On the Road: VitalHub

 

Just under three years ago, we initiated a small position in VitalHub (VHI), a Toronto-based firm that acquires software companies in the healthcare sector. Since 2016, management had been quietly toiling away in obscurity, building the company’s revenue base and acquisition expertise under the watchful eye of a shareholder-oriented board.

VitalHub was small when Pembroke first initiated a position, but it was growing and highly profitable. Its small size meant that most investors passed it over despite its strong financial metrics.

Pembroke’s Newest Software Consolidator

VitalHub’s management has an impressive track record of acquiring companies with “sticky” revenue and strong customer relationships. VHI buys these smaller firms at attractive prices and increases their margins and free cash flow.

How is management able to secure deals at reasonable prices? They look where many others do not: for niche technologies that serve hospitals and other providers in countries with large public health systems.

The company has established a foothold in Canada, the United Kingdom and Australia. Its products include health record management, patient scheduling, clinic portals and accreditation portals. By bringing all of these products under one roof, VitalHub is providing its sales team with a deeper suite of products. Over the past several years, this has allowed VHI to complement acquired growth with healthy organic growth.

A Quick Word on Serial Acquirers

Some of Canada’s most successful public companies have been active and systematic acquirers of other companies, particularly in the information technology sector. Constellation Software (and its spin-offs Lumine and Topicus), CGI, as well as Descartes Systems Group, all have enviable track records of using their free cash flow to consolidate competitors under one roof.

Their success is characterized by discipline in what they are willing to pay for targets, a commitment to profitable growth, and deep management teams with industry expertise and merger and acquisition acumen.

In addition, these companies tend to make acquisitions and grow at their natural speed. That is, they use the free cash flow generated by their existing businesses to make deals. While some have tapped the equity markets opportunistically and early in their life cycles, they in general have grown to a size and scale where they can achieve their acquisition goals without diluting shareholders.

Their stable and self-financing business models allow them to make acquisitions throughout the economic cycle, especially when targets are struggling or competing acquirers lack access to capital. As free cash flow per share has grown over time, shareholders of these successful consolidators have been rewarded.

VitalHub, an Outlier

However, if we look at the organic growth of the serial acquirers just mentioned, VitalHub is clearly an outlier.

Over the past five years, Constellation Software and CGI have grown organically at 1 to 4%, while Descartes has grown at 4 to 9%. VitalHub, on the other hand, has grown organically by more than 15% per year over the same period. We attribute this success to the company’s ability to identify proven products and cross-sell them to its customer base.

The business is not cool, but it is predictable and highly profitable. What more could shareholders want?

On the Road to Learn More

We recently had the opportunity to visit with the management team in Toronto. The Pembroke team spent some time discussing the company’s long-term inorganic and organic opportunities, as well as the CEO and CFO’s vision for the future.

As an investment team, we try to evaluate what a company might look like when it “grows up.” In the case of VitalHub, it is clear that this company has the potential to grow into something much larger in the coming years. The end market is large, and there are many potential targets across multiple geographies for VHI to consolidate (over 150 currently identified). Furthermore, the company has the balance sheet to execute its plans.

Pembroke carefully monitors the pace of acquisitions and the prices management is paying. We are constantly urging them to move forward at a deliberate pace and with continued discipline. Pembroke also follows the integration of acquired businesses by reviewing VitalHub’s progress on the bottom line, as we do not want the company to sacrifice earnings growth for revenue growth.

Over the past five years, revenue growth has exceeded 25% annually and EBITDA margins (Earnings Before Interest, Taxes, Depreciation and Amortization) have remained above 25%. So far, management has also demonstrated the patience and operational skills that Pembroke values.

VitalHub is not as small or unknown as it was three years ago. Nor is it as cheap as it was. Investors have flocked to the stock in recent years, reassessing the company’s prospects to better reflect its historical performance and future opportunities.

This Could Be the Beginning

The Pembroke investment team remains optimistic, but knows that the pressure on VitalHub to execute is higher than in the past. Of course, it is too early to call VitalHub the next Constellation Software or even the next Descartes. The company has a long way to go before it joins the Hall of Fame.

However, management is on the right track. VHI has the capital, the expertise, and the business opportunity to create significant wealth for shareholders. As always, it will not be a straight line, but patient shareholders should enjoy watching this story unfold over the next decade.

 

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