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Margins Matter

Margins Matter
"When we acquire a company, we care more about margins than growth."                                                                                                       - Fortune 500 CSO

By now, we know the days of growing at all costs are gone - at least until they're back again at the top of the next cycle.

But for startups whose most likely acquirers are industrial giants, growing at all costs should never be the end game.

These acquirers look to add products that can eventually become their own business units at scale - that means $100M+ in revenue and P&L accretive to the entire organization.

Why? Because these firms are valued on their cash flows and dividends to shareholders, not revenue growth, see below.

I constantly use the "Rule of 40" on my blog posts since it's perfect for calculating the efficiency of growth, something large industrials care more about than most.

The formula for that metric is YoY Growth % + FCF (or EBITDA) Margin.

It's called the Rule of 40 because 40% and above is the gold standard.  If you're growing 40% annually, you should be cash flow breakeven.

Learning from Siemens' Brightly Acquisition

Siemens acquired Brightly this week and the announcement noted that the acquisition would be accretive to their income statement. Siemens was able to buy a higher gross margin business with a higher growth rate that also lifted their operating income targets.

This is a powerful combination for potential acquirers, but only true if you're business is profitable or at the very least breakeven.

Brightly is slated to grow 13% (not great, but better than Siemens) this year with operating margins between 11-16%, presumably before debt, but for this exercise assume this number is FCF.

Their Rule of 40 is between 24-29% - average for their revenue range - but Brightly was acquired for 10x 2022E revenues.

Now, take a hypothetical startup that is growing triple Brightly at 39% but burning at a -20% FCF margin, not only is the Rule of 40 lower at 19% but the company is also no longer P&L accretive.

The revenue multiple on this profile is likely 33-50% less than what Brightly was acquired for because you lose the multiplier effect of better growth and adding to the bottom line.

The next 12 months will be full of acquisitions in and around these sectors. I'll enjoy watching these numbers come out and discussing them with you all here.