Qi3 Insight: Intriguing Instrumentation · Qi3 Insight: Intriguing Instrumentation With UK sales in 2010/11 of £7.5bn and world sales of £50bn; instrumentation is a relatively small

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Qi3 Insight: Intriguing Instrumentation

Qi3 Insight: Intriguing InstrumentationSome lessons from an industry that has

outperformed during the recent recession

Report prepared by: Mark Littlewood, Deepa Wallis, Robin Higgons & James Wheatley Qi3 Ltd St John’s Innovation Centre Cowley Road Cambridge CB4 0WS United Kingdom

Tel: +44 (0)1223 422404 Email: [email protected] Web: www.qi3.co.uk

© Qi3, November 2011 Qi3 Limited registered in England & Wales no. 4863154.

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Contents1.

1 Contents ............................................................................................................................................................................12 Executive Summary ........................................................................................................................................................23 Overview of the Instrumentation Sector ......................................................................................................................34 Introduction to Qi3 ..........................................................................................................................................................45 Global Impact of the Recession ....................................................................................................................................56 Drivers for Recovery and Growth ..................................................................................................................................6

6.1 Dynamics of Organic Growth ...............................................................................................................................6 Post-recession Trends .....................................................................................................................................6 Geographic Diversification .............................................................................................................................6 New Product Development ............................................................................................................................76.2 Acquisition Strategies ...........................................................................................................................................8 Acquisition for Product Diversification .........................................................................................................8 Acquisition for Geographic Diversification ..................................................................................................8 Acquisition for Recovery .................................................................................................................................8 Acquisition for Conglomerate Growth ..........................................................................................................9

7 Putting Success into Context .......................................................................................................................................108 Comparison with the US Giants ..................................................................................................................................119 Conclusions ....................................................................................................................................................................12

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Executive Summary2.

The turbulent economic times precipitated by the 2007/8 ‘credit crunch’ are still unresolved. In the UK, manufacturing output dipped sharply and then recovered to a growth rate above that of the economy as a whole. But at the time of writing, UK manufacturing output has stalled, and it is unclear whether we shall return to a period of modest growth or prolonged, ‘L-shape’ recession.

But the instrumentation industry has bucked the trend of manufacturing as a whole. Qi3’s recent analysis of 15 of the larger UK quoted instrumentation companies has shown outperformance in sales, profits and share prices. The combined sales of these companies in 2010 was £5.6bn, with £250m (5%) being invested in R&D. After deleveraging their balance sheets, the companies have combined cash reserves of over £800m which they are now using to fund acquisitions and further develop their global presence.

These businesses followed a pattern through the last four years. Firstly they reacted speedily to the downturn, by cutting costs, reducing debt, stalling acquisition activity and improving operating performance. Second they focused on organic growth, new product development and exports – particularly to China and other markets which are expanding faster than the West. Thirdly they used their now larger cash reserves in 2010/11 to return to acquisition activity in earnest. Many of the newer acquisitions have strong strategic relevance in that they bolster the companies’ presence in emerging markets and provide additional product ranges that can be offered through their global distribution channels.

The UK instrumentation sector was not alone in this pattern of activity. Instrumentation companies in the USA mirrored this with high levels of R&D investment in 2008/9, followed by a return to major acquisitions in 2010/11.

Our study has focused on 15 larger quoted companies. These businesses generally entered the recession with diversified geographical and market bases and moderately strong balance sheets which could weather the financial storm. Qi3’s knowledge of the 2000 smaller instrumentation SMEs indicates a very different picture, with some companies doing well, but a significant number struggling with poorer cash reserves, less diversified customer bases and lower exports.

Looking to the future, Qi3 recommends continued focus on organic growth through product range extension and global market share. Acquisition strategy should focus on opportunities at attractive valuations with strong strategic rationale. Attention should be paid to short term earnings impact and the potential for balance sheet risk.

This report provides insights for those within the instrumentation sector, and perhaps some lessons for others within the engineering and manufacturing industries.

