Teqnion AB (publ) (TEQ) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the Teqnion 2024 Q3 Q&A. I'm Daniel, this is my friend, Johan. And as usual, we will alternate between the questions that have been sent into our Q&A e-mail and live questions coming in through the team's chat. Sorry, I think we have a little bit of disturbance there. Sorry for that. But before we jump into the actual Q&A, would you like to say something about the quarter?

Yes, I can say a few words. Hello. Good morning. We released the quarterly report this -- today, I guess. I guess, you have had some time to read it through. As you see, we are losing some margins, and we're not happy for that. We have a few companies that are really performing well, having really strong margins, and we have quite a few companies right now that are actually losing money, which means that the overall marginal is dragged down, of course. This is not in a place where we would like to be, obviously. We're working very closely with these companies in order to make them profitable again and take care of things. And overall, what we see, the industrial market in Sweden is fairly weak. It's a little bit better for us in the U.K. And yes, we're fighting on, we are fighting hard, and we're trying to improve everywhere. Maybe that should be sufficient for now.

Yes. Let's get into the concrete actions on the questions. So the first question we got in the e-mail inbox is from Andreas from Germany. He basically has two questions. One, will we consider investing in companies in Germany, Austria, Switzerland region? And also, would we consider using Bitcoin as an investment for our balance sheet?

Quick answer, hopefully, is that, we are constantly looking for new acquisitions, but we're right now focusing on where we are. So it's mainly Sweden and the U.K. We're also looking in other countries in the Nordics. When we feel comfortable enough in the U.K., we will move into another geography. And we never say never to anything.

On the second question, it's a quick no. We think we understand that there's a lot of upside with Bitcoin, but we are not into that one stability and something that we truly feel that we trust ourselves. We've got a question from Benjamin on the team's chat. He's wondering, the order backlog went backwards in this quarter. Can you explain where it's coming from?

To think -- I don't think I have a quick answer to that, actually. What we see is that, of course, the big -- we have the order backlogs when it comes to the housing companies, they are not having big order intakes right now. And there are some other very niche companies that have long order backlogs. Most of are really profitable companies that have rather short backlogs. And so the backlog is -- yes, it shows you a trend, but it's not crucial to what we will believe will be shown in the future.

No. I think, I won't say unfortunately, that's maybe not the right word. But going back 3 years, 5 years, I think the backlog correlated more with our actual revenue and profit. And then over time for reasons, which basically is that we try to find great companies without focusing on if they have a long backlog or not. The backlog actually says a little bit less about our future profit than what it did before.

Yeah. Absolutely.

Another question from Benjamin is, which companies are unprofitable, less profitable besides the construction related ones?

Everything that supply heavy industry in Sweden are striving at the moment. Because the big global industrial companies sell less and has less orders, which means that we're squeezed a bit there. Thinking again, yes, it's also a little fluctuation. We always see a little bit of fluctuation in some of the defense industry, because a lot of the big countries -- don't have to be big countries. All of the Western countries are focusing, of course, on personnel and actually material when it comes to weapons and not so much training equipment and alignment equipment, where we are strong, which means that there's a lot of projects that are -- that has to stand back. Because we have to focus on defending ourselves. Something else that I'm missing.

Yes. I think the big thing is, of course, that the macro in Sweden have really made it clearer, which companies that are underperforming. I mean, they -- some of them were doing good or maybe even great financially. And due to that reason, we have not taken enough steps into making them even better companies or great companies. That is what we've seen now and for a while. So the ones that are unprofitable are, as I said, the ones that have more customers within the industrial sector, but it's less of an industrial thing. Yes, it doesn't help. But I mean, it's...

No. Sorry, you are so much better explaining this. But what happens, of course, when we actually have to -- when the orders are not automatically in the facts, so to speak. They're not in the inbox anymore. You actually have to go out and ask the customer for what they need. Then, of course, we see that we should have done that much more during the good economic days.

