SUMMARY
Judges Scientific (JDG.LON) stands out as a unique player of consolidating scientific instruments market. With its extensive acquisitive history over the past 10 years and combined expertise of highly experienced management teams at both the parent and subsidiaries, the long-term growth outlook for the company appears intact despite the sluggish performance over the recent short-term.
KEY INVESTMENT POINTS
■ Positive long-term growth outlook with well diversified business portfolio:
The management of Judges Scientific (JDG.LON) identifies scientific instruments as a sector where the UK could be a global centre backed by many world-leading educational and research institutions. While the scientific instruments market includes various products across the industry, it is largely propelled by 1) government/public spending on higher education, 2) the need for the private sector to comply with regulation and 3) pursuit of optimisation. Hence, Judges benefits from such relatively stable long-term outlook of the industry while operating in various fields that ranges from chemicals to engineering. The scientific instrument market remains highly fragmented with over 2000 privately held companies in the UK, and provides a large pool of business expansion opportunities for Judges. The company currently has 12 business units with c.85% of group revenue generated from overseas and boasts a well-diversified customer base with no single customer comprising more than 10% of the group revenue.
■ Highly skilled management team with clear strategy and principle:
The core strategy of Judges Scientific (JDG.LON) is “Buy and build”, which differentiates the company’s acquisition model from those of usual private equity firms. More importantly, Judges management is known for being a good acquirer with the execution of a fast and effective acquisition process while treating vendors and staff with respect. We believe the success of deals as well as post-acquisition management of subsidiaries are significantly attributable to such strong reputation of the management team.
When it comes to a new acquisition, Judges has the followings as key principles: 1) focus on global niche market leader with solid profitability; 2) the business generates sustainable cash flows; 3) pay 3-6x EBIT according to size; 4) make sure that, post deal, there is a strong management team, preferably with extensive experience with the firm.
■ Strong focus on shareholder value creation with cash management:
Judges has increased its dividend by at least 10% p.a. over the past 11 years. While the management does not have a specific target payout ratio, increasing dividend and enhancing shareholder return comes in a priority along with debt repayment and investment. Under prudent cash management, the management expects to increase dividends continuously as long as the business scales up. It is also worth noting that the management team owns a collective 19% of equity including the CEO holding of 15%. The group managed net debt to EBITDA well below 1x with net debt to equity ratio below 20% except last year, when debt level was heightened upon a series of new acquisitions.
INDUSTRY OVERVIEW
Background & Outlook
The scientific instrument market benefits from long-term growth drivers such as expanding higher education and continued needs for improved measurement and optimisation across science and industry. While the long-term demand fundamentals remain solid, short-term cyclicality can stem from government or public sector spending, business climate, and relatively long period for product development or commercialisation. The past three to four years have seen uneven demand and led to slower than expected order intake trends across the sector.
Competitive landscape
The M&A market for scientific instruments is very fragmented with over 2000 privately held companies in the UK. The industry peers that participate in similar business areas to Judges or hold alike acquisition strategy include Halma (HLMA), Oxford Instruments (OXIG), Spectris (SXS), Thermo Fisher Scientific (TMO), Danaher (DHR). However, Judges mainly focuses on niche markets with small-sized firms that have established or potential market leadership as an acquisition target. Hence, the company faces little competition not only in purchasing new businesses, but also in each subsidiary’s operating environment. Judges has no history of losing a small deal in a bidding competition thanks to its unique positioning
COMPANY OVERVIEW
Business Description
Judges Scientific plc is AIM listed company that specialises in [or in support of] the design and manufacture of scientific instruments. With the founder & CEO, David Cicurel, being a corporate turnaround specialist and veteran dealmaker, the company pursues business expansion both through acquisition and development of a scientific instrument business portfolio and organic growth within its subsidiaries.
The company has a widely diversified business portfolio and most of subsidiaries are exporters generating c.85% of revenue overseas. As a group, North America and Europe (excluding UK) comprised 27% and 24% of total revenue respectively for FY2016.
