On the lookout for enduring businesses

Five years ago, we started out with a goal to build out a collection of wonderful private businesses within Cymbria. Our plan is to own our private businesses forever, which brings its own unique set of challenges: We have to move up the quality spectrum and focus on enduring businesses that will thrive in the long term. We do not use excessive debt to enhance our returns but are still looking to achieve returns that are comparable to or better than Cymbria’s public equity portfolio. In addition, we are looking for exceptional management teams that share the same ownership mindset as EdgePoint, who think and act like owners and do all the little things to ensure customer success. With this in mind, we knew that few companies would have the attributes that we were searching for. So what are some characteristics of our approach that have allowed us to find and partner with the wonderful private businesses you own in Cymbria?

1. We prefer to build goodwill rather than buy it:
   Something that has stood out to me at EdgePoint is that we are all entrepreneurs at heart. Many of us have started and operated businesses before joining EdgePoint including Tye, Geoff and myself. We see ourselves as businesspeople investing in businesses rather than investors. If you sat in our offices, you’d be surprised by how energized we get identifying ways for our businesses to win. We love the challenge of getting our hands dirty solving hard business problems.
   
   The pest control industry is a dream industry for us to invest in. We have admired some of the public pest control companies for ages. It has the attributes we look for in an ideal business:
   

   1. An enduring and growing industry – unfortunately for all of us, not only are we unlikely to get rid of pests permanently, we continue to see the frequency of bed bugs and cockroaches grow with increased urbanization and warmer temperatures.

   2. A mission-critical service – whether it be mice in the house or wasps building a nest in your front porch, pests are not only highly disruptive, they have a regrettable inclination to reproduce and make your pest problem worse if it’s not resolved quickly and effectively. Now imagine managing a restaurant or an apartment building and you can see how important it is to have a vendor that you can trust.

   3. A business that requires almost zero capital to support growth, and as a result, has high returns on incremental capital – most companies typically require significant capital to finance growth. In contrast, while the pest control business requires trained technicians, leased trucks, and route density to support unit economics, it has limited capital needs beyond this as the business grows. When you own a business for a short period of time, your entry price frequently dictates your return. However, when you own a business forever, your long-term return tends to mirror the incremental returns on capital of the business. This was a perfect business model for our approach to private investing.

   
   Unsurprisingly, with these attributes, it’s nearly impossible to acquire a pest control business of scale. The same public companies we admire trade at over 40x earnings and would acquire smaller competitors at similarly high multiples. We took a harder route to establish our pest control business. Instead of paying an unjustifiable multiple for a bigger business, we took advantage of our permanent capital and longer time horizon to buy a small pest control business and do the hard thing of investing in its people and growing it organically with the hope that it would become a big pest control business in five to ten years.
   
   Going down this path was exactly as advertised. Running a business is completely different than being a passive minority investor – there is always a leak that needs plugging. When you first take the keys, you slowly find out about the broken windows, the technician who is impossible to manage, or the unhappy customer who you have to rebuild trust with. Credit goes entirely to company president Simon and his team, who have been able to manage the daily blocking and tackling while building the foundation for meaningful market share gains by investing in technology, scaling the team, and building a reputation for best-in-class service.
   
   Last year, the business generated more cash flow than our original purchase price, a more-than-ten times increase in cash flow in less than five years and has grown to become a top-five pest control company in Ontario, all while requiring limited incremental capital. More importantly, there is still plenty of room to grow and take more market share. As a Cymbria shareholder and owner of our pest control business, that translates into a continuously growing stream of cash flow that has almost no capital requirements. There are few companies in Canada with the same quality and growth profile of our pest control business and we cannot wait to see what they continue to do in the future.
   
   
   

2. Betting on our people:
   We spoke about our new investment in Leading Edge Physiotherapy at the most-recent Cymbria Day. It shares a lot of similarities with the asset management industry – it’s an attractive industry to be in but is extremely dependent on their people. They will make or break the success of the business.
   
   Several EdgePointers had the opportunity to give a financial literacy camp in Edmonton for our physiotherapists’ children last fall. The night before the camp, the dinner conversation turned to how each of us joined our respective companies. There were many memorable stories, but I wanted to highlight two of them.
   
   We have an EdgePoint partner we’ll call “Jane”. Jane seems born to be an EdgePoint relationship manager due to her strong sales skills combined with her even stronger personal connection to EdgePoint’s belief system. The funny thing is that the first time she “sold” EdgePoint was to her friends while she was working in Operations at CIBC Mellon, EdgePoint’s custodian.ⁱ Tye spoke to the group at CIBC Mellon one day about EdgePoint’s philosophy, how important our partners are to our business, how they are an extension of that, and how their contributions matter to EdgePoint’s success. After Jane heard Tye speak, she knew she had found like-minded individuals and told her friends that they had to work there. Her passion got back to the EdgePoint office, resulting in an interview and offer so she could become one of our official (and most vocal) advocates.
   