Yes. We see that in a lot of the industries, where the demand in the industry is down maybe 10%, 20%, even 30%. And of course, some of our companies suffer from that and also to be very transparent. Some of the companies, they blame that for the reason of not being profitable. I mean that is, of course, part of the truth. But the other side of it is that if the market is down 20%, it means that 80% is still there. And we should, and we need to be good enough to capture that product. If the market is not at 100%, I mean, that's different, and it's not. We're going a question from Hai from Oceanside Invest, who has two questions. One part is regarding the refined acquisition strategy, where it says, the acquisitions we made over the last few years are companies that are less sensitive to economic fluctuations. Could you please share some of your thoughts on the common characteristics of the few acquisitions and why we haven't done those earlier? And why we believe that they are more resilient on the housing market? That's the first part.

Well, I think, we talked about this a few times before, and we can definitely talk about it again. When it comes to the cyclical companies, we have some contract manufacturing companies that are somewhat cyclical. We have the house builders, of course, very cyclical, because the housing industries like that. It's -- the blame is on me. Well, didn't I understand this? Yes, I did. Did I believe we could outmaneuver it? Yes, I did. Did I think we can do it in a flexible way and a little bit better than everyone else? Yes, I did. Because that's how I view the world. I think we should be better than anyone else and always be on our toes and grasp, there will be market opportunity that we see even in bad times. It's too complex to live like that in every aspect of everything, which means that we try to focus on our core values, which is -- we pursue companies that are easy to understand. Because we will always have to deal with people. Human beings are always involved still in all businesses. And human beings are complex. And we love each other and we try to be our best here. We try to constantly improve what we do and how we interact with our companies and with our customers and suppliers. And -- but there's always a human being there that, that needs to be encouraged, that needs to be coached, that needs to be improved. And sometimes that is complex enough. We don't need a very complex manufacturing facility or a complex business model or very hard to understand the products or softwares or whatever. So we try to keep the business simple and we try to focus on the competitor as businessman and businesswomen. Sorry for the long answer, but this is the core for what we do. We target a lot of potential acquisitions and talk to the people that are running them and try to figure out if the culture there is healthy enough for people to love what they're doing, trying to be good at what they're doing and staying on for a very long time. Those are the companies we're looking for. I'm very -- I might be some naive in that we can -- in the past that we could -- we could buy small housing companies, because it's the lovely product. We shouldn't buy a company, because we love the products. It's a stupid way of buying a company. I've done it, and now we have to pay the price for it. Lucky enough, we are no longer, yes, one person here doing that work now. We are more than two, because we have Daniel and we have a team around us that helps us and supports us and Daniel is very, very much focused on finding these. Let's call them simple business model companies with great people companies. It's a total different animal today than it was 5 years ago, when Daniel wasn't here. And I'm extremely happy for that. Even if I sounds harsh. I'm very happy about.

Thank you. I think another facet of that question or the answer is that the common characteristics. We look for companies that -- and the ones that we have acquired lately, they have very or maybe even extreme high return on capital. And we like when it's robust over time. I mean, that's something that we do not compromise with. And then putting the software, I mean, it's interesting that it has been like that for a while, but of course, will it continue and that I mean, if they have extreme high ROIC, and we believe that will continue. That's something we're interested in looking to make super simple. Another question from Hai is regarding the ROE of free cash flow. He says that he places a huge amount of attention or emphasis on free cash flow. And it's good that we also measure it similarly. However, when it comes to making M&A, do we use that metric to assess the investments and companies? I think we more or less answered that question.

I think we did it just now. But of course, we -- it should be so simple. The balance sheet should be so light. So most of the earnings should pop out as cash.

