Description

“I don't know whether we're going to get 50 to 100 baggers on these vertical market software deals. We're going to get a lot of baggers one way or the other…. without massive amounts of risks” – Mitch Rales

Chapters Group (CHG GR), is a German-based company that is led by a team of highly accomplished investors including Sator Grove (18% shareholder), Mitch Rales (~15%), MIT (~9%), and William Thorndike (~8%), the author “The Outsiders”. Shares trade in obscurity on the junior exchange in Germany, but over the last two years Chapters has grown at ~60% CAGRs. Even more, shares still trade at a reasonable valuation (~18x our 2025 EV/EBITDA), which provides us significant upside.

Mitch Rales, Co-founder & Chairman of Danaher (DHR), is an icon amongst programmatic acquirers. DHR’s stock price rose by an unprecedented 1,800x over the last 40 years (~21% CAGR). DHR’s success has been fueled by its proprietary Danaher Business System (“DBS”), which was first created by Rales in 1985. By combining DBS with a kaizen-like mindset towards continuous improvement, DHR has proven to be even better at building businesses than acquiring them, which is critical to the success of programmatic acquirers. Nowadays Rales no longer manages DHR and most of his ~$5bn wealth is still in its shares. Yet, to diversify Rales is allocating money towards young aspiring CEOs that he can coach and mentor along the way.

In early 2022, Rales took a ~15% stake in Chapters Group and many wondered why Rales would tinker with a ~$25mn investment in an orphaned German security? In a recent podcast with the reclusive Rales, he explained that his goal is to find young, passionate founders who could provide him the chance to make 50-100x returns over 20-30 years. In other words, Rales invested because he thinks he can make >50x his money and he intends to be heavily involved. Also, in the same podcast Rales highlighted his affinity towards vertical market software (VMS) companies and how he aspires to build a “supercharged” version of Constellation Software (CSU CN), which we found to be extremely compelling.

Chapters Group, (fka Medical Columbus & Mediqon Group) is market cap is ~$500mm and there’s only one analyst publishing research.

Its led by CEO/Chairman Jan-Hendrik Mohr, a value investor-turned-operator who has attended Berkshire Hathway AGMs since age 17. Previously Jan managed a hedge fund for highly regarded German families with a few hundred million in AUM. But in 2018, Jan’s fund acquired a ~30% stake in what was then called Medical Columbus, a beleaguered health care software business with a $10mn market cap that was trading below book value. Described as both highly intelligent and superbly creative, Jan intended to help turn the company around. Yet they received a ~$12mn offer for their main asset and it was sold. Upon closing its founder intended to liquidate, but Jan had other ideas. Jan, despite having high-quality investors like Notre Dame and MIT, grew weary of the short-termism associated hedge funds and he aspired to follow in Buffett’s footsteps by managing a pool of permanent capital.

In 2019, the business became a decentralized holding company. Originally it had a broad mandate: back entrepreneurs building platforms to acquire businesses facing succession issues. Managed in a highly decentralized manner, each platform would target a different market. The following year they made four more acquisitions of quality companies for ~5x EV/EBIT and Jan became their CEO at the age of 31. Jan subsequently shut down his fund and went all in at Chapters.

Over the last few years, under Jan’s helm, the company has transformed itself from a penny stock to a compounding M&A platform. They’ve deployed ~€180mn across ~40 acquisitions and it now generates ~€100mn run-rate revenues and >€27mn run-rate EBITDA (>27% EBITDA margins). They have now six disparate investment platforms and by design, Chapters owns an 80% stake in four of its platforms while the management teams own ~20%. In addition, Chapters owns ~30% of Software Circle (SFT. LN) and a 55% stake in Fintiba. Currently we estimate >50% of EBIT comes from VMS assets.

The key investment factors behind our thesis include: Chapters’ is designed to compound capital at high returns for years and M&A is accelerating. Jan is being coached by legends, which should help to ensure success. Lastly, we believe it is poised for its next chapter, as a higher quality, VMS-focused company.

Chapters Group has almost no debt and it exhibits characteristics of other “100 baggers.”⁵ Mainly it’s a small company with a large total addressable market. It has robust growth (>40%/yr) which is complemented by high cash flow conversion, high ROICs and strong barriers to entry. It’s led by an owner/operator team with heavily aligned incentives and it’s trading at a reasonable valuation.

Its operating model mimics that of many great programmatic acquirers. There is an incentive-based approach, a long-term orientation, and decentralization which enhances the group’s agility to scale while still harnessing the entrepreneurial spirits of its managers. They acquire companies led by experienced M&A practitioners who remain in place and each platform is held fully accountable for its own results. Group CEO’s earn modest salaries and no bonuses, but given management retains a 20% stake there is a strong alignment of interests. Furthermore, its subsidiaries must pay the parent company a 10% interest rate on capital used for acquisitions. This provides a clear incentive to only make acquisitions with an expected return that exceeds this ~10% hurdle and only after debts are repaid can management participate in its 80/20 profit split. This drives a culture that’s intensely focused on cash flows, which is the lifeblood for any successful programmatic acquirer.

Thus far, Chapters has mainly acquired companies in German speaking parts of Europe, where they have competitive advantages as Germany is an extremely relationship-based market, making it difficult for foreigners to compete. Also, there are very few buyers competing for assets this small (<€5mn revenues), which allows Chapters to sustainable acquire businesses at mid-single digit multiples. For deals Chapters issues equity at >15x EV/EBITDA to its highly engaged and supportive shareholders and they acquire companies for ~6x EV/EBITDA, leading to immediate value creation.

