Chit Chat Stocks - Kelly Partners Group: Why I'm Buying this Small-Cap Serial Acquirer (The Next Constellation Software?) $KPG

Episode Date: November 27, 2024

On this episode of Chit Chat Stocks, Ryan gives a stock report on Kelly Partners Group (Ticker: KPG, listed in Australia), a company rolling up the small accounting firm space. Listen to the full episode to see whether he is buying the stock. We discuss: (00:00) Introduction to Kelly Partners Group (07:36) Current Business Model and Strategy (12:01) Understanding the Partner-Owner-Driver Model (17:42) Industry Durability and Growth Potential (23:51) Valuation Considerations and Market Positioning (39:10) International Expansion and Market Opportunities (43:20) Comparing Kelly Partners Group to Constellation Software (49:31) Management Insights and Team Dynamics (55:31) Valuation Challenges and Future Projections ***************************************************** JOIN OUR FREE CHAT COMMUNITY: https://chitchatstocks.substack.com/  ********************************************************************* Sign-up for a bond account at Public.com/chitchatstocks  A Bond Account is a self-directed brokerage account with Public Investing, member FINRA/SIPC. Deposits into this account are used to purchase 10 investment-grade and high-yield bonds. As of 9/26/24, the average, annualized yield to worst (YTW) across the Bond Account is greater than 6%. A bond’s yield is a function of its market price, which can fluctuate; therefore, a bond’s YTW is not “locked in” until the bond is purchased, and your yield at time of purchase may be different from the yield shown here. The “locked in” YTW is not guaranteed; you may receive less than the YTW of the bonds in the Bond Account if you sell any of the bonds before maturity or if the issuer defaults on the bond. Public Investing charges a markup on each bond trade. See our Fee Schedule. Bond Accounts are not recommendations of individual bonds or default allocations. The bonds in the Bond Account have not been selected based on your needs or risk profile. See https://public.com/disclosures/bond-account to learn more. ********************************************************************* FinChat.io is The Complete Stock Research Platform for fundamental investors. With its beautiful design and institutional-quality data, FinChat is incredibly powerful and easy to use. Use our LINK and get 15% off any premium plan: ⁠finchat.io/chitchat  ********************************************************************* Sign up for YellowBrick Investing to track the best investing pitches across the internet: joinyellowbrick.com/chitchat ********************************************************************* Disclosure: Chit Chat Stocks hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome in. This is the Chitchat Stocks podcast. My name is Brett Schaefer, and as always, joined by Ryan Henderson. We are doing one of our Wednesday research episodes. This is our monthly stock reports where we go through a company, essentially an audio and video format. We might share some charts here. And if you are looking for more numbers, I would subscribe to our free newsletter. We'll have a further discussion with Ryan's show notes, graphics charts all throughout the episode. But we're talking a maybe undercovered company. It's a company headquartered outside of the United States. It is Kelly Partners Group. And if that doesn't make it sound like a, you know, a sexy industry or something that people could get incited about on Twitter, on The Mildly Fool,

or in online forums, the returns have been quite good. And Ryan thinks there are some characteristics to this business that can make it somewhat like Constellation Software, but for the accounting industry. So with that tease, Ryan, why don't we start talking about the business? What is the backstory here? How was Kelly Partners Group formed? Yeah, to give a little more of a tease, the CEO here and the founder says he wants this to be like the Berkshire of accounting. Now, I know Berkshire is quite a different business and it's a little audacious but while it might sound like a bit of a boring business i do think there's a lot of this company checks a lot of the boxes that i look for and so i'm glad i came across it but in

terms of the backstory the founder is brett kelly and he's integral here he's a very important part of the thesis he uh he's kind of this eccentric guy he's done a number of podcasts he's written a number of books he writes a book every seven years and he actually wrote this book when he was in his early 20s which was i think it was called like how should i'm blanking on the name convention either conventional wisdom or something like that and he basically interviewed i think it was 60 different really important people and was able to get in touch with them and this was prime ministers this was former presidents of the united states like somehow he got them all to just kind to share their story and give a little bit of piece of wisdom.

And he wrote a book and it became a bestseller. Anyways, he's a bit of a storyteller and he actually at one point says, he's like, I think 50% of people like me, 50% of people don't like me. That's fine. The worst thing you can be is not memorable at all. And so he is kind of this, I guess, polarized and eccentric figure, but he's a pretty good salesman, if you will. So anyway, that's long-winded. We'll get into him a little bit more throughout the episode. But he started in investment banking and eventually got fired

because he, quote, did not work well with other team members. That's his words. And he said he agreed with that. He thought it was kind of frustrating to go through the work to advise a deal and then you do all the work and people might not take your advice. So he said he grew frustrated with it. And so he moved on and decided to get his CPA, become a professional accountant, and he completed his master's in tax. At this point, he had a pretty solid business acumen. When he was in investment banking, I believe he was in an M&A division, so mergers and acquisitions, and he had built up a good sense of how to value businesses. And he believed that accounting firms could be good businesses if they were operated correctly. So keep in mind, he's got this blend

now of investment banking, valuation, I guess, repertoire or ability to value businesses along with the actual field expertise of accounting. And so one of his friends approached him and asked him to help him set up an accounting firm. And here it is in his own words. He says, in March, 2006, a friend of mine asked me to set up a firm with him. He said, Brett, The CEO's name is Brett. You have 75% and run the business. I'll have 25% and run the clients. Could that work? I said, sure. He said, I don't know anyone that knows more about business than you and I'm a really good accountant. And so that was kind of a basis of a partnership. And really that was the preview of what would become Kelly Partners. So at the time

that he had set up this partnership, he was also working at a larger accounting firm and you manage your own book at the firm, but you're a part of a bigger company. And as the story goes, they said, you know, you could become partner once you meet these responsibilities. And he said he met the responsibilities later on in the year. He came back to him. He said, you know, it's time for me to become partner. And they said, we can't really do that deal anymore. We can do this other deal. And basically, he says they went back on their word. So he left. It was apparently not a very good departure. He seems quite bitter with them. And I think it kind of built a chip on his shoulder to be the guy across the street stealing business from them. So he started his own firm. Kelly Partners was built on spite a little bit. Potentially. It's not the worst thing. There's quite a few successful businesses, I think, that have been built on that. Yeah. I mean, whatever his motive, it seems to have worked so far. And so he set out starting his own firm. And at the time, he told his clients, like I said, you have your own book while you're at the bigger company. He told his clients, hey, I'm thinking about starting my own business. Would you be interested in that? And they were like, yeah, no worries, no problem at all.