Yes. We talk a lot about earnings. Because it's rather simple. The concept is usually easier and it's obviously due to accounting reasons also a little bit more stable over time. But the companies that we look for the earnings that come out from the income statement should be the cash flow over time, maybe not all quarters, but over time. All right. In the meeting chat, Errol, is looking at the balance sheet and says that there is a significant increase in prepaid expenses since the beginning of full year '23. Could you provide some insight to why this number has more than doubled? I think that -- it's one part is, of course, we have more companies. But I think the more significant part of the question is that it's -- it hasn't doubled, but it's quite a bit of a timing thing. And if I remember it correctly, we're talking about SEK 10 million or so. We don't foresee that it's going to move in that direction. It's going to fluctuate. From Galileo Invest in the inbox. We have a few questions. Regarding -- he has one regarding the CEO coaches of the HQ people. He was a -- I'm making this a little bit shorter, but, how are we working with the CEO coaches and the CEOs to ensure that we get the information that we need quick enough to make decisions?

It's a long question. I can't read it because it's too far away. I'm smiling, because you have so good eyes.

Glasses. No, but we work very closely with the entire team here. We're 9 people, and we talk every day, more or less. When it comes to the CEO coaches and how they've been working for many years is that, we -- we walk through everything together. And of course, they are schooled into the technical way of doing things, which has been -- we have a lot of patience and we work really closely with those that we consider needs that close coaching. Maybe we've been -- and I think, I wrote something about it in the CEO letter, we've been working rather soft in supporting them. And we -- and it's easy to do when everything is going okay. Also mentioned in the letter, right now, we're working a little bit differently because we see that we have been let's call it, too soft. It doesn't mean that we are harder or harsher or anything like that. But now we are following up more on specific number, specific actions and coming with more concrete examples of what we believe is necessary to execute on in order to get things on track again. So it's a little bit different now. This is the way to do it in a recession. And I'm, of course, a little bit, okay, let's say, a little bit disappointed in myself that I haven't been -- I'm managing to get this through to my closest friends here at the headquarter that this is the way to do it when times are tough, and they are right now. So normally, we work very closely with them. We talk about everything that needs to be executed, and we have a good plan for it going forward. Yes. There comes so many words out of my mouth. I'm sorry. Good words.

We're trying to be as good as we can in all times and we're trying more -- now more than ever to be really responsible, which means that, I mean, we're trying to win. I mean, in simple terms, we're trying to win in capitalism.

We hate to lose.

We hate to lose. And being responsible and being stewards of your money and also being very responsible to the people that are employed, because I guess the question is partly directed to let how -- both how we work with CEOs, but also the patients that we have with CEOs, if we think that they are underperforming. Of course, the responsible thing to do is to try to support them and help them to take the right actions for the company. But I mean, our first loyalty and responsibility comes to the shareholders and the Teqnion family as a group. It's not about having CEOs having their jobs for as long as possible, even if they don't do it well enough.

And another question for Galileo is, are we involved in double checking tax analysis on a subsidiary level when it comes to big projects?

We, as you and I?

Yes.

Yes. We look at everything. All of us here do. We are a team. We work as a team. And of course, we have very individual task while we're out meeting with our companies, but it's very much a team effort, and we are definitely involved.

Good. Another question from Galileo is, are there any companies that we have acquired since I arrived that are going through any issue? If so, which one and what are you doing to fix that?

No, nothing. Galileo is perfect. Everything he touches is turns to gold.

Easy. No absolutely, we have that. And I think that we try to be transparent. We also don't want to pick out anything because there is certain things that not everyone needs to know about from a competitive reason, but also for internal reasons. As a group, they perform, I think, you can see that in the numbers, but some are performing roughly not better than expected and some not.

And some apart.

Yes. Going back to the team chat. [indiscernible] and Mattis is wondering, would we ever consider divesting a company? And if so, what would be a valid reason?

Yes. Well, we've done it over the years when we see that the product isn't relevant enough. The companies might be too small or not profitable enough. We don't see that it can -- we don't see that it has the right to exist over a decade and so. And since we're trying to do this forever, we need companies that without much of attention from us is going to continue to be relevant in a decade and 2 and 3 as well. Which means that if we see that something is too fragile or too small or whatever, then we tried to do something with it, so we don't have to focus so much on it in the future. And that have been historically that we closed companies down or we incorporated the bids that are still relevant, being incorporated that into other subsidiaries. So this is something that we've always been doing. And we will, of course, continue doing it if we decide that it's the right way to move forward.