Judges’ 12 business units are grouped under two segments: Materials and Vacuum.
1) Materials – 49% of group revenue, 61% of Adjusted operating profit contribution
Subsidiaries include: Armfield, GDS Instruments, Fire Testing Technology, Dia-Stron, Sircal, PE fiberoptics.
2) Vacuum – 51% of group revenue, 39% of Adjusted operating profit contribution
Subsidiaries include: Scientifica, Quorum Technologies, UHV Design, Deben, CoolLED, EWB Solutions.
Subsidiaries
Armfield was acquired in 2015. The business designs and sells engineering equipment and research instruments for universities and technical colleges through its worldwide agents network. The field of study includes chemical, mechanical, environmental and civil engineering and food technology.
Fire Testing Technology manufactures, designs and service fire testing equipment's that measure the reaction of various materials to fire. The business was the first purchase of Judges in 2005.
GDS, acquired in 2012, designs develops and manufactures equipment and software used for the computer-controlled testing of soils and rocks. This technology is used to evaluate the mechanical properties that are key in geotechnical and earthquake engineering design.
Dia-Stron, purchased in April 2016, is a leading specialist in the supply of test instruments and automation for small fibre and sheet materials. The business has a strong market position especially in human hair testing and mainly sells to large personal care companies.
PE fiberoptics is a leader in the manufacture of test equipment for characterisation of optical fibers used by major fiber manufacturers across the globe where the business is driven by the growth of internet. Judges has been holding 51% of the business since 2005. Sircal designs, manufactures and distributes rare gas purifiers typically for use in metal analysis utilising the Arc/Spark spectrometry technique. The business was purchased in 2010.
Scientifica, added to the group in 2013, offers micropositioning equipment, microscopes and advanced imaging systems used in electrophysiology and neuroscience supplying to universities and research centers.
UHV Design, purchased in 2006, specialises in the design, manufacture and supply of high precision sample heating and manipulation products for use in the high and ultra-high vacuum markets for materials research.
Quorum Technologies, bought in 2009, manufactures scientific instruments primarily used for electron microscopy sample preparation driven by education and life sciences growth.
Deben is a precision engineering company which specialises in the field of tensile testing, motion control and specimen cooling for microscopy applications. 51% of the business was purchased by Judges in 2011.
CoolLED, purchased in February 2016, designs and manufactures cutting edge LED illumination systems for researchers and clinicians, particularly in the life sciences sector.
EWB Solutions was added to the group in November 2016 and manufactures bespoke edge-welded bellows used in Ultra High Vacuum systems and other scientific, medical and defence applications.
Key Competitive Advantage
While Judges Scientific remains small with little economy of scale effect, we find the company’s key strength lies in its unique market positioning and a clear business strategy. By focusing on small/micro-sized firms, Judges can stay away from unnecessary bidding competition when it acquires new business. More importantly, the highly reputable management team are known as a “good acquirer” which attracts vendors and facilitates the deal process.
As for managing and growing 12 different business units, the company does not seek synergies or integration. Instead, the acquired companies’ management largely remains independent in its operation as the group fully respects the existing management team while providing support and advice. Judges focuses on implementing financial controls and cash management, i.e. repaying debt and reinvesting in further acquisitions, post acquisition, which leads to improved shareholder return.
Management team background
Alexander Hambro, Chairman – Alex Hambro (born 1962) is an independent consultant for a number of private equity and venture capital fund management groups and family office investors advising his clients on the establishment of alternative investment funds and investment strategies. Alex has been in the private equity industry for 21 years during which time he has acted as a principal investor, manager and sponsor of private equity and venture capital management teams. Alex managed the venture capital and private equity fund investment portfolio for Hambros plc, prior to its sale to Société Générale in 1998.
David Cicurel, Founder/ Chief Executive Officer – David Cicurel (born 1949) founded Judges in 2002 having spent much of his career as a turnaround specialist and, subsequently, as an ‘active value’ investor operating with his own funds. He has been responsible for several corporate recovery exercises including two UK public companies, International Media Communications plc (later known as Continental Foods) and International Communication and Data plc.