So they started out and he really excelled with that. And the firm ended up being very successful. And that kind of springboarded what became Kelly Partners. So he had his own business and then he had the business side of things that he was running for his friend. At some point, however, he decided that he wanted the split to be more equitable so that the minority partners would have a little more control, a little more sense of the decision making, a little more, I guess, profit sharing. So he went back to Scott, who was the friend he set it up for, and he said, let's make it a 51-49 ownership split where Brett Kelly gets 51% and Scott would get 49%. That is the structure of the current operating businesses today, and we'll get into that, but that's kind of the foundation. So he fell into it initially a little bit serendipitously, like his friend came to him asking him to do it.

He was sort of a reluctant founder, but afterwards he said, you know what? This is scalable. Let's try to do it. All right. Well, I know we'll have some follow-ups on some of this later, but what does the business look like today? What is their strategy? Yeah. So Kelly Partners currently has, I believe, 37 operating businesses as of their latest report. However, the reports are semi-annual and I think the latest one was in June. So they may have made some acquisitions in the last kind of couple months that added to it. It's not exactly clear,

but somewhere between like 37 and 45 operating businesses. Keep in mind, they'll sometimes do a couple acquisitions in bulk and stuff like that. So it's a little bit hard to tell, but I think 37 is a good count. The majority of those operating businesses are located in Australia, but they've recently acquired a few in the US as well, which I'll touch on in a sec. But these businesses are pretty simple. They're chartered accounting firms that primarily service small to medium-sized businesses. So in terms of financial size, the operating businesses typically generate $1 million to $2 million in annual revenues. revenues um and it's it's think about it it's good for like that accountant that partner it's a good business for them um and the way kelly describes it is a lot of these people like scott his initial client his first one that did this they like accounting they like uh the details

of it getting in the nitty-gritty helping businesses file their taxes and that's what they're passionate about. They're not necessarily passionate about HR and payroll and running the business side of things. And so he says they get a lot of people that are kind of in that situation where that's not their passion. They're willing to do it and they know that that's part of running a business, but it's not exactly what they're excited for. So as for the acquisition strategy, it's a little bit unique. They do not issue really shares ever. So they have committed to publicly and so far have only used debt to acquire new accounting firms. Now, they did do an IPO. So shares obviously grew in that time and they raised capital that way. And they may at some point

uplist to the New York Stock Exchange in the US, which would potentially raise money as well. But when they use debt to make the acquisition, that debt is then put into the operating business and is typically paid out over the following four to five years reportedly they have a strict valuation model every every serial acquirer has a strict valuation model um but they try to pay maybe not those in 2021 remember those but they say they do yeah you know i guess there was some out there i don't know embracer group uh mohawk group if you remember that one or what they changed their name to what did mohawk group change their name to i can't remember i can't remember some consulting nonsense but those ones let's just say we're pretty confident that kelly partners has

a better hurdle rate than some of that nonsense that was getting thrown around during the 2020 2021 bubble yeah and they say that they pay four to five times earnings on their acquisitions which people listen sometimes you hear four to five times earnings and you think oh wow that's you know, remarkable deal because you're used to public markets, but keep in mind, these are small businesses. They're run by one or two people. Yeah. It's typically key man risk, right?

In this case, you're pretty much buying out a partner. So four to five times earnings. If you keep those earnings flat over four to five years, you're assuming that that partner is going to be doing the same thing in four to five years, people's life change. So it's not apples to apples with public company valuations, but four to five times earnings, if you can get them to stick around and you can believe that the earnings for that operating company is going to still be there in four to five years, that's certainly a good acquisition. The other part that's kind of interesting here is that when they acquire

the company, as I mentioned earlier, they're acquiring 51% of it, but they'll pay out the acquisition price over two years. So the first year, they'll pay out one third of the purchase price and then the other two thirds or the remaining two thirds are paid out in year two. So it's kind of nice from a little bit of a cashflow dynamic there where you don't actually have to pay out the bulk of the cost until the end of year two. And then once they have become a Kelly operating business, they then pay out 9% of their annual revenues to Kelly each year. Now, that sounds like a lot, but for small accounting firms, it can be worth it.

And I'll touch on why in a second. But according to Kelly Partners, that 9% goes directly to Kelly's quote, central services team, which reinvests all the money into the Kelly operating platform. I'm going to talk about that here in a second, but just to reiterate, so it's clear on all these acquisitions, when KPG acquires a firm, it owns 51% of the shares while the previous owner retains 49%. Kelly Partners Group then receives 51% of the profits and 9% of the total revenue. Now I'm going to touch on all this in a second, but the overall strategy is what they call their partner owner driver model. This is not just a send us a check in the mail every month type of roll-up.

It's a little more hands-on. They're a little more integrated. I think a few years back, they were making decisions at the business level, like operating decisions, trying to say, hey, you should do this, do this. From what I understand, they've backed off a little bit because I think probably the business owners don't really like being encroached on that much would be my guess. But they still take a lot of the responsibilities off the business owner's hands, which makes it real easy. I've got a little illustration here showing what the partner owner driver model looks like. If you're interested, check it out in the newsletter, it'll be there. But yeah, that's the basics of it. 51, 49 split, and then they get a 9%. I think they call it like a licensing fee.