We're trying to be the best and I think that -- I hope that everyone understands the part of this chat that, we do what we think is the best in order to create the most value over time. And in a very simple theoretical world, getting rid of companies that lose money would be very easy and suddenly margins go up and profit go up. But of course, in the real world, there are a lot of things attached to that, both when it comes to that actually not so to get rid of something that is losing money, but the bigger part is maybe the soft issues, which is both that we need everyone who's working here needs to feel that there is no safety involved, everything needs to be fixed because otherwise, something happens in people's heads. And of course, that is also something we tell everyone that our favorite holding period is forever. And that means something, which we need to treasure as well.

And we do, yes.

Yes. An e-mail from [indiscernible] Sorry for that. It's a long question. But to summarize it, it's about the housebuilders. Given that so many housebuilders are striving right now and prices probably are cheap, which yes, they are. Shouldn't -- or should we look at buying more of those cheap and wait for macro to be better?

Is this trick questions for me? No, we're not. I think, we covered this topic before. No, we're not looking at buying any more companies from that industry. We need to be in industries where it's not that cyclical at all. And you can still love wooden housing without owning them. Companies producing them, I mean, wooden houses. Please buy wooden houses for yourself and your friends and family.

Exactly. I mean, it becomes a little bit simplified, of course, when we talk about the industries or verticals, because it makes it so much easier to understand. But of course, in the real world, if you would look at a vertical, there are always good companies and bad companies for a lot of reasons. We talk about that we don't want to have contract manufacturers, but of course, they are good contract manufacturers. I mean, TSMC, one of the greatest companies on earth, they only do contract manufacturing. That seems to be working for them. But it also comes down to, of course, who we are. Obviously, we are not the best people to do the best at running contract manufacturers. And on average, it's a little bit more difficult. And we know that it's very difficult to find the best people all the time. So that comes down to complexity issue there.

Absolutely. Yes, it's the same complexity. It's a much more complex business model.

Yes. [ Karl ] is wondering, on the topic of earnings versus cash flow that you talked about here, how would you look at having EPS growth as a financial target versus free cash flow per share as a target?

It's a question for you, right?

Yes. I can take that. We have a 5-year target. So over time, as we said, the EPS per -- the earnings per share and the free cash flow per share should be very similar. But the free cash flow, of course, bounces a little bit more. And we believe that in order for us to run the company to best and in order to create or reduce complexity, earnings per growth makes it easier. But of course, if you put together our financial targets 1, 2 and 3 that basically you could back out what the free cash flow needs to be, because otherwise 1 and 2 cannot be in place at the same time. I hope that's somehow answered. But I think it makes it a little bit easier to follow, and it makes more sense for us internally to not by the end of the year, start saying that let's not pay employees in order to make cash flow better. A question from [indiscernible]. As an investor, I've been trying to understand the size of the M&A runway. Is there a convenient description of the market where we perform M&A? There are some other serial acquirers, such as LIFCO, who says that they only have three verticals, called [indiscernible] software as many, but they are all VMS. How do you think about our M&A market and how would we describe it?

Okay. Yes, we have, yes, it's Daniel that many do the search, both for new potential acquisitions. We look at many companies because we are very picky with what we want to acquire. We meet with you say closer to 200 per year. And I maybe think we meet that maybe 100, but I don't see, everybody you meet, so that, that might be why. But we meet a lot of companies and what we're looking for is, of course, companies that we believe is going to be relevant in a decade and more fulfilling these criteria that we mentioned already. They should be really good. They should have high margins, high return on capital, and they should produce something that is more or less their own, like their own brand name, their own design product. So that they hold their own future in their own hands, so to speak. Also, we look at the free cash flow there, we look at how good they are at actually turning their earnings into cash. And, yes. So we should understand what they're doing. We should realize that it's a strong and resilient business model, and we should believe that the people is really good at what they're doing. And then, of course, there's so many other aspects to look at. But those are a few things that we definitely look for and try to pinpoint before we proceed to try to acquire something.