David Barnbrook, Chief Operating Officer – David Barnbrook (born 1952) is a Chartered Engineer with more than 20 years’ experience as a Senior Manager and Director in sectors encompassing defence, instrumentation, aerospace and customer service. He is a former Program Director at EDO MBM Rugged Systems and Operations Manager at Muirhead Vactric Motion Controls, both of which are suppliers to the defence and aviation industries.
Brad Ormsby, Finance Director – Brad Ormsby (born 1976) is a Chartered Accountant who has significant senior finance and operational experience acquired during nine years at PwC followed by six years at Eurovestech plc, the pan-European development capital fund, and associated companies. Prior to joining Judges Scientific, Brad was Chief Financial Officer at Kalibrate Technologies plc, where he was actively involved in the company’s successful IPO.
Recent Earnings review
Total revenues grew 2% to £57.3m in FY2016 with organic growth of 2.5%. Some solid performances at existing subsidiaries along with healthy contribution from new acquisitions only partially offset weak performance at Armfield and two existing Vacuum businesses. The Material segment revenue was flattish Y/Y largely due to Armfield performance falling short of expectation. The Vacuum revenues increased 4.5% thanks to new acquisitions, but the margin dropped. The group adjusted operating margin declined to 12.5% from 16.5% in 2015 upon production issues at one of its subsidiaries. Accordingly, the annual ROTIC fell to 15.2% in 2016 compared to 24.1% at the end of 2015.
2017 and long-term outlook
While the organic order intake was sluggish in the first quarter of 2016 similar to the past two years mainly due to weak demand, it rebounded in the 2H 2016 and has remained healthy through the first quarter of 2017. The management expects to resolve the production issue that occurred last year but is uncertain on the speed of such progress. However, this should eventually contribute to profitability improvement. In addition, the weakness in GBP upon the Brexit vote provides a favorable operating environment for the company which, as an exporter, is influenced by EUR and USD.
The management’s long-term financial target stands at 25% of adjusted operating margin (before central costs), as it focuses on improving organic earnings growth as well as acquiring new businesses. While there is more upside for topline growth rates depending on the scale of further acquisitions, we forecast near-term revenue growth at 7% and adjusted operating margin to recover to 17% level into 2020.
VALUATION
Compared to the past trends, Judges Scientific shares are currently trading in line with its 3-year/5-year historical average multiples: P/E 15x, P/S 1.5x, EV/EBITDA 10x. Despite continued business expansion via new acquisitions, valuation multiples have contracted after peaking in early 2014 as both topline growth and margin have declined driven by poorer performance of subsidiaries. While such multiple contraction over the recent years can be well justified by slowed market demands, Judges shares have outperformed its industry peers during the past 5-10 years largely attributable to its niche market positioning, in our view.
Considering the rather long-term business/product cycle of Judges, it is unlikely to see meaningful multiple expansion in the near term. However, should the operating environment remain stable, we see little downside from current share price level. On the absolute bases, a DCF and a DDM derived fair values imply some upside from current price: the DCF method based on stabilising growth outlook (e.g. 10year sales CAGR 7%, Gross cash flow CAGR 9%, perpetual growth rate 2%) with 7.0% WACC arrives at £18.81 and the DDM leads to £16.37 with dividend growth rate of 10% for the next 5 years and 7% for perpetuity.
Risks
Upside risks: Given the slowed market expectation especially after lacklustre 2016 earnings results, any subsidiary operational improvement should be key positives to the stock performance. We see the following as upside catalysts: 1) better than expected performance of subsidiaries upon strong order intake; 2) new acquisitions that can enhance the existing portfolio; 3) favorable currency environment with weak GBP.
Downside risks: Major downside risk lies in: 1) acquired company does not meet its expected profitability; 2) global economic and trade uncertainty upon Brexit; 3) threat of new technologies making existing products of Judges Scientific obsolete; 4) unfavourable currency exchange rates (c. 50% of revenue in the USD zone and c.33% of revenue in the EUR zone).