And we'll talk about that in a sec. So what are their financing costs like? What's the debt look like? How expensive is it? I did not actually check the rate on the debt. I assume – It's not going to be ultra low since they're smaller. No, and the debt is held in the operating businesses themselves. So it's not – like if one company, if one operating company goes under, the debt that they owed is limited to them. So they're not structured in a way where it's –

I don't know. Yeah, I get the logic around those. But if an operating business goes under, like, that's not a good thing. You know, when people say that, I don't think that's a situation where the business is in a healthy spot. The other follow up I had was, oh, shoot, what am I missing here? Oh, around the churn. So you mentioned the key man risk. Do they have any good data around customer retention? Because I know the big concern for a roll up like this, especially where one where it's a services business where you have these small business relationships are they able to retain the clients and is that the key reason why they have the 49 percent the sorry are they able to retain the partners or the clients the customers on the end because you mentioned the

key man risk of like all right you acquire this accounting firm but if we ruin the customer relationships well the the profits are going to disappear uh do they have good data around that about that customer retention yeah i mean the it's not as not specifically data but they talk about it a lot uh so keep in mind the partners stay on so the partners stick around and usually you're taking stuff off their hands so they're able to dedicate more time to the clients um maybe they can increase their book of business they're able to take on more clients um but really if you have i think the clients tend to be loyal to their accounting firms in general because part of it is it's a personal relationship that you have between a client and an accountant.

The other part is over 10 years, over 15 years, however long you've had that client, you have come to understand the intricacies of that client's business. And there's nuances, there's certain expenses, there's certain things they do that are different than every other business. And it's really time consuming to switch to a different firm. And what part of the big sell for the partners is from Kelly's perspective is we'll help you find a successor. So they're willing to do that. A lot of their acquisition candidates end up being people that are late in their years and they're looking for a successor. And so they help them do that. It's something they talk about all the time, which is when you've been with an accounting firm for a long time,

you're rarely going to switch. It's quite difficult to switch. It's time consuming. I mean, and there's actually some interesting accounting treatment around that, which I'll talk about, and it kind of leads to misleading earnings figures. But yeah, I'll get to that in a second. Does that kind of answer your question? I mean, it is likely very low churn, but they don't give any specific numbers. Right. It seems like if you're targeting small businesses, the one churn is, well, they're not a business that operates anymore. But I could see, and if you take the large accounting firms that are a part of the public companies that do SEC filings, it seems like those fees just go up every year. So I would think the industry has steady ability to raise prices. But maybe we can talk about that near the end in an evaluation work. But anything else on that, Ryan? Yeah, just to your financing question, I assume it's case dependent. So whoever their lender is, which it sounds like they have certain creditors that they go to frequently for these operating company acquisitions. I assume it's case dependent.

And with it being paid out over four to five years, the rate might be, I would assume it's probably around 10%, but I can actually pull up, I'm sure that figure is somewhere in their filings as well. So I don't have it on here, but yeah. Yeah, I'm guessing, yeah, even if it is 10%, some people might say, well, that's kind of expensive, but if you're able to buy a business at five times earnings, there's a 20% earnings yield. And as we'll talk about in this next section here, there is that ability to raise margins once you enter the consolidated business. So you can still get a good return, even if that

cost of debt looks relatively high. But let's move on to the other side of the business. So Kelly Partners is out there. They want to acquire accounting firms. Now, Ryan, why don't you tell us why an accounting firm would want to sell to Kelly Partners Group at what people might say is a very attractive price. Yeah. This is the first question I had and probably the first question a lot of people have is like, you've got a business, say four to five person firm, maybe a little more. You're doing one and a half million in annual revenue. After all your expenses, you're maybe taking home 250,000 in annual profits. Why would you want to sell half your business and pay a 9% fee every year to Kelly Partners? The way Kelly paints it, and I think

this makes sense is that Kelly offers a standardized operating platform. So this takes out a big chunk of the responsibilities required for actually running the business. You no longer need to pay for your own systems. HR, which keep in mind, HR is not just one function. That's a number of functions that are done at the business level. IT, marketing, trainings, like training no employees. Kind of the list goes on when you think about the stuff you do on a day-to-day basis that is not focusing purely on your clients. Most of that gets handled by Kelly, which allows the partner to actually focus more on serving customers. And it also gives them more free time to handle more customers if they were working at capacity, which a lot of these

are, you think about like software business, you're going out, you're really trying to find customers. With an accounting business, you're getting a lot of local inbound. You're getting people that need an accountant. They're going to your office saying, hey, can you take on my business? So sometimes, I'd say oftentimes, you're kind of working at capacity and it's more just a function of, can I find the time to service more clients as opposed to not being able to find them? And there's actually a quote here. It says the investment, and this is the 9% investment, because the other thing you're getting is money. What are you getting on the acquisition? You're getting money. So this investment has freed up accountants to spend 40% more time with clients, which has improved the quality of service and allowed the company to handle more clients. so there's a couple things right you're you don't have to do spend time doing stuff you don't like you in you get margin expansion as well because you're not paying for all that's all that stuff

on your own you're getting the operating system from kelly so you don't there's probably literal software expenses and subscriptions that go out the window and caught in addition to the time savings um and you get money over the first two years that acquisition you get your payout um so That part's nice as well. Kelly reports that on average, this reduces the operating company's working capital by two-thirds moving onto the Kelly operating system and profit margins nearly double. On average, they state that accounting firms go from 19% to 33% margins once they're with Kelly. Then the other one here that it's important to mention that, okay, you're doing a million in revenue. You got 19% margins. You sell the Kelly, you get a buyout. Margins go up

to 33%. You're able to service more clients, so potentially more revenue as well. Your actual take-home earnings for the partner, they don't change that much. So you're still making as much money at the end of the year, but you're doing way less work or way less of the work that you don't like to do. The other part is quality of life stuff. So apparently a lot of the acquisitions that Kelly makes are from partners that are looking to retire. They want to find a successor, or at least they want to phase out, kind of phase into retirement. So Kelly promises to find successors for the firm, but it also allows those current partners to work a little longer. If you're not working 60-hour weeks, all of a sudden, you know what? Maybe I can work for

another five or six years, whatever it is. So they don't have to manage the business as much. They get a nice payout. They can reduce their hours a bit, keep the company alive, still keep their employees in business, still service the clients while they ease into retirement, it ends up being a decent gig. And they actually break it out in their presentations and say, here's how many potential targets we've got in each country in terms of acquisition targets. Here's how many of them are currently looking for a successor or an estimation of how many might be looking to retire in the coming year. So yeah, that ends up being their ideal acquisition candidate. Okay. And this reminds me, and I know that I would call the Constellation