And maybe just to add two more points to that, not specifically pointing out another company. But I think that if you would start looking under the umbrella for some of the serial acquirers, you would see that they might have a certain name for the vertical, but it's more of a name rather than something else in order to help interested parties in kind of understanding what it is. We could make up those names as well, but it doesn't make any sense for us because they very much work independently of each other.

We're not organized that way. Also it would only be a facade...

And we could call them [indiscernible] And then the second part of that, I mean, I understand it's very difficult to gauge how big the M&A market is. And I think one of the reason is probably because it's so much bigger than where we are right now. And somehow, just to put some words on it, we are in some kind of industrial business-to-business market that then you can size up the size based on the geography and company size. But we always try to learn. I think, that I mean, you have an engineering background. So that obviously helped when you started out doing more of the industrial stuff. I'm an economist. So I don't come from that side. So I think that, when I came in, we tilted our sort of confidence a little bit. And then, of course, where we meet with this 100, 200 companies per year and we learn things from our companies, that also, hopefully, over time, expands our circle of competence a little bit. So a very long answer, which is not really a crisp number .

But of course, this is the part where me and Daniel really enjoy being and exploring and improve. This is so much fun. And we see that we have progressed a lot. And yes -- he asked a little bit about the pipeline or how it looks for the future going forward. And it looks really, really good.

Yes. I want to say one more thing regarding that. I mean, when it comes to just, we have a lot of fun at our work. And it's a lot serendipity. We don't know what's going to happen every day. And some of our acquisitions are things that we thought that we were looking at, and then we found kind of that thing, and that's one above. And some of the companies like our latest acquisition, U.K. Lanyard Makers, UKLM. I don't think in a million years that we would think that would be a great business looking from the outside. But when we got the numbers and when we started to speak with the team in order to understand what they were doing, it was like, wow.

They are so good. They are so good. Yes.

Mufasa in the team chat is wondering, how do you replace subsidiary CEOs when they leave, retire? How easy is it to find the quality managers to lead "boring businesses"?

Maybe for once, they shouldn't think it's boring. It's probably the best job in the world to run a business. The responsibility and also the full aspect of being responsible for a legal entity and all your coworkers, whatever you deliver to your customers and all the relationships with supply chain and so forth. It's a really, really fun job for the right type of people. I know that we talked about this many times, but I think it's worth mentioning again. Acquiring companies can be really easy, at least if you don't care about what you pay for them. We can, so it's a little bit trickier for us. But when it comes to recruiting the right type of person to be in charge and take -- to take on the responsibility to run a business like this, it's really, really difficult. And there, we have only now 18 years of experience, and we will never perfect that. But it's we're at least very much better today than we were years ago. The hard thing or the real critical thing of building something, a group like this and scale it is, of course, to have a recruitment process that will make sure that you get the right type of people running these businesses. I mean, we acquired the -- normally, we acquired a company from the founder or an entrepreneur that has been operating in for many, many years. And that person has so many hats. He sees that company from within and from afar and he knows all the different notes of it. And all of a sudden, we're going to recruit someone. And we all know and we're humble about that. And no one can come in and control all of those notes that is necessary where all those different hats that you need to be wearing as a CEO of a company like this. So there will always be a compromise, and that's why we also need the CEO coaches that are really, really good people, and they are all very familiar how it is to run a company which means that they can work closely with the newly employed subsidiary CEOs and try to get them into the right, I don't know, into the right position, both when it comes to business sense and as a leader and everything else that is necessary. So the short version of this very long and badly answer is, it's easy to acquire a company. It's really, really difficult to hire the right people to run the companies, and we have the greatest respect in that part of the business.