Judges Scientific plc (JS) is an AIM-quoted UK-based group specialising in the acquisition and development of a portfolio of scientific instrument businesses. JS has acquired 15 companies since May 2005. Most of the businesses occupy dominant global market positions in small niche markets; they have high operating margins, low capital requirements and high returns on capital. Long- term growth drivers are based on the expansion of global higher education and a continued worldwide drive across science and industry for improved measurement and optimisation. Historical acquisition multiples are in the 3-6x EBIT range. The market for scientific instruments is very fragmented with approx. 2000 private companies in the UK alone. The potential for future acquisitions is substantial with little competition for small companies with EBIT <1m. Management has a strong track record and is focused on shareholder value. We already anticipate that 2016 will be a bad year for JS due to a combination of production issues and a slowing demand at some of their most profitable businesses. We believe these problems are of a temporary nature and have created an opportunity to invest in a quality business with attractive growth potential at 10x next FY cash-earnings.

 

 

 

JS designs, assembles and sells high-quality scientific instruments with a focus on material sciences and vacuum. The company designs most components and outsources manufacturing unless they are readily available. The only exceptions to this are UHV Design, which makes everything itself from lumps of metal and Armfield, which subcontracts everything including assembly. JS generates sales of approx. £56m, 60% to Universities, 10% to testing firms and the rest to a diverse group of researchers from pharma, biotech, commercial and industrial backgrounds. More than 80% of sales are exported. Most of the company's products have a long lifecycle, and many products are sold in different markets and countries.

Although JS does not publish details on each underlying company for competitive reasons, we give a short description of what we understand to be the five largest profit contributors of the group.

 

 

East Sussex-based Quorum Technologies manufactures market-leading scientific instruments primarily used for electron microscopy sample preparation. Electron microscopy is an essential research tool in almost every area of scientific endeavour, from the fight against cancer and major diseases, through to food safety and the development of advanced microelectronics and new materials. Quorum has two main products: a coating system and a cryo system. The coating systems have a dominant market share in the high-end market, and cryo systems have strong leadership in their segment. JS acquired Quorum in 2009 for £1.5m when the company did £0.5m EBIT and £4m of sales. Quorum has grown substantially since then and regularly produces operating profits of £2m.

 

Armfield’s innovative engineering, teaching and research equipment is aimed at the broad disciplines of civil, chemical and mechanical engineering for universities, schools and colleges. Their industrial division provides market-leading R&D technology for applications in food, beverage, edible oils, ingredients and pharmaceuticals industries. Armfield is a market leader with a 15% market share and was acquired in 2015 for £10.1m. EBIT at the time was £2.1m on £14m revenue. Judges has said that Armfield had a challenging year in 2016.

 

 

 

Scientifica is a world leader in micro-positioning equipment for microscopes and advanced imaging systems used in electrophysiology and neuroscience. Their products are in use at most of the top scientific laboratories throughout the world, where they help researchers unlock the secrets of life as they investigate the mysteries of the human brain, nerve and other cells. Scientifica sells several instruments, some with a significant market share. 

JS acquired Scientifica in 2013 for £12m; Ebit was £2.2m on £12m revenue.

 

 

 

 

GDS designs, develops and manufactures equipment and software used for the computer-controlled testing of soils and rocks.

JS acquired GDS in 2012 for £7.6m. EBIT and revenues were respectively £1.27m and £4.9m at that time.

 

 

b) High operating margins with a 7-year historical average of 18%.

d) High and stable market shares in small niches.

e) Moat: The key aspects of JS' businesses are science and sales. The IP, reputation and client relationships have been developed over an extended period, often decades.

f) Fixed cost structure: approx. 60% of costs are fixed, mainly specialised personnel (many PhDs)

g) Low capital requirements and asset light (Working Capital/Sales = 10-12% & Depreciation/Sales < 1%)

  

Organic growth for the last 5y was 5.6% p.a. Sales are impacted by the success of new product launches and external factors such as public sector funding, FX and the macroeconomic environment. Two topics generally drive their market. One is education; there has been an increase in university education and these universities need equipment. The other topic is the continuous strive to perfection and measurement - optimisation. Everything humans do, they try to optimise, and when they optimise, they want to measure. These long-term drivers of growth are unlikely to fall away, and we think it's safe to assume that future organic growth will at least keep pace with global GDP. Historically, the success of certain products has resulted in higher organic growth, but our base case is based on annual revenue growth of 3%.