Software shareholders a bit prickly because I think, and given Constellation Software's performance, I think rightfully so, they hate any comparisons to Constellation Software just because it's been a hundred beggar and more. But when I hear about some of the special sauce at that company. It's about their internal sourcing mechanisms where they're much better at finding these niche vertical market software companies than anyone else and getting them at a reasonable price. Have you seen anything from Kelly talking about this and how their strategy is for finding these tens of thousands of accounting firms and finding the one that fits their criteria across one of the three companies, Australia, United States, or United

kingdom no i i don't know how they build their database but i would assume they acquire data from some sort of information services provider um around you know general business data in the area local business maybe you're buying it from a national provider or something like that i mean there are businesses where their entire thing is they just collect data on businesses they find how old people are and they can just pay for access to it i assume part of it's that i assume part of it's them doing their own collection as well so i'm not exactly sure what the makeup is there but they do have a um i'll talk about this here in a sec they've got a database of all the potential acquisition candidates or i'm sure it's refined over time and it changes um but potential

acquisition candidates a pipeline they've got who might be actually be selling who they're actually talking to, who's in contract phase, all that stuff. Yeah. Because the problem with these roll-up types, and we saw that with the copycats for the Amazon small business roll-ups, which I don't think was that good of an industry to begin with, but really the concern I think a lot of people have with these types of companies is, well, anyone with $100 million can start copying you. And I think one of the key things for people to look at for Kelly Partners, for Constellation software for other people is what is their culture of just the process of going, all right, finding any candidates and moving down to what fits our hurdle rate. And it seems like Kelly

Park, I mean, they're much younger, so hopefully they develop it more and more over time. But if they build up that database and that muscle memory, I think that will be quite important. And we've talked about some of this, Ryan, but what's attractive about the underlying industry? What's attractive about small accounting firms, that sector? Yeah, just before I touch on that, the other thing here is reputation, right? Like if you have $100 million, you can go do the same thing as Kelly Partners. But if you're someone that's selling and it's an equal price and you've got employees there, you've got clients, you're probably going to go with the company that's done this a couple times, the company that's publicly listed because you kind of feel a better sense of safety or security that way. than the person that's doing it for the first time because Kelly's got the proof that they've

done this before and it hasn't hurt the businesses in the past. If anything, they've done better after being under the Kelly operating system. So it's not – these are small businesses. Someone spent their life building them. I think the last thing they want to do is just throw it away. Maybe if you pay a ridiculous price, they'll throw it away, but that's not really what they're looking for. As for the actual operating businesses, there's a couple of things that I like about the companies KPG acquires. So first of all, the industry is very durable. Tax law and therefore tax complexity tends to grow. Small and medium-sized businesses will always need this service. So there's not as much, we keep using that Amazon example where

there's these Amazon small businesses, those can disappear pretty quick. And they have, and they're very susceptible to changes to the platform, something like that. That's not the case for small and medium-sized accounting businesses. Second one, we already touched on it, great customer retention. If you've been around for a while, you've had the same accounting firm for 10 years, unless they absolutely price gouge you, you're probably going to stick around. um and i think people tend to do that not to mention we know some accountants we know companies that have accountants uh accounting businesses of this size when they have a customer relationship it's not just like some random customer they're important to them they probably get dinner

together they probably go out they probably you know they maybe they're family friends whatever it is these are actual relationships so there is high customer retention there as well third one is the organic growth um the operating businesses under kelly partners kelly partner groups umbrella grow organically and and part of that is kpg takes some of the responsibilities off the partner's hands so that allows them to go out and get a bigger book of clients um the other part is probably to some degree a little bit of pricing increases as well uh it's i mean they have averaged, I believe, roughly 5% organic growth from 2018 to 2024. So there's that benefit as well. You think about the kind of businesses, small businesses, if you were going out and

acquiring one, you'd feel like acquiring an accounting business would be pretty stable. Yeah, that's fair. Better than an individual restaurant or an individual seller of random goods online stuff like that and looking at or good it's also not capital intensive it's not like you're buying like a i don't know a consumer packaged goods company or something like that something in construction yeah or any sort of small manufacturer or something like that that might have a bit more capital investment need and if you look at that last part the organic growth i know constellation software is supposed you know it's supposed to be the best company ever invented and it might be, but the one knock on them, or not the one knock, but a knock people

have is that organic revenue. And it seems like given this model, there might be more durable organic revenue growth given, as we talked about, that customer retention figure, the durability of the industry, and probably the pricing power that you can implement every year. All right, let's look at KPG's financials as a whole. Someone's looking at this stock, hopefully, at our good friends at FinChat.io. What do the financials look like? What do the numbers look like? What's their growth been? And then obviously, as we get further and further to the end of this episode, we'll talk about valuation. Don't worry, listeners. All right, listeners, you know how much we use FinChat.io here. That's why we are excited to

announce that starting today, FinChat is offering 25% off any paid plans using our link. FinChat does not run sales like this very often. So if you want to get 25% off, you have to sign up before midnight on Monday, December 2nd. As a reminder, FinChat is a stock research platform that we use for all our financial data, whether it's generic metrics like revenue and earnings per share or more company-specific KPIs, FinChat's got it. We use FinChat every single day for our research, and we hope you will too. Again, if you've ever thought about signing up for FinChat, now is the time to do it. Using our link, thinchat.io slash chitchat, you can get 25% off any paid plans. The link will be in the description. Yeah, Kelly has grown quite quickly

since its IPO, which I believe was in, I actually don't remember the IPO date, but I think it was 2019. They were growing quickly before that as well, but the IPO gave them some cash and it also So it gave them that reputational advantage, which kind of allowed them to speed up their acquisitions. And it's not all acquired growth. I mentioned it earlier. 2018 to 2024, Kelly's operating businesses have averaged just under 5% organic revenue growth. So that part is quite nice. In terms of the profitability, if you look at GAAP earnings figures, it's going to be very misleading.