   One of the physiotherapist partners at Leading Edge almost made a similar career change, but fortunately a change in environment was enough. Even though he loved working with patients, it was the peripheral issues that were the problem – treated terribly by the owners of the business, had no say in operations and received zero feedback. It had gotten so bad that he was planning to quit the profession to do just about anything else. A chance encounter with Grant, Leading Edge’s founder, was enough to convince him to give physiotherapy another chance. Today, the love is back and he (and his patients) are thriving at Leading Edge.
   
   These are just two stories, but both EdgePoint and Leading Edge have benefitted from placing their trust in our people. Grant and the team pride themselves on their investment in people first. They’ve worked very hard on their culture at Leading Edge and delivering outcomes to their patients has gone hand in hand with that. Their efforts are already paying off – three new clinics in Edmonton and Calgary with more on the way are a great start, but it’s WHO are in those clinics that matters more.
   
   We’ve been fortunate to attract some of the best physiotherapists to join our new and existing clinics at Leading Edge. This will ultimately be the biggest determinant of how successful we can become. We started a scholarship program this year to provide physiotherapy students with both mentorship and financial support – if you’re looking to start a career in physiotherapy, we couldn’t think of a better place to learn. We’re just getting started and are excited to continue building across Canada.
   
   
   

3. Leaning into the long term:
   We have talked about how our permanent capital is an advantage for certain business owners. The reality is that many business owners are just looking to sell for the highest price. What they aren’t told, is that embedded in that high price are unintended consequences and very different expectations and alignment – the higher the price, the more debt a private equity firm has to take on to reach for returns; the higher the price, the more people they have to fire to improve margins; and the higher the price, the more likely they are to exploit customers for short-term profits. Ask any entrepreneur who has sold their business and they will tell you that this conflict of interest can lead to the demise of many formerly successful organizations. Our long-term approach means that we will not be the most-active buyer of businesses, but we have been fortunate to meet many like-minded and talented entrepreneurs who self-select for the right partner to grow their company.
   
   At the end of 2020, we acquired our financial technology business that provides mission-critical software to financial institutions in North America. It is the number one provider of loan software in the auto and equipment industry in Canada. There’s no shortage of acquirers for high-quality software businesses but one of the interesting things that came up after our initial investment was that a U.S. private equity firm offered to pay 25% more for the business than our eventual purchase price. The founder of the business was willing to take a lower price from Cymbria because he believed that over the long run, the business would be worth more if he partnered with the right business partner.
   
   The last three years have not been smooth sailing. Our largest vertical, auto finance, has seen volumes decline because of supply chain and production issues in the automobile industry. Higher interest rates have hurt financing volumes and the profitability of many of our customers resulting in delays and cancellations. Despite a challenging external environment, the business has grown revenue at 15% per year and we have leaned into our long-term vision for the business as we look to grow in the U.S. and new verticals. We have continued to invest in our product, enhanced our implementation capabilities to deliver against our promises for customer success, and strengthened our management team to support the long-term growth of the business. Life and progress aren’t linear, and neither is growth. With the investment phase behind us, we believe we have a business with a better product, stronger customer relationships, and more growth opportunities than what we had three years ago. We could not be more excited about the prospects of our team and the business.
   
   

4. Investing only when we see an opportunity:
   In the winter of 2022, I was having drinks with a friend who acquires software businesses. We were commiserating over being constantly outbid for different software businesses at valuations that defied our reasoning. I mentioned then how we were buying higher quality software businesses at materially cheaper valuations in the public markets. We owned many of these names in Cymbria, such as SAP, Blend Labs and Qualtrics.ⁱⁱ All of which ended up being the top contributors to performance in 2023. The last example, our investment in Qualtrics, ended up being bought out by private equity just three months later at a 73% premium to the pre-acquisition price.
   
   The private equity market has an estimated $2.6 trillion of dry powder looking for the next acquisition. What has historically been a premium for illiquidity relative to the public markets has now turned into a discount, that is public companies currently sell for a discount to comparable private companies. Private equity has become an asset-gathering game where they have to buy businesses to generate fees (and replace their sold businesses), regardless of the prices they have to pay, and at the detriment of the end-investor.
   
   We have never had and never will have a target allocation for private businesses in Cymbria. We evaluate each investment opportunity relative to how attractive it is to the other businesses, public or private, we own in Cymbria. Unlike the private equity industry, we have the luxury of being patient and waiting for the right investment opportunity regardless of whether it’s a private or public company.
   
   In the meantime, with a growing team of hundreds of employees, as well as clients and patients relying on our private businesses, we understand the weight of their trust and the responsibility it entails. We view our business partners as partners of EdgePoint and our number one priority is to do everything we can to make our private businesses as successful as possible. This can take many forms whether it be structuring incentives and compensation, supporting acquisitions, hiring exceptional talent, or introducing new business.
   
   As a Cymbria shareholder, you are an owner of our private businesses and their success contributes to the continued growth in Cymbria’s asset value. Come visit our physiotherapy clinics. Give us a call if you have pest control problems. Always feel free to reach out if you have any ideas on how you can help our private businesses become more successful, we are always trying to find ways to get better.