Galvanic Applied Sciences is a niche analytical instrument business selling gas measurement tools to the energy industry and liquid measurement tools to chemical and process industries.  The company has been growing quickly (core gas measurement business has at least 27% TTM growth for the past 7 quarters), has 26% operating margins, has low capital intensity thus generating a 75% after-tax ROIC, and has a strong balance sheet with over $9 M in cash.  Despite the business’ strong operating performance it trades for only 2.7x TTM EBIT and 3.3x P/E excluding cash.  I believe the company should trade for at least 11x these earnings or around $3.00 per share, making the current price of $1.30 extremely cheap.

Galvanic is composed of two businesses: Galvanic Canada, which is the gas measurement business, and Galvanic Lowell, which is the liquid measurement business.  Galvanic Canada is 80% of EBIT and Galvanic Lowell is 20% of EBIT.  I will discuss them separately.

Galvanic Canada

Within Galvanic Canada, there are two types of products.  Over 90% of the business is analytical tools that measure the composition of gas (hydrogen sulfide and total sulfur analyzers, gas chromatographs, etc.) which they sell into the natural gas processing market..  They also have a small electronic flow and pressure measurement business here (Gas Micro) that’s just under 10% of revenues that they sell into the gas distribution market.  The Gas Micro business is in Canada and the analytical tools breakdown roughly 30% in Canada, 20% in the US, and 50% internationally.

Galvanic Canada is the legacy business and is the jewel here.  In the TTM it has produced $12.8 M in revenue and $3.6 M in EBIT for a 28% operating margin.  The business has been on a strong growth trajectory, with TTM revenue growth of at least 27% for each of the past 7 quarters.  I cite the TTM figures because there can be some quarter to quarter lumpiness.  The growth is likely decelerating, but in the first half it was still 10%, and Q2 in particular grew 12%.  This growth has been fueled by international expansion, and international revenues have grown at least 32% for each of the last 6 quarters.  In the first half of this year international grew 45% year over year.

Galvanic Canada was a $12 M revenue business in FY06 and FY07 that declined to $6.7 M in revenues in FY10, likely making the past few years of growth look like a cyclical rebound at a glance.  The composition of those revenues, however, tells a different story.  Galvanic used to have a larger $2-3 M revenue Gas Micro business in those years (peaking at $3.3 M in FY05) and this has declined and stabilized around the $1.0 M level (Gas Micro has been at this level for the past five and a half years).  While there were some declines in analytical instruments in North America from FY06 to FY10, it was only around a $2.0 M revenue decline.  Furthermore, the Canadian dollar strengthened significantly during this time and 60% of analytical instrument sales were outside of Canada at this time.  In FY08 foreign exchange had a -12% impact on these export sales, which works out to around a $700k decline from currency movements alone.

From the $6.7 M revenue trough in FY10, only $1.5 M of the revenue rebound has come from a rebound in analytical instrument sales in North America.  The overwhelming growth has come from winning new international business, which has grown by $3.4 M to the current record levels where international now comprises over 50% of analytical instrument revenues.

Galvanic Lowell

Galvanic Lowell was a business they acquired for $2.5 M USD in July 2003 called Metrisa, partially to diversify the business into liquids, and partially to broaden the geographic exposure outside of Canada.  Galvanic Lowell’s products are used in liquids process markets to measure chemical concentrations, viscosity, turbidity, and suspended solids.  This is a much smaller business than the core gas measurement operations, and in the TTM they have done $4.5 M in revenues and $0.9 M in EBIT for a 20% operating margin.  This business breaks down roughly 5% in Canada, 40% in the US, and 55% internationally.

This business has not had the same sort of growth trajectory as gas measurement, but it has still been growing nonetheless.  Revenues grew 27% last year and are up 3% in the first half of this year.  Similar to the gas measurement business, international has been a growth driver with revenues growing 99% last year.  It’s different, however, in that Lowell has always had a meaningful international business as over half of Monitek’s customer base has historically been in Germany (Monitek are their products for the food and beverage industry).

Ownership and Management

Jerry Zucker, the late industrialist from South Carolina, more well-known in Canada for his acquisition of the Hudson’s Bay Company in 2006 started acquiring shares of Galvanic Applied Sciences in 2005.  He initially bought 1.8 M shares in 2005, bought a little more subsequent to this, and then died of a brain tumour in April 2008.  He was worth around $1.2 B at the time of his passing, and this wealth was derived from InterTech Group, the industrial conglomerate that he built to over $3 B in revenues.  Around the time of his passing, just as the business completed the poor FY08 that I alluded to above where revenues declined by 25%, he brought in a new CEO, S Grant Reeves, from InterTech to turn the business around.  Reeves actually continued running InterTech’s PBI Performance Products business at the same during his roughly 1.5 year tenure as CEO.  Subsequent to his appointment to the CEO position, the Zucker family trust acquired another 2.76 M shares, which brought them up to the 5.85 M shares -- 36% of GAV -- that they own today.

Reeves was subsequently replaced by Helen Cornett as the CEO in August 2010, who had been the CFO since 1995 and I believe was essentially a co-founder of the company.  I think much credit should go to Cornett as the business has steadily grown from $11 M in revenues to $17 M in the couple years since she took over, but it’s tough to know how much of that growth was made possible by changes implemented under Reeves.

I have no special insight into the intentions of InterTech or the Zucker family trust, but it seems to me that Galvanic is a pretty logical acquisition target for an industrial conglomerate that already owns 36% of it and installed its own people to run the business just a few short years ago.

Valuation

The current market cap is $21.3 M and there is $9.2 M in cash and securities for an EV of $12.1 M.  TTM EBIT is $4.5 M, so the company currently trades for only 2.7x EBIT.  TTM net income is $3.7 M, so the P/E is 5.8x, and excluding cash the P/E is only 3.3x.  I think that’s an extremely cheap valuation for a high margin, high return on capital business without any significant end user concentration that is growing at a healthy rate.  My fair value estimate of $3.00 per share (11x these TTM earnings) corresponds to around 12.5x earnings if you assume no gains/losses from forex, no finance income, and a slightly higher tax rate of 28%.

Continued strong operating results

Sale of the company, possibly to InterTech Group

Use of the substantial cash position, either in a share repurchase/tender offer or an acquisition