So they report on $108 million in last 12-month revenue, Australian dollars, I should say. I'll do some conversions to USD in the valuation work. But on $108 million in revenue over the last 12 months, they report just $3.5 million in net income. But there's an accounting treatment that does not make much sense here. So I'll try to explain it the best I can. So when Kelly acquires an operating business, that operating business has to estimate It's asset value. So it'll go through the tangible items like their computers, their chairs, whatever equipment they might have. Like if someone were buying our podcast, we'd have to say, what are all our assets worth? And we'd go through and we, all right, Mike's a hundred bucks, the lights, whatever. You go through the tangible stuff.

Then you'd have the intangible ones as well, which the biggest asset for an accounting firm by far is customer relationships, which is intangible. And they have to state the value of that upon acquisition. However, the accounting treatment for customer relationships is to amortize the value over 10 years. But we've already talked about it. If you've got a customer that you've been working with for five to 10 years, they're probably not going to leave. So you've got that – you've amortized the value at a 10-year basis, and it leads to – especially when Kelly has elevated the acquisitions quickly over the last few years, the amortization jumps really fast. But that's just not based in reality, and you can see that in the cash flow. The cash flow still comes to the company, but they're writing off these relationships slowly.

um so it just it leads to this big discrepancy especially in like heavy acquisition periods where net income is just extremely under representing the actual cash flow to the company so the metric that i think is more valuable here there's two really there's owner earnings which they go ahead and break out um and that is cash flow available to the parent entity its owner owner earnings is Cashflow to the group after taxes and finance costs, after taking into account working capital investments or changes and deductions for maintenance capex. So that's one measure as well. The other one that I like is what they call underlying net profit after tax before amortization.

So essentially what that's doing is it's taking the earnings of the businesses that are there, not the newly acquired ones, so it's excluding the acquisition growth, and then it's stripping out the amortization. The only concern here is there are one-time costs that they strip out, but they also strip out one-time benefits. So I think it's a useful metric to look at both owner earnings and underlying net profit after tax. Basically, they've got $7.8 million in owner earnings in Australian dollars, which would represent 11% net margins, but that's taking into account the acquisitions. So the underlying net profit after tax margins, you're looking more at like 24%, 23%, 24%. And it's actually been elevated lately because – sorry, it's been – I'm kind of rambling here. But the margins have contracted lately because they went through a period of elevated acquisitions, and it takes time for those acquired companies to hit the new profit margins under Kelly Partner Group's operations. So that part becomes – you should see margins start to inflect unless they continue to kind of elevate the acquisitions that they're doing year after year. and he actually said this, like in 2023, that was when margins really compressed quickly.

And he said, I understand the margin compression in that margin in this period. Sorry, it was a weird quote. I understand the margin compression in this period, but know that that won't continue. He was very forthright about that. And then the next year it did not continue. So he was right. The other thing I'll mention here. So you've got the 9% revenue fee that you pay Kelly Partners Group. They invest that into what they call their operating system or the fuel behind their business. They actually go ahead and in 2023, they added, so they collected, I'm looking at the numbers here, $8 million worth of that revenue fee. They added another two and a half million that they invested into that fuel or that operating system,

their central services team. That's come down this year. So that was another reason for part the margin contraction that you saw. Overall, I think you're probably looking at, they target 35% margins. I think they should be able to get to 30%. If you've got your businesses doing 33%, I don't see why you want to be able to do it yourself, assuming that you have more and more of a growing operating business as opposed to new acquisitions. yeah i think that all makes sense i could see the investors out there getting a bit concerned about these numbers maybe you know you look at some of the stuff and they're because look they're telling you what owner earnings are but if you look at the cash flow it looks good as well and in fact

the operating cash flow might look a little bit higher than what they're saying the owner earnings are so taking that to account it's not like they're pulling a number where they say look hey net income or whatever our ownerings are this high but we're just draining cash off of the balance sheet that's not occurring maybe one follow-up have they ever talked about given how they're at positive cash flow how would they ever self-finance without debt do they ever do some deals out here uh you know from all internal financing or have they never mentioned that i haven't seen any mention of it i think they like having the debt i think it's kind of a forcing mechanism to make these partners who have now become 49 owners in what has a business that

has debt it forces them to get a little more profitable a little quicker um and part of that is getting on the kelly operating system and getting kind of bought in there um so i think that kind of helps. They say they're generating 30% returns on invested capital. If they can continue to do that with debt, I think it allows them to kind of grow quicker, but maybe. If they had a big up list to the New York Stock Exchange, I assume it wouldn't be out of the question. Yeah. Yeah. I can understand that. All right. Let's talk about international expansion. They have really focused at first in Australia, their home market. I'm not sure if this guy is Australian, but I assume he is. This is really talking about the reinvestment runway, which

is incredibly important for a roll-up strategy. Again, we'll talk Constellation Software as an example. For perhaps the last five to seven years, everyone's been, not everyone, but there's been a lot of skepticism about how big the strategy can get. And they've proved that, well, they can get much bigger than perhaps anyone thought. And that led to some fantastic returns. So we're moving international, which is really just the United States and the United Kingdom. Why does this matter? What sort of runway does this give them to grow? Yeah. Like you said, most of the operating businesses that are still in Australia, but they have been acquiring in the UK and the US. Those are kind of the two big markets that they talk about. And they've made it clear that