In 2023, Chapters spent >€50mn on acquisitions, more than the past two years combined, and they made considerable progress in building the “home for mission-critical businesses”. In 1H 2024, they added four more VMS companies and Chapters took a ~30% stake in UK-based Software Circle, which owns VMS assets in the UK. This is unofficially a platform as Jan has been heavily involved with Software Circle for many years and served as Executive Director. Also, Software Circle’s shareholder base includes many German family offices who are supportive of Jan’s ambitions.

More recently Chapters announced a potential €60-80mn equity offering at 24.70, or a 17% premium, with €52mn backstopped by existing investor Daniel Elk (former Spotify CEO) and a high-quality group of family offices. Equity offerings usually require a discount, but this premium highlights the scarcity value in owning Chapters’ shares this early in its lifecycle. Ultimately the size of the actual offering will be based on its acquisition opportunities, but we expect capital will be allocated quickly we include this M&A in our 2H '24/'25 ests. Nevertheless, Chapters is eager to achieve scale and to become self-funding, which ensures faster near-term growth and less dilutive equity in the future.

Over time Chapters will likely create many more decentralized acquisition platforms with as many as two-three joining per year. To this point, Jan suggested that with the right systems in place, Chapters could eventually have 15-20 acquisitions platforms with each making several acquisitions a year. As it scales, Chapters also intends to add debt at its subsidiaries and eventually corporate leverage of 2-3x ND/EBITDA, which would reduce its cost of capital and the risk of more equity offerings.

Moreover, Rales believes it’s a competitive advantage if he can help his young founders succeed. Rales is working with Jan to implement DBS-like systems and on strategic planning. Jan and Mitch have an active dialogue and Jan also has a relationship with Danaher’s former Head of M&A, who is providing him valuable advice related to scaling platforms. In early 2024, Chapters hired Marc Mauer as its COO to facilitate acquisitions at existing platforms and to establish new ones. Mauer brings two decades of experience as both a VMS investor and operator as he previously led one of CSU’s platforms (Valaris). Since joining, Marc has further institutionalized Chapters by adding systems to accurately measure day-to-day results across entities and he is driving best practices across Chapters’ subsidiaries. We think the formalization of best practices will lead to higher organic growth and Jan sees a tremendous opportunity to drive price at its existing assets. In summary, Jan fosters a culture of continuous improvement and long-term thinking, which Rales believes were key to DHR’s success.

In his rare interview, Rales went on to describe his affinity for VMS companies and we agree. Frankly, VMS businesses are the optimal platforms because they have sticky revenues, strong pricing power, limited cyclicality, high margins, and strong cash flows. For Rales a key learning from DHR was its focus on higher quality assets with recurring revenues and Rales believes he can build a better, more durable Constellation Software for the long term by focusing on more growthier assets. Rales is also pushing Jan to specialize so that deep domain expertise can lead to more synergies as well as more strategic opportunities across its subsidiary companies. Finally, Chapters’ shareholder base is very similar to that of Arcadea, another privately-owned VMS acquisition platform that’s backed by Paul Buser (Sator Grove), William Thorndike and Mitch Rales so they are already utilizing VMS-industry specific playbooks.

In August 2023, the company renamed itself Chapters Group AG (from Medicon Group) to express that they’d embark on several new and successful chapters in the years ahead. To us this was a signpost that the next chapter, as a VMS company has commenced. Chapters divested some legacy property services businesses and we wouldn’t be surprised if more legacy assets are divested with the capital going towards VMS acquisitions. Going forward we envision mostly VMS deals originating from its country specific platforms. The end result will be a higher quality company with more resilience, higher margins and stronger cash flows. Moreover, we believe its EBITDA margins could rise to >35% (from ~27%) as this is their target margin for VMS assets.

Another potential upside driver is its ~56% stake in Fintiba. This is a fast-growing business which sits on customer deposits and earns interest income. What intrigues us most is that Jan has always been inspired by Warren Buffett. Buffett has lauded the benefits of owning insurance companies which provide float/capital that Berkshire can in turn deploy at higher returns. Chapters’ annual report now lists a subsidiary, Global Hearts, a financial services company. Intentions are not clear, but if Chapters were to open a banking subsidiary to facilitate Fintiba’s growth then this could provide a source of low-cost financing for acquisitions and higher returns.

In terms of guidance, Chapters only provides a “base level” target, their proxy for NAV/share, but this merely uses the EV/EBITDA multiples that they paid for the assets. Surprisingly the lone research analyst does not include M&A in its estimates.

The main risk factors associated with the company include: the lack of a historical track record, deal execution and limited segment disclosure. Yet Chapters does provide revenue and EBITDA by acquisition year, which indicates continued organic revenue growth in previously acquired assets. There are concerns that Chapters may overpay for Software Circle shares, but Jan is more heavily invested at Chapters.

In regard to trading liquidity, Bloomberg shows <$1mn shares trade per day, but local brokers can be source greater liquidity. Finally, we believe it’s just a matter of time before shares are uplisted to Germany’s main exchange. This should lead to improved disclosure and increased trading volumes. Over time, liquidity constraints will naturally dissipate as the company grows.

Catalyst

Finalized 60-80mn cap raise, new aquisitions, new M&A platforms added, increased focus on VMS assets, increased sell-side coverage, uplisting to main German exchange.