends up with a $7.5 bonus. [Effectively a 25% ROCE hurdle (2.5%/10%)].
Gustaf: What are your thoughts on outsourcing?
Fredrik: The manufacturing companies that utilise outsourcing have higher margins and lower capital employed. It is better to be an assembly manufacturer than a fully integrated one - both in terms of return and cash flow.
The big problem is that if you have a production manager, that manager will always make the case that it is more profitable to produce in-house. With a strong-minded production manager, you will never be able to outsource. And that does not work.
Many of them do not understand that their job is not necessarily to produce goods themselves but to solve it in the best way. It is a tricky organisational nut to crack.
Ironically, the best outsourcers are former production managers who become CEOs. They suddenly see the light of outsourcing and become masters at it. They are amazing!
So, if you want something to happen on the outsourcing front, you should make the production manager CEO.
Gustaf: How do you spread your and Tomas’ competitive drive?
Fredrik: The entrepreneurs have it in their blood. We do not buy companies with a management that is not driven. The drive is what made them so good.
We had our first CEO conference this spring. It drives motivation and spreads the performance culture. Entrepreneurs learn how we think when we meet them in person.
Board meetings are not that important to us. The continuous dialogue over email and the phone is paramount. They can call at any time. Questions always arise at random and should not be saved to board meetings.
Gustaf: What do you look for in CEOs?
Fredrik: The drive, and it is tough to assess. People can be different, but it works out as long as they are driven. Johan Bladh and I, and Per Waldemarson at Lifco for that matter, are very different. But all of us really want to make things happen, which is essential.
Gustaf: What is your favourite book?
Fredrik: The godfather of Swedish decentralisation is Jan Wallander. He invented it in the 1960s. It forms the basis of everything!
He wrote Decentralisation - why and how to make it work and The Budget - an Unnecessary Evil. He was both an academic and a business leader. Svenska Handelsbanken was one of the world’s most profitable banks for 40 years thanks to him. He understood that the local branch level should make all decisions.
It worked well at Handelsbanken until the regulation and bureaucracy that ensued from the GFC fallout.
Jan was the decentralisation predecessor. He banished budgets. As a researcher, he had seen that budgets, forecasts, and plans did not work.
We have a unique industrial tradition of decentralisation that is hard for us Swedes to apprehend.
Another classic to study is Hans Werthén at Electrolux. He was the next big decentraliser [Werthén made some 200 acquisitions over 20 years]. He said: “It’s not only about planning but parrying."
I also like Percy Barnevik’s book On Leadership, 200 Lessons. He split up ABB into profit centres, and that is also decentralisation.
They all had their pros and cons, but Wallander is most impressive. If you should read one book on Swedish decentralisation it is Wallander!
These business leaders have shown that conglomerates can lead to higher performance as long as you have a simple profit goal, decentralisation, and provide employees with trust.
Henry Singleton at Teledyne is also a role model. You can translate the Teledyne story and get Lifco - multiples and all. The stories are more or less identical.
The comical thing is that when we are now making ourselves IPO-ready, Nasdaq requires twice the amount of papers that they did in 2014. They are heading in the wrong direction. Business plans and budgets are considered something good. They are leaving simplicity for bureaucracy and complexity.
It is great fun to dodge that while the rest of the economy is leaving Wallander, Werthén, and Barnevik.
Tomas: While Fredrik mostly reads historical novels, I read tons of fiction. Haruki Murakami is the author that I am most fond of.
Gustaf: What is your career advice to young professionals?
Fredrik: Make sure to get a lot of responsibility early on in an environment where you can learn. My first CEO role was in Bramsche in Germany, and I got it because no one else wanted it!
Become a CEO in Säffle or Vansbro, do not try to stay in Stockholm. If you want to learn about people and business, you have to make do with the opportunities on offer.
Tomas: It is tough to become the best at something you do not find fun. It cannot be rewarding every minute, and some early mornings will be hard. But I chose Proventus - over McKinsey and other brand names - when I moved back to Sweden [after having had Michael Lewis, author of Liar's Poker, as mentor at Salomon Brothers] because I thought it would be more fun, and I have never looked back.
Gustaf: What life lessons are you trying to drill into your kids or is a common saying of yours?
Fredrik: I leave that to my wife. They do not listen to me anyway...
Tomas: From my second mentor Johan Björkman: "Once is a mistake, twice and you are out" ("En gång är ingen gång. Två gånger är en gong-gong")
Gustaf: When do you think we can expect an IPO, and how can investors, business brokers, and entrepreneurs contact you?
Tomas: Fredrik likes to be on the phone, while I prefer email. He calls me and I email him back. So call Fredrik or email me!
We have deployed capital faster than we expected. During the capital raise three years ago, we said that the IPO was ten years out not to stress. But when Fredrik and I said ten years, we really meant maybe 5-7 years. But we have surpassed even that.
The stock market is turbulent, but we are making ourselves IPO-ready, and it may come this fall at the earliest.