Betting on change

In the first of two articles, Richard celebrates perhaps the sweetest investment of them all: The humdrum business that incubates a better one.

Though my stock-in-trade is businesses reliably executing established and successful strategies, my biggest winners have often been businesses that pivoted.

They incubated better businesses from within the business they already operated. In time the better business replaced the one that spawned it and now they are reliably executing successful strategies.

The joy of buying these companies as they pivot is that traders are often disillusioned with them, because the performance of the new business is obscured by the lesser performance of the legacy one.

Lack of interest leads to undervaluation, giving far-sighted investors an opportunity to buy shares cheaply.

Unlike a straightforward turnaround, which can realise its potential in a year or two, a successful pivot may pay off for decades.

Owning companies as they transition can be testing though, because changing a business is risky and a successful outcome is unlikely to be obvious to outside investors.

In this article I hope to revisit a few successful pivots to identify characteristics that may help us identify future successes.

Pivot #1 – Tristel

Runner up in my list of successful pivots is Tristel, which for most of its history had made disinfectant for medical instrument washing machines but in 2013 found itself without a market when machine manufacturers began to market their own disinfectants heavily.

When Tristel’s biggest customer, the NHS, recommended hospitals use manufacturers’ disinfectants, demand for Tristel washing machine disinfectant evaporated.

Tristel had seen this coming. The new washing machine disinfectants were more dangerous for humans to use than its unique chlorine-dioxide chemistry but it did not matter because the noxious chemicals were being used in machines.

Machines, though, are expensive, and Tristel had for many years been working on products that could be applied safely by hand as long as the equipment being cleaned was simple, like endoscopes used in outpatient departments, and the correct procedure was followed, which Tristel ensured by providing an audit system.

Tristel’s wipes and foams did not require the instruments to be taken away and cleaned, and the hospital did not have to find the money for a washing machine.

While the machine manufacturers had found a way to dispense with Tristel, Tristel had found a way to dispense with the machines (in some circumstances).

Sales of Tristel’s new products had been growing for years, but not yet sufficiently to offset the catastrophic decline of washing machine disinfectant sales, which presented investors who could see growing sales of wipes and foams as an opportunity to corner a new market:

The ‘b’ shows when I added shares in Tristel to the Share Sleuth model portfolio I manage for Interactive Investor with the help of SharePad (and previously ShareScope). The chart also shows the two times I reduced the portfolio’s holding in Tristel, marked with an ‘s’. The remaining shareholding is worth many times the original holding.

Today, in the UK, Tristel is the dominant supplier of disinfectant to some hospital departments including, for example, Ear Nose and Throat (ENT), and although it appears to have achieved much of its potential at home, it is growing rapidly overseas.

Pivot #2 – Jet2

My favourite pivot, not just because it was very profitable but also because I admire the company’s management so much, is Jet2, an airline which as Channel Express originally flew flowers from the Channel Islands and carried the post.

In 2002 the company launched Jet2, a leisure airline connecting holidaymakers in the north of England with the Mediterranean and in 2006 it took its first package holiday customers away.

By selling online and by phone, focusing on families, and expanding gradually outwards from underserved northern airports, Jet2 stole a march on other leisure airlines and package tour operators. By owning the planes, and the slots at the airports, it had much more control over the customer’s experience than online travel agents.

Although the Great Financial Crisis, a volcanic ash cloud, and the pandemic have intervened, Jet2 has been a great investment:

The ‘b’ shows when I added shares in Jet2 to the model Share Sleuth portfolio. The chart also shows the two times I reduced the portfolio’s holding in Jet2, marked with an ‘s’. Nevertheless the remaining shareholding is worth many times the original holding.

Today, Jet 2 is the UK’s leading package tour operator to the Mediterranean, and it no longer ferries flowers.

Pivots #3, #4 and #5

Some other examples of companies that pivoted are XP Power, Treatt and 4Imprint.

XP Power was a distributor of industrial power supplies that transformed itself into a designer and then manufacturer.

Treatt still is a supplier of commodity citrus oils, but it has become the inventor of a wide variety of flavours from natural sources, from tea to ingredients that improve the taste of drinks incorporating sweeteners.

4Imprint was a distributor of promotional goods, trinkets like T-shirts, key rings, and mugs, branded with a company’s logo.

Instead of stocking promotional goods, it incubated a business that became the glue between manufacturers, distributors and organisations with a brand or message to push. It has grown into North America’s biggest direct marketer of promotional goods.

Arguably all of these businesses are still good investments today, but what interests us is the common factors that might give us clues about companies pivoting now.

Characteristics of a successful pivot

Finding commonalities is, perhaps, a fool’s errand. These companies are special because their pivots made them more unique, giving them advantages over competitors. However, I think they do share some characteristics.

The first is that none of these companies were basket cases. These pivots did not happen because a new chief executive was parachuted in to rescue the business.

The pivots were nurtured for years or decades. In the case of Tristel and Jet2, the chief executives who masterminded the changes are still running the businesses today. XP Power’s chief executive has only just retired (its founder and chairman still serves). At 4Imprint and Treatt the person responsible for the new business ultimately became and currently serves as chief executive of the whole company.

None of these companies acquired their new capabilities by buying other businesses. They built on strengths and opportunities they had identified in their existing businesses.

Another coincidence is that, with the exception of 4Imprint, all of the companies were vertically integrated and became more so.

Tristel is a manufacturer and once it is established in a new territory it often seeks to control distribution (for example by acquiring local distributors).

Jet2, flies passengers who typically buy tickets direct and fly on its own planes from its own slots on holidays it has packaged.

XP Power sells predominantly through its own engineer salesforce, the largest in the business, which it developed as a distributor.

Treatt, originally a processor, is just about to open its new headquarters with laboratories that will make it possible to collaborate much more effectively with customers, big name beverage brands.

Even 4Imprint, which leaves production and distribution to its suppliers, owns the customer relationship.

It seems likely to me that creating a unique business takes a long time and consistent management. It also follows that if the business is unique (in a good way), it will have to take on many of the activities required to bring the new product or service to market itself.

In my next article I will examine a few businesses that appear to be pivoting now, and share some of these characteristics.

That does not mean they will be successful. My sample of successes is small and I have omitted at least one business I thought would pivot but I gave up on, perhaps wrongly.

However, it only takes one or two of these businesses to succeed to make a portfolio sing. I think they are worth the effort.

Richard Beddard

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Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard

Have you invested in a business that’s pivoted to a more successful one? We’d love to hear from you in the comments section below!