Qi3 has extensive knowledge of the user markets for instrumentation, the companies in the field and the sensing, electronics, optics, materials and software technologies that underpin this complex sector. We work with large corporations, smaller enterprises, Universities and Research Institutes across Europe to support marketing strategy, technology and innovation strategy, technology commercialisation, acquisition and disposal, strategic alliance and business development in high value manufacturing, engineering and instrumentation amongst other industries.

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With UK sales in 2010/11 of £7.5bn and world sales of £50bn; instrumentation is a relatively small market sector, but its importance lies in the vast range of manufactured products that rely on effective instrumentation for their research, development, production and maintenance. Half of all Fortune 500 company revenues and 70% of FTSE 100 revenues are in sectors which are reliant on instrumentation.

The range of applications in the use of instrumentation means that the sector is fragmented, with key markets as diverse as space, defence, automotive, environmental services and medicine. It is noticeable though that, even with this high level of fragmentation, instrumentation companies across the sector are showing higher than expected rates of growth, profit and revenues.

To understand why, we have analysed the performance of 15 UK-based instrumentation companies, representing both the largest in terms of revenue and smaller companies. 80% of the companies analysed have a global presence.

The companies analysed were:

Andor Technology ▪E2V Technologies ▪Elektron Technology ▪Filtronic ▪Halma ▪IDS ▪Judges Scientific ▪Optos ▪Oxford Instruments ▪Renishaw ▪Rotork ▪Smiths Detection ▪Spectris ▪TT electronics ▪Ultra Electronics ▪

Overview of the Instrumentation Sector3.

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Qi3 has an extensive knowledge of the Instrumentation sector. Many of us have worked in executive commercial roles within the sector. Our personnel have wide-ranging experience helping clients bring new sensing and instrumentation modalities to market, reposition and rejuvenate existing instrumentation technologies. Through the management of a number of instrumentation-related groups for the UK’s Knowledge Transfer Networks, we have facilitated interactions between industry and academia. Our interest and expertise in the sector led us to conduct this research in order to understand these major trends and their market drivers.

Introduction to Qi34.

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Global Impact of the Recession 5.

During the recent recession of 2008/2009 the global instrumentation sector dipped significantly in terms of revenue and growth, as illustrated below.

This contraction was mirrored by the general UK manufacturing sector, with a 7.4% reduction in output between November 2008 and November 2009. However, by adopting new strategies and adapting to the downturn, the instrumentation sector has bucked the trend. In general, the companies analysed exhibited growth between 2007 and 2010, as illustrated below.

Many of the companies in the UK instrumentation sector have recently posted larger than expected revenue, growth and profit figures for the 2010 financial year. As this is a sector wide trend across different parts of this particularly fragmented industry, there must be some overarching processes driving this trend for growth.

Examples of companies among those exhibiting impressive growth figures are; Oxford Instruments (24%), TT Electronics (23.3%), Spectris (12% since 2009), Halma (11%) and IDS plc., which showed a 35% increase in revenues in 2010.

There are three possible ways that these companies could be growing; organic growth, geographical market development or acquisitions. The first part of the recovery was achieved organically, through market penetration, market development, product development, and geographic diversification. Product development became a key focus, with companies investing on average 5-7% of their annual turnover on research and development; approximately £480 million of investment in the UK. Acquisitions initially fell as companies reduced overheads leading to a consolidation of cash in the sector, estimated to be around £800 million in the UK. Acquisitions are now increasing, maintaining the momentum of growth going forward.

Figure 1. The size and growth of instrumentation and electronic market (Datamonitor)

Figure 2- Reported revenue for 13 instrumentation companies 1, 2007 - 2011

1 For clarity, Smiths Group was excluded from this figure as the revenue they reported was much higher than the others analysed, skewing the scale.

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2007 2008 2009 2010 2011

Andor Technology

E2V Technologies

Elektron Technology

Filtronic

Halma

IDS

Judges scientific

Oxford Instruments

Renishaw

Rotork

Spectris

TT electronics

Ultra electronics

Revenue £000

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Drivers for Recovery and Growth 6.