- Strong exporters in their global niche markets

- Solid EBIT margins (gold standard 25%)

- Sustainable profits and cash flows

- An acquisition price between 3 to 6x EBIT

- Borrow up to 2.5x EBITDA at 2 to 4%

 

Post-acquisition JS creates an environment for the businesses to thrive, implements robust financial controls, repays debt and reinvests in further acquisitions. The market for scientific instruments is very fragmented with approx. 2000 private companies in the UK alone. The potential for future acquisitions is substantial with little competition for small companies with EBIT <1m. JS’ small size with a market cap of £80m is a key advantage, offering ample opportunity to create shareholder value with the acquisition of attractively priced small companies. JS’ focus on UK companies is explained by the higher acquisition multiples in both continental Europe and the US for the type of businesses JS is looking to acquire.

In our base-case scenario, we assume that JS continues to spend £5m per year on acquisitions, the average of the past five years, at a multiple of 6x EBIT. Historical acquisitions were done at 5.1 x EBIT.

 

 

  

 

 

During the 1st half of 2016, adjusted EPS decreased by 19.2%, as the result of a combination of weak demand in 2 of JS’ largest businesses and production issues in an important constituent of the Vacuum division (names not publically disclosed). The company believes the reasons for the disappointing sales are cyclical and not structural in nature, a view they say is confirmed by the large microscopy manufacturers such as Hitachi and Zeiss. Fluctuations in demand are inherent to their business, but in 2016 the impact was unusually large because it hit 2 of their largest businesses simultaneously. JS also suffered from production issues in a fast growing business where the ERP system created problems with the ordering of parts. A new manager with a strong operational background is trying to address the problem, and the result of his efforts will become clear over the course of 2017.

 

Over the past 5 and 7 years, the average adjusted EBITA margins were respectively 19% and 18%. The last 3 years the operating margins have been below average for the following reasons:

b) The acquisition of Armfield in January 2015, a business with structurally lower operating margins

d) An increase in R&D expenditure

 

 

Our base case assumes adjusted EBITA margins of 16% and 17% in 2017 and 2018. We believe these assumptions to be conservative for the following reasons:

 

b) The businesses acquired in 2016 have above average operating margins and compensate for the lower margins of Armfield.

With a tax rate of 20.25% and a cost of debt of 3% (currently lower) this gets us to cash earnings of £7.5m and £8.3m for respectively 2017 and 2018. At today’s stock price, we pay 11.1x 2017 and 10.0x 2018 cash earnings.

 

 

 

David Cicurel, CEO, listed JS on AIM in 2005 as an investment vehicle to buy stakes in small public companies across a variety of sectors and push them into being taken private at a premium. This business model soon proved to be out-of-date when valuations in public market became too rich. However, through his first acquisition, FTT, Mr Cicurel discovered that in the world of scientific instruments, there were many small companies in the UK with a dominant position in a tiny niche. Rather than a public-to-private arbitrageur, JS became a vehicle for buying private companies making scientific instruments. To date, the company has completed 15 acquisitions and only one divestment. Since 2005 the share price increased from 105p to 1404p with cumulative dividends per share of 165p generating a total return to shareholders of approx. 28% p.a. over the 11 year period. Adjusted EPS (diluted) increased from 4.8p in 2005 to 107.3p in 2015.

 

This article in The Telegraph gives more background on David Cicurel:

 

 

 

- Key man risk. Mr Cicurel has built a network and a reputation that facilitates the sourcing of attractive acquisitions. At the age of 67, we currently see nobody at the company that could replace him. Although he is convinced that the board members will protect the company’s focus on shareholder value, JS’ ability to source attractive acquisition targets is compromised if he would no longer be at the company. That said, Mr Cicurel is in good health and has no intention to retire anytime soon. From an operational perspective, we see the CEO’s impact as less important as each business is managed by an MD who reports to David Barnbrook, COO.

- A poor acquisition.

 

 

 

JS is a portfolio of companies with strong market positions in very small global niche markets. The businesses have high barriers to entry and attractive characteristics such as high operating margins, low capital requirements, high returns on capital and long-term drivers of growth.

 

The CEO is aligned with shareholders and has a strong track record. He’s focused on investing cash flows at high rates of return. The company’s small size gives it the opportunity to pursue a large pool of acquisition targets that are available at attractive prices.