they plan to push heavily into those. I've got a little chart here showing basically what they estimate as their TAM. They say accounting businesses, excluding the big four and mid-tiers that are just available in each market. There's 35,000 in Australia, 87,000 in the US, 40,000 in the UK. It looks like half of those have a partner that's planning to retire in less than five years, which is kind of interesting. It seems high, but maybe I guess they probably know the numbers better than me. But so far, the expansion has been really US heavy. They acquired a couple accounting firms in Los Angeles recently and just announced a greenfield business in Texas, which is basically

becoming Texas. They have built a partnership platform in Texas with a specific Texas management team who owns a minority of the business. So they're kind of setting up shop locally. And the thing that I like here that gives me a little more confidence about the international expansion is that it doesn't require parent company know-how. So if you're Kelly Partners group, you're acquiring the company that has the local know-how. So it's not like you have to get reacclimated to different tax laws or something like that. The acquired business is the one that's going to have that knowledge, whereas you just have to kind of set up the acquisition shop there. There is some upfront costs to entering new markets from what I understand. I can't remember

where I read this, but basically getting your business licenses for that area, maybe setting up a local team to operate there. Those are the costs to get set up. But once you're making recurring acquisitions in those markets, it becomes kind of less costly to do so. So tons of firms available for acquisition. It seems like they're successfully expanding, particularly into Los Angeles and I guess Texas as well. But I don't see why this playbook wouldn't work in those markets. It's not like you have questions around whether or not a product's going to resonate with consumers. It's just purely financial. So it seems pretty easy. Not easy, but straightforward. Right. And then every state's going to have

accounting needs and there's going to be accounting needs that are specific to that state. All right. We've talked Constellation Software and you are going to give a caveat here that it's not the exact same and it's not going to be a guaranteed 100-pegger, but looking for the characteristics of a high-quality business can help find some winning stocks. It's not about finding Constellation Software after it's gone up 200,000%. I have no idea how much the stock is up since its IPO, but it's about finding a company that can maybe do something similar over the next few years. That's how you actually make money. So with that being said, why do you think Kelly partners group can resemble a constellation software yeah and just to be clear we might

have some people that listen to the show that love constellation software so uh yes it is not constellation software the returns are not constellation software yet for anyone that doesn't know constellation software because i've mentioned it like a million times at the show they are a serial acquirer of vertical market software companies small vertical market software companies similar honestly to a playbook like similar to the kelly partners group playbook where it's like very programmatic acquisitions they kind of um cast a wide net uh and it's very volume based um and they have generated they're like a 250 bagger since ipo so it's been phenomenal returns why do i think it's can be similar or like what are the similarities

The first one, I've got basically five here, but the first one is thinking small as an advantage. So like Constellation Software, Kelly's acquisition strategy is very volume-based. They aren't competing with the giant capital allocators, the giant private equity companies, because buying one small accounting business in the UK isn't really going to move the needle for one of those big capital allocators. So it kind of gives – they're fishing in a bit of a different pond, which is nice. The second one here, there are tons of targets. So it's a very – in terms of their ideal business, they've got thousands and – I think probably hundreds of thousands between the UK, Australia, and the US. Here's a quote from Brett Kelly. He says, there's 28,000 firms that we are contacting consistently across the US, the UK, and Australia. There's 138 live leads. We are actively meeting with firms.

We expect that we can very materially grow the group over a virtually unlimited runway unless governments decide that they're disinterested in taxing people in the future. In other words, Sid's way of saying there are plenty of targets. That's not going to stop anytime soon. The third thing, and that is very similar to Constellation Software, the third one is taking this programmatic approach to acquisition. So KPG has gotten to the size now where they have set up a dedicated acquisitions team. it's no longer just brett kelly calling people and and shaking hands and signing the deals solely himself um they've got a team for it obviously constellation has probably tons of teams dedicated to finding uh acquisition targets and for those that don't know constellation they've got this

massive database of basically every vertical market software it seems like in north america maybe globally um and they frequently send them emails to those founders just waiting for them to be ready to sell and they'll get a few fish that bite and it's not necessarily this like we'll pay more than everyone else it's oh are you having a bad day let us buy your business from you uh achieve multiple and it seems like it ends up resulting in a lot of these acquisitions where it's not necessarily it's not that they don't care about the quality of the business i'm sure they do um but that isn't their primary focus the primary focus is can this be a durable business? Can we get it at a cheap price? That's pretty similar between KPG

and Constellation Software. Then the last, I guess, last two here, there's very little capital intensity in both cases, Constellation Software and Kelly Partners Group. When you look at the operating businesses, they're just not that capital intensive. You're selling software or in Kelly Partners Group, you're selling accounting services. It's not like you have to buy a lot of inventory in order to do that. So that's kind of nice. I would say in Kelly Partners Group's case, it's maybe a little more inbound demand as opposed to going out and spending a lot of money on marketing. If you're an accounting services business, you probably don't need to spend that much money on marketing. You're probably getting phone calls or knocks on the door

from local businesses. So that part's maybe a little nicer for Kelly. The last thing I'll mention is that they kelly brett kelly is like he's unapologetic about copying the best acquirers he like if you go through they have an owner's manual on their investor relations website and there will literally be quotes from mark leonard quotes from uh what's his name uh who's the lvmh founder why am i bernard arno yeah there'll be quotes from buffett and he's basically, he's kind of this avid reader who's tried to steal kind of the playbooks from some of these companies. And in one of the pages in his presentation, he takes this quote from Mark Leonard on measuring return on invested capital. And he really liked it. He thought it applied

well to Kelly Partners Group. And the quote from Mark Leonard is, if you add organic net revenue growth to ROIC, you get what we believe is a proxy for annual increase in shareholder value. In a capital intensive business, you couldn't just add organic revenue growth to ROIC because growing revenues would require incremental invested capital. In our businesses, we can nearly always grow revenues organically without incremental capital. It's very similar to Kelly Partners Group. So measuring ROIC, it's also kind of a nice similarity between the two businesses. So not identical. Constellation probably had a more unique model, especially at the time when they're rolling this out and they have maybe almost for sure a more refined process in terms