6.1 Dynamics of Organic Growth

Instrumentation companies in the UK and USA have exhibited growth in both traditional geographic markets and in the newly industrialising markets in Asia. These emerging markets are growing rapidly, with particularly large growth seen in China.

Interestingly, with regards to market penetration; there is little evidence of companies taking significant market share from each other. Much of the strong recent growth in revenues can, therefore, be attributed to geographic diversification to the Asian markets, and post-recession recovery.

Current Trends

These trends are illustrated in several company annual reports. The Oxford instruments annual report 2011 stated:“The rapid strengthening of industrial markets after the recession of 2008/2009 was faster than we had expected.”

This statement is mirrored in other instrument company annual reports. For example E2V technologies, Halma, Elektron plc and Renishaw all provide instrumentation and services to industry, fuelling their recovery. The Spectris annual report states; “Improving customer demand has led to revenue for the year increasing by 14.6%.”

Will the growth continue? The following was also reported in the Spectris annual report;“Sales to the academic sector and to research institutions were very good in 2009, helped by government stimulus packages in a number of regions. Although some of these government-funded research programmes in the developed economies ended during 2010, the market overall remained resilient.”

However, Renishaw has recently reported a softening in the UK and US markets, perhaps there are early signs that the post-recession strength is starting to peter out.

Geographic Diversification

The majority of the companies show large growth in the Asian markets, particularly China. Asia now accounts for the largest proportion of Renishaw’s revenues. This growth has catalysed the overall return to growth in the instrumentation sector, by providing confidence in growth for investors, as well as capital for restructuring and R&D projects.

“Continued investment in infrastructure projects, particularly in China and the Middle East, provided good demand for our equipment, and we received a large number of orders for our X-ray analysis systems from the cement industry in China and, in the Middle East, for our rheometers to control the quality of asphalt production.” This quote, from Spectris’ annual report, shows how important these growing markets are.

Rapid industrialisation is driving growing demand in these new markets. Halma illustrates the significance China has taken in their most recent growth plans in its 2010 report. It discussed plans to open three new offices in China in 2011, contributing 4.5% of their revenue. Halma also doubled the number of strategic business units in Mumbai, and their Indian revenue rose by 32% the following year.

In addition to new product development, companies are also using product localisation to support geographic market penetration. This is highlighted by Renishaw bringing out a new controller with integral power amplifiers, targeted at the Asian market because of potential poor quality power supplies. TT Electronics has closed its sensor manufacturing in the UK and moved it to India and China, and Andor showed a substantial growth of 30% in Asian (non-Japanese) markets.

Rapid growth in Asian and developing markets is expected to continue, e.g. Halma forecast that 10% of its revenue will come from China in 2015, and Rotork is building two new factories in India, with one factory encompassing an R&D facility.

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New Product Development

Despite the recent economic down turn, the instrumentation sector has seen a high level of investment in internally funded R&D. It plays an increasingly central role for many companies looking to counteract the poor economic climate in the west and exploit exceptional growth in the east.

Oxford Instruments took the decision, in 2009, to suspend acquisitions until the world economy stabilised. Simultaneously, it increased funding by 29% to their in-house R&D expenditure, which helped to exploit the demand from their research based customers. They attribute their organic growth figures to their R&D department “…delivering an average annual compound organic growth rate of 12.8%, compared to our 10% target. This was facilitated by the rapid culture change that has been achieved across our business, bringing a highly commercial focus to our R&D capability and significantly accelerating the pace and quality of technological innovation across the Group, despite the severe downturn suffered by the global economy.”

Releasing new products that are specific to the customer requirements has been important in capturing parts of new emerging markets, both geographic and application. The example of Renishaw has already been referenced. In the Oxford Instruments 5-year plan, launched in 2006, internal R&D was an integral strategy with the objective to “become a more customer focused organisation, and concentrating on new products in sectors such as nanotechnology.”

