M&A Announcement

Sep 22, 2020

Slides

Thank you very much. Good afternoon, everyone. Welcome to our call. Thank you for joining us at such short notice. I'm joined by our CFO, Barbara Gibbs. I hope by now you will have had access to an RNS and hopefully a presentation too. So we'll run through the 15 or so slides and hopefully have plenty of time for your questions. At the end. So we'll get started. And turning to the second slide, we're very, very excited to be acquiring windy city wire and cable, which is a fantastic US based controls business. It's absolutely consistent with our business model, which, as you know, is about strong differentiating value add customer propositions It's about exciting organic growth potential. And it's about strong management teams and culture that will deliver that for us, and this business has that in space. It's also right in our strategic sweet spot. So expanding into the U. S, which I believe is the best industrial market for our seals and controls businesses. And it's in a core product range that we understand well. They have an incredible track record of performance. And with a platform to deliver market share gains in structurally high growth and segments. Will pay consideration of £357,000,000 with a funding structure that allows us to maintain a conservative and flexible balance sheet. And in year 1, the deal will be both significantly earnings enhancing, and it will cover comfortably our cost of capital. So turning now to the next slide and a quick reminder of our strategy to put the deal into some context We've built the group on some very strong foundations of value add distribution. We look to grow into core large developed markets with both current and adjacent product ranges. We look to develop scalable businesses that can sustain exciting and resilient organic growth. And of course, we support the development of capability required to effectively operate those businesses at scale too. All of this while retaining a strong balance sheet, as I said. And windy city wire and this transaction hits on all of these strategic points. Turning the page now to slide 4 and an overview of the transaction itself. The highly effective business and I'll come on to talk about it a bit more in a second. Windy City is majority owned and led by the founder, Rich Galgano. And along with a strong management team, he will be staying with the business. It's a distributor of premium, low voltage wire, and cable with a strong service component and reaches across all of the US. They have a track record of double digit revenue growth growth and 26 years of uninterrupted profit growth. Revenues are expected to be in 2020, $190,000,000, and EBITDA of a little over $44,000,000. So the consideration of $357,000,000 is at a multiple of 10a half EBITDA and 11a half EBIT. And the group's return on capital will be in the high teens next year after the transaction. We'll fund with a 10% placing and the rest in debt, and far Barbara will cover that in more detail in a minute. Turning now to slide 5. It's right in our strategic sweet spot, as I said. The importance of the US in our future is, is significant. I believe it's the biggest best and most potential industrial market for us. And of course, it gets controls into the US, a core product range that we understand well in Europe. I just love the value proposition of this business. It's simple. Is highly effective and is truly scalable. On top of that, it's accretive to the group's future organic growth and earnings. So it's in structurally high growth and segments with a differentiated proposition driving market share gains, and a fantastic platform of technology, facilities, network of facilities, and some controlled supply chain on which to build real scale in the future. On top of that, as I said, it delivers very strong financial returns for the group. So now turning the page, I'll take you through this in a little more detail in the business itself, slide 6. 4 and it's headquartered in Bolingbrook, which is near Chicago. We've been aware of them for some time and build been building relationships with, the people around them, and in fact, managed to circumnavigate, a formal process, which was great. We've done extensive due diligence, as you would expect, spent a lot of time together, got to know them well. It's a really impressive management team and a strong and performance oriented culture. It supplies product that is designed for customer convenience and for productivity with a high speed to market and high touch customer relationships. It operates with diverse, with diverse customer base in structurally high growth segments like building automation, audio, video, fire, security, data centers. And it has an incredible performance track record with revenue CAGR of 12% in the last 10 years and EBITDA margins now over 20% and growing. Moving now to the next slide, the value add customer proposition. The model, as I said, is simple and yet very, very powerful. They have patented products that are essential to customers and yet at low component costs. So products that are built for convenience, as I said, they're smart wire as wiring that has specially designed compound for reduced friction. They have what's called rack pack. Wire wheels are stored in custom sized and labeled butt which can be easily transported conveniently stacked for an organized workspace, and then the wire pulled from the multi box simultaneously as the technician works, and this convenience leads to productivity gains for the customers 20 to 30% normally on their labor costs. The business has been built for speed to market with the same day dispatch policy based on technology and network of facilities and some control of the supply chain. And they maintain close contact with their customers with sales reps and data from their systems allowing them to be agile and responsive. So once you're on this platform, you never come off. It's a very compelling proposition and undoubtedly gaining market share. In many respects, it reminds me of the characteristics of our Hercules aftermarket business in the US. Again, a simple Seagulls product packaged for convenience and productivity in kits on a strong technology and distribution base with speed to market through same day delivery. They're both very simple, but very, very powerful models. Turning the page now to Slide 8. I think this slide really demonstrates the the quality of this business. You can see in the pie chart 2 critical factors from my perspective Firstly, for a diverse range of end customers who typically transact small values with multiple repetitions So there's no concentration nor dependency. And once they're on, they rarely leave. As you can see from the recurring base chart on the right, the retention levels are sectional. So it's a quality business. The model is very resilient as well as truly scalable. And as an example of that, resilience through COVID-nineteen, 2020 revenues are expected to be flat year on year with profit growth of around 18%. Moving now to the next slide, number 9. Great track record for performance, and I think this chart speaks for itself. The EBITDA growth has been exceptional at 13 percent CAGR. I mentioned earlier the revenue growth organic revenue growth at 12% CAGR. And that built up it built up some excellent margins, which I think represent the pricing power from the differentiated services, along with the benefits of scale. And with strong cash conversion and returns characteristics in many respects, as you would expect, the financial model is very, very similar to diplomas. I'll come back in a second to explain why I think this performance can continue into the future. Again, turning the page to slide 10, I've mentioned how the business has a strong platform to deliver its customer proposition and financial performance. It's really critical This platform is built for growth and scale. And it's kind of what we're trying to do as a core part of the operational strategy in our existing diploma businesses. That develop the capability to operate at scale. So firstly, they have a network of facilities across the country, and that drives speed to market, it builds customer base in local territories. Technically, they have some control of the supply chain with some light to manufacture which is basically insulating the wire with compounds. And we do some of this already in Europe, and that brings, you know, benefits to speed responsiveness quality control and some margin. They have great systems, which are crucial to allow the customer servicing element to operate successfully at scale. And finally, it might be most critically, you know, talent is a key part of the capability for this platform to operate at scale. And I'll talk a little bit about that now on the next slide. 11. I've been so so impressed with Rich Gallgado, with the strength of the team, and with the powerful culture. He's carefully built a broad and effective team. So they have a very experienced CFO who's done public, markets, roles before. Strong and disciplined operations leads, at a fantastic sales organization. The culture is built around many of the diploma characteristics, accountable, agile customer, and performance orientated. This team is fully on board and committed to partner with us on the next phase of windy city wires development, which is exciting. Moving now to the next slight significant future growth opportunities. So I'll talk a little bit about the track record, which is phenomenal. They built a brilliant customer proposition and there's a fantastic platform for scale. So now it's really about how they'll continue to grow. And for me, this is, I think the most exciting part. The lower voltage wire market is huge, and we have a tiny share. The business benefits from exposure to high growth and segments building automation, pro audio, video, fire security, as I said, data centers, and the like. So along with the structurally high growth rates, they've also been, and they'll continue to take market share as the 13% revenue CAGR demonstrates. They're now starting to