of acquiring these companies. But certainly some similarities in terms of the addressable market and the go-to market, if you will. Makes sense. And yeah, it is a good way to put it that it's a much more ideal business to be able to grow without having to spend a bunch on capital investments. And you can see why accounting services and software have both of those similarities or both of those positive characteristics. As we close out here and get through your valuation work and whether or not you're buying the stock, let's talk first about management. It's a very, very important, perhaps the number one thing in a roll-up. So what do you think about this team and how confident are you in them? This episode is brought to you by

our friends at Yellow Brick Investing. Yellow Brick is an aggregator of the best stock pitches across the internet. By tracking thousands of blogs, newsletters, fund letters, podcasts, and more, they collect and summarize the best stock pitches and bring them to you in a single place. If you're a regular listener, you know that we use Yellow Brick every single week here on the podcast to discover new investments or just find reports on companies we've already heard of. Try it for yourself. Simply go to joinyellowbrick.com slash chitchat and search a company or ticker you are interested in. You are bound to find a great report on just about any company. That's joinyellowbrick.com slash chitchat. Heads up folks, interest rates are

falling, but you can still lock in a 6% or higher yield with a diversified portfolio of high yield and investment grade corporate bonds on public.com. You might want to act fast because your yield isn't locked in until the time of purchase. Lock in a 6% or higher yield with a bond account only at public.com forward slash chitchat stocks. Yeah. I didn't look at too much of the rest of the team. I listened to a lot of interviews with Brett Kelly and read through a lot of the investor letters, and he seems to be the spokesperson for this company by far. He's quite the character. some people might think he's a little full of himself

that's probably fair like when they acquire companies he sends the acquired company his books which is kind of like I don't know seems like something a little for yourself to do but they're business books like they're geared toward I think it's called conventional wisdom

is one of his books it's like you're learning from a lot of great individuals and I don't know it's more self help I think, yeah, if you want the culture of your business to be cohesive, maybe that makes sense. I don't know if it's self-fulfilling or how much that applies to actually running the accounting businesses, but I could see how that makes sense. I don't know if that's a red flag at all. yeah i mean a lot of it he kind of toes the line of is that is he being full of himself or is he just being ambitious and he's got a chip on his shoulder i i tend to think it's he's got the chip on his shoulder and he dreams big um he does like to think big he likes to say you know i want to be the berkshire of a county and i want to model myself after lvmh all this stuff so he certainly

has big ambitions i also think he has a good grasp on what drives shareholder value and having a background in investment banking accounting mergers and acquisitions and going out and buying and valuing small businesses which he did for a long time it kind of builds that muscle um if you will so i like how he got kicked out or not kicked out he was he didn't fit in with the big consulting and accounting firms which we kind of think kind of lead to group think sometimes but yeah that actually might be a positive yeah i i would not be surprised he talks about the book the outsiders all the time i would not he he has maybe tried to model himself like this but he cares about the same things and he has sort of the same approach

and he's not this consultant turned ceo mercenary who's in there for a paycheck he owns 48 of the shares outstanding. No new shares have been issued since the IPO. They have no executive options. It's cash-based performance bonuses. He is as aligned as you could be. And his care for shareholders is very clear. Yeah, I think so. And we're getting your notes here. Did you have something on incentives or did you just mention that? I just mentioned it. I honestly did not go through the proxy here because you can look at it and you can see it's 48%. You can see it's cash-based bonuses. The share count is literally flat over the last three and a half years to the share. That's copycat constellation. That's pure copycat.

And they actually, right after their IPO, I think they bought back some stock. So they're not afraid to buy back if it's the right time. They actually just cut the dividend as well because they think they have a lot of targets they can go after. So they had a dividend, pulled back on it. They see a whole bunch of acquisition targets, especially in the US.

It kind of coincided with their US launch, which I tend to like. I think they're in growth mode and Brett Kelly sees a lot of opportunity to deploy capital. All right, let's wrap things up here. Valuation. How are you valuing this stock?

And what do you think are reasonable estimates financially for the next few years? Yeah, it's a little tough. First of all, I think it's tough to value serial acquirers to begin with because so much of growth might – you never know what growth is going to come from organic versus acquired. So it becomes a little difficult and the math is a little messy. But Kelly has a $258 million market cap in U.S. dollars. As I mentioned earlier, though, they do use debt to acquire companies. So the enterprise value is probably the more important metric here. They have $26 million in net debt, which keep in mind, I mean, it's actually a relatively small amount.

Their net debt to EBITDA ratio is like I think around one, so it's very manageable. 80% of that debt is in the operating businesses so they have like a tiny amount at the actual company level but theoretically the liability is limited potentially to the operating companies anyways the EV comes out to 286 million USD over the last 12 months the stock is up 102% so and earnings have not doubled in that time so the stock has gotten more expensive if you're looking at this relative to last year. But to run the numbers quickly, I'm going to use the underlying and net profit after tax before amortization figure, because I do think the amortization accounting treatment doesn't really make any sense. And I'm fine with looking at the

pre-acquisition profits as well, because I think they're going to deploy. I think it's money well spent when they put money towards the acquisition. And it's a useful metric just to see how much you're earning from the operating businesses before the acquisition spend. So, and keep in mind, it's an adjusted number. I hate adjusted numbers as much as the next guy, but it's rare that the adjusted numbers are going to be lower than your actual operating cash flow. So in this case, the proof is in the cash flow, at least, where you know it's not like it's totally misleading and they're just backing out all costs.

That's not the case. Anyway, so for 2024, Kelly Partners Group had 16.2 million USD earnings in underlying net profit after tax before amortization. Using that figure, the stock trades at 17 times. I think those margins will expand a bit over time for the reasons I mentioned earlier, less excess spending on the central services team and new acquisitions maturing. But just to run some quick numbers, here's kind of my estimates. 15% annual revenue growth. Like I said, revenue growth can be, who knows? If you're getting 5% organic, you have no idea what the total revenue growth is going

to look like because you don't know how many acquisitions they're going to make. But I'm calling 15% annual revenue growth until 2030. I think their current CAGR has been like 30%. And they're still very small, still tons of acquisition candidates. I would not be surprised if revenue grew much faster than that. Anyways, I digress. Underlying NPATA margins at 30% in 2030, 15 times multiple, so a little bit of compression, steady share count, debt to EBITDA metrics stay consistent. If that happens, you're looking at about $75 million in underlying net profits after taxes, but before amortization, and a market cap of just over $1.1 billion.