Ultra Electronics has released seven new products since September 2010. Optos has also increased its R&D department to 30 scientists and engineers, and Andor has increased R&D spend to 9% of revenue. Filtronic, after making a loss this year, spent the largest proportion of revenue (14%) on R&D of any company surveyed. IDS plc (Immuno Diagnostic Systems) spent approximately 10% of revenues on R&D, a substantial proportion for a small company. Elektron plc. has opened a new R&D facility in Cambridge as part of its re-structuring of the group, and shows the overall commitment to long term R&D expenditure.

There has been some other remarkable spending on R&D across the sector, Spectris spends over £60m on R&D; almost equal to its net profit. The companies analysed spent over £250m in total on R&D last year, which is comparable with the total amount spent on acquisitions. This shows the importance of New Product Development in the strategic response of these companies to recessionary market conditions.

R&D has been extremely important in allowing these companies to exploit both new emerging markets and the domestic industrial markets that are recovering from recession. Continued funding suggests confidence in the recovering markets and their ability to support growth in these companies.

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6.2 Acquisition Strategies

Acquisitions were a part of the growth plans for many instrumentation companies over the past decade. However, when the global recession occurred in 2008, acquisitions in the sector plummeted. Many companies chose to decrease their levels of debt, restructure and reduce overheads, to conserve cash on the balance sheet. Using information from our analysis, we estimate that the instrumentation sector in the UK has a combined cash reserve of around £800 million.

As the economy recovers, acquisitions have begun again in earnest not only to increase general growth, but more specifically to acquire new products and to strength global positioning. In particular, global players benefited through the acquisition of companies with distributors or offices in emerging markets and of products that are focused on these industrialising markets.

Acquisition for Product Diversification

After focusing on R&D during the downturn, acquisitions are now far more attractive and instrumentation companies have been looking to acquire both technology, and IP rights. The new products added to their portfolios may improve their positioning in newly industrialising markets, or help them to capture further market share in traditional markets.

Optos is an excellent example. It recently acquired Accutome, which added three new handheld devices to their portfolio, and also Opto Global, which has already added another two products, with others in the pipeline. However, the acquisition of Opto Global was not purely for products but also to strengthen their global positioning. “In acquiring this business, we [Optos] will bring a significant network of distributors in the Middle East, Africa and Central and South America with a direct sales force in Australia…” Adding this kind of distribution network will help Optos to maintain its global position as the foremost ocular imaging company.

Oxford Instruments returned to the acquisition trail in 2011, buying Omicron (Germany) and Omniprobe (USA). These acquisitions were ambitiously funded through a new £40m share placement. Most recently,

in line with its ‘14 cubed’ growth strategy, it has acquired Platinum Medical Imaging in Florida to strengthen its US base and medical imaging service business.

Acquisition for Geographic Diversification

Spectris has been receiving many orders for rheometers from the Middle East. This was made possible through its acquisition of Reologica, a Swedish rheometer specialist. Ultra Electronics has made 42 acquisitions since its management buyout in 1993, 4 of which came last year. Each added new products to the company’s portfolio. These acquisitions were not purely for products though; they were targeted at specific markets. Spectris made five acquisitions in the past year, two of which were in Asia, supporting a 23% increase in Asian revenues. The parent group of Smiths Detection, Smiths Group plc, made twelve acquisitions for its subsidiary companies during 2010, of which “six extended our [Smiths Group] footprint in the faster growing Asian markets. The acquisition strategy seeks to add complimentary technologies, to support geographic expansion in faster growth markets…”

Oxford Instruments has recently opened an office in Brazil which could support the identification of new acquisition targets in this emerging market.

All of these acquisitions are focused on emerging markets, especially in Asia, as these are the main sources of growth and it is predicted that this trend will continue.

Acquisition for Recovery

Many of the smaller instrumentation groups (revenue <£50m) have been making calculated acquisitions to aid their recovery from tough economic times. Filtronic, which made a loss of £300k in the previous financial year, has completed its acquisition of Isotek Holdings, which has already contributed £4m of turnover to the company. Elektron (£50m revenue) made its largest acquisition last year (Hartest), and states that it is looking for more to increase its ‘brand stable’.

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Acquisition for Conglomerate Growth

Judges Scientific made two acquisitions in 2010; Quorum and Sircal, both funded using bank loans, and state that it is seeking similar acquisitions in the coming year (with its cash balance of £2.5m). Both acquisitions contributed to the company’s 42% growth.

Halma has retained cash reserves of £42.8m for further acquisitions in 2011 after a record run in 2010 and is looking to acquire profitable companies, with associated IP rights. TT electronics has (according to its annual report) £110m available in cash, and its 2011-2012 growth depends on a combination of organic and acquisition growth.

There is an emerging phenomenon which one might term ‘the rise of the small conglomerate’. Smaller groups such as Elektron and Judges Scientific are acquiring other instrumentation companies to build conglomerates of many different brands, becoming scaled down versions of Ultra Electronics, Thermo Scientific and Halma (of 45-50 different sub brands) This could have very positive implications for smaller instrumentation businesses in the UK which seek exit opportunities.

We predict acquisitions will be a significant feature of this sector for the next 3-4 years, if markets continue to go from strength to strength. The industrial sector of instrumentation looks in a particularly strong position, showing growth in markets that are likely to continue to expand. In the long term, as South America continues to industrialise in the same way as Asia, there will be even greater opportunity for companies to increase revenues and profits, as long as they can position themselves well and capitalise on this growth period, using new products and acquisitions.

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General manufacturing growth may be recovering, but this recovery still has a way to go. Manufacturing output rose 1.8% in May 2011, following a drop of 1.6% in April (Office National Statistics). The summer and autumn have seen renewed drops in manufacturing output, with September’s output only 2.0% above that of the previous year. This had led many analysts to state that recovery is still fragile, and therefore the growth in the instrumentation sector may comtinue to be precarious.

One company which has been posting results that have gone against the trend is Filtronic plc which posted a decrease in revenue by over almost 30%. Filtronic supplies large OEMs with a range of niche products, such as instruments to complete transceiver modules, and says in its annual report 2010 “with the rapid evolution of product technology and other corporate decisions the size of our addressable market may be affected. We may also fail to forecast market movements correctly so missing opportunities or wrongly predicting product longevity.” It divested its semiconductor and defence businesses in 2008, which coincided with a drop in share price.

Rotork showed good figures overall, but, although its Fluid Systems division increased revenue by 7%, pre-tax profit fell by 6.8% for the same period due to a lowered operating margin. However, the controls division showed an 8.5% increase in profits on a similar revenue increase.

Renishaw noted, in its annual report 2010, that it had experienced some reduction in size of the UK and Europe market, but this was cushioned by a large increase in the size of the Asian market. To help counter this downturn the company acquired the ex-Bosch manufacturing plant in South Wales, in June 2011.

So, although these companies have been showing strong figures on the whole, the underlying truth may be that if manufacturing does not continue its recovery in the UK, and if they are unable to capitalise on opportunities, both domestically and abroad, there may be problems ahead.

Putting Success into Context7.

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The largest instrumentation companies in the world are based in the United States and include Thermo Fisher and Danaher, which have revenues of $11bn and $13.2bn respectively. These companies may be headquartered in the US, but they have a truly global presence, so it is of interest to compare their growth patterns to UK instrumentation companies, which, despite being smaller in scale, still compete in the global market.

Thermo Fisher achieved a 7% growth in revenue and a strong increase of 17% EPS (which was their target for the year). It increased R&D spend by $40m to over $250m in total, representing approximately 2% of revenue. This is much lower than the average 5-7% of revenue from the large UK companies.

Emerging markets played an important part in the post-recession growth of Thermo Fisher; spending $600m in acquisitions in emerging markets and technology to strengthen its geographical position. The company has a targeted strategy for increased and sustained growth in these markets, recently completing their acquisition of Dionex Corp for $2.1bn. Dionex receives over 1/3 of its revenues from Asia and other emerging markets.

Danaher delivered record revenues of $13.2bn; an 11.5% increase from the previous year, yielding the highest revenues of any instrumentation company in the world. It also acquired 19 companies in the year, across all segments, for a total consideration of over $2bn. Technology development has been important for this company, as it has released 1800 new products in 2010 alone. This is significant, but an R&D investment of 6% of sales enables a large number of acquisitions to allow this company to increase its product portfolio. In common with much of the instrumentation sector, Danaher has also been placing a focus on Asia. It invested heavily in emerging markets in 2009, a strategy that has paid off, with an average growth in revenues of over 20% across these markets and over 30% in China alone. The strategy that was adopted in China is now being copied in other countries, such as India, which has seen organic growth from $25m revenue to $200m in the last five years.

These two companies seem to be mirroring the UK companies but on a much larger scale. Their growth strategies and clear focus on capturing as much of the Asian market as possible means that they will come in to direct competitive contact with many of the UK based instrumentation companies. However, a problem arises when comparing these and other US companies with UK groups. These companies operate in many other sectors with non-instrumentation sales contributing to growth and revenues. For example, instrumentation accounts for only 25% of Thermo Fisher’s sales, and even less for Danaher. There are other companies in the US showing similar trends. Ametek, which deployed $540m in acquisition funds in 2010, also showed growth of the same magnitude of Thermo and Danaher (8%) compared to 2009. However, sales had dropped sharply in 2009, to a 3-year low. This fall in revenues and subsequent recovery was seen across the US and UK instrumentation sectors. Growth, both organically and through acquisitions has definitely returned to the sector.

Although this analysis doesn’t take into consideration the other sectors in which Thermo and Danaher operate, it shows similar growth patterns between UK and US instrumentation companies. The instrumentation market is truly global so it is not always vital to concentrate on where these companies’ headquarters are based. Further in depth analysis is needed to understand these relationships in more depth.

Comparison with the US Giants8.

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Instrumentation companies responded to the recession by focusing their efforts internally on research and 1. development, and by reducing acquisitions to minimise risk in a volatile climate.

The resultant new products enabled them to capitalise on continued growth in Asian markets and on the post-2. recession bounce back in Western markets.

As the economy recovered in 2010, companies began to release their large cash reserves, built up during the 3. downturn, to make domestic and worldwide acquisitions – with a focus again on the lucrative expanding Asian markets.

That activity was mirrored in the USA with companies such as Thermo Scientific and Danaher reporting higher 4. investment in R&D in 2008/9 and subsequent increases in acquisitions made in 2010.

Acquisitions are now supporting organic growth in adding value to these companies. Combined together, these 5. factors explain the high growth rates seen recently by many instrumentation companies.

Continued organic growth through new product development and geographic diversification combined with 6. carefully crafted acquisition strategies are the key to maintaining this success.

The effects of a return to sluggish manufacturing performance, especially in an ‘L-shaped’ recession are hard 7. to predict. Nevertheless, most of the companies analysed have positioned themselves in growing geographical markets and strengthened their balance sheets since 2008.

This analysis has focused on large, quoted companies and anecdotal evidence suggests much greater stress 8. on smaller, less diversified companies. This is especially the case for companies with lower cash reserves and limited access to Asian markets.

To find out more please visit the Qi3 website: www.qi3.co.uk

Conclusions9.

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Qi3 LtdSt John’s Innovation CentreCowley RoadCambridge CB4 0WS United Kingdom

Tel: +44 (0)1223 422404Email: [email protected] Web: www.qi3.co.uk

Documents

Qi3 Insight: Intriguing Instrumentation · Qi3 Insight: Intriguing Instrumentation With UK sales in 2010/11 of £7.5bn and world sales of £50bn; instrumentation is a relatively small