Today, it stands at $400 million. Aussie. I may have messed up the conversion there a little bit, actually. Anyways, it's a triple or more if those numbers come to fruition. That's over six years. I think that'd be a great result. Seems achievable. it's not crazy cheap though it's not like you're marrying great results here with like an insanely

cheap valuation no one's discovered this part of that is brett kelly's been out on podcasts telling the story big and micro cap club it's i mean there's investors have caught on to the story a lot lately they recently uplisted to i think otc markets so um or maybe some other exchange it's more investors have caught on the stocks doubled in last year it's a little more expensive. After this six-year period, what do you think the reasonable runway for reinvestment would be? Because I know listeners are, you know, I've seen the numbers, but would there still be plenty of accounting firms to go after, after the six-year period, or is there any sort of saturation fear if you were underwriting constellation software 10 years ago you

would have thought how many more of these can exist i think if they really iron out that playbook it's not like they're gobbling these up and destroying these businesses like they're still the businesses are still running independently and generating a lot of profits i don't see why it would mature in 2030. That probably means 10 to 20 acquisitions a year, maybe a little higher as you get out towards 2030. There's 100,000 of these potential targets out there. I think they're a long, long ways from saturation. All right, beautiful. Last question. Are you buying the stock and what risks are you watching out for? Yeah, I think so.

I haven't bought anything yet, but I think I'm going to take a starter position. The bummer here is that this will force me to finally get that Interactive Brokers account because I think I'm going to buy it in Australian listed because they have not uplisted to the New York Stock Exchange yet. And I don't really want to buy their illiquid US security, so I'm going to have to buy it in Aussie. But yeah, in terms of the business, I like it. I like the operating businesses.

But the management and the ownership and the incentives, it checks a lot of boxes for me. And then I am a little wary on the valuation, but really what I'm waiting for is to see whether or not this blueprint can continue. The biggest question I have is, do the operating businesses, do the accountants, the partners that are running the operating businesses feel the same way about Kelly Partners that the people at Kelly Partners do or how they portray it? Does the central services team really make them that much more efficient? If they can have margins start to expand because they have been in this elevated acquisition period and so far they have a little bit. But if the margins don't expand, it's a bit of a thesis buster, assuming that they're not growing their acquisition pipeline really quickly. If margins can expand and they're able to start acquiring 10, 15, 20 businesses a year, that's going to give me a lot of belief that this playbook can really work. The risk I'm looking for is A, the margins.

So if margins are still low or contracting, and they're not acquiring a ton of new businesses, that tells me that there's something wrong with my thesis. And then they show that metric of how much they invested on top of the 9% revenue fee that they got. But if that continues to grow as well, that tells me that they're maybe being a little loose with how much they spend on the central services team. I don't know. It just becomes like maybe not as capital efficient as I thought this company was. I could sneakily turn into some – they might not call it invested capital, but it might in reality be some invested capital that you got to put into it. I think one you're probably thinking of but just didn't mention is the ability to grow the number of acquisitions per year because it's much easier to acquire a couple of businesses per year and they have done that but continually scaling that until they get to kind of a steady state figure

you just don't know if they can do it until they do but that's that's what comes with buying this instead of constellation software you have a higher risk but potentially higher reward I think this one for me as we close things out here and then i'll let ryan give his final takes it's definitely going on the watch list it has a lot of the characteristics that we look for which is reasonable valuation management team you can trust now i'd have to verify that myself and kind of listen to him and then a competitive advantage which i know these ones are unique but you can kind of see that forming yeah and i you know i don't know if it's a red flag or if it's a positive but at the end of his owner's manual that they put out on their investor

relations website he talks about what it takes to become a hundred bagger like a hundred bagger stock and he mentions the chris mayer book and he talks about like the formula that's listed in that book and and what the average company has done to get there and he talks about how they're trying to get there sometimes yeah yeah if this were a company where like i need him to be the best operator possible maybe i'd be a little worried but if he's a serial acquirer and he's valuing businesses himself on a regular basis i guess i don't care that he's that that he seems to have this passion for the investment community. Yeah. I can see the one concern is just he wants to be Mark Leonard so badly. He wants to be a hunter beggar that if it starts not working out,

you could see this being a situation where they, I'm not saying they are, but it would be a situation where they get a little fuzzy with the numbers just to make things look better if they're going poorly because they have this reputation. He wants to be charismatic. He really wants to be like this so that'd be the one concern but so far seems like the numbers are are holding up yeah great i think that's it that's pretty much everything i've got it's going to go in the uh our it'll go on our sub stack as always there's a lot of charts in here and i've i mentioned a couple resources at the end as well that you can check out but uh it seems a bit like a gem for all the small caps that we've looked at and we do the small cap of

the week, all the time. There's so many companies that have just a ton of hair on them, and there are usually some concerns, but this seems to check a lot of the boxes. Yeah, it looks better than 95% of the small caps that we look at on the Power Hour, but you can't invest in every stock, and you got to find the ones that look attractive to you. I will say, if you've made it this far in the episode, I would definitely consider subscribing to the Substack because we have started using their chat function for all the free subscribers. We just have a free newsletter. So if you want to use that we basically have a it's similar to say a twitter thread i'll post a

question in there like hey what do you think of the episode hey what do you think of kelly's partners group or toss a few charts in there and we have some much healthier discussions without the spam bots and all the stuff that's making twitter much much worse so if you want to go there instead you're going to spend a lot more time there and i'm glad because we already have some people contributing to that uh discussion board but we're going too long here let me hit disclosure, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guests may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you,

everyone, for tuning in. Make sure to check out that newsletter as always, and we'll see you next time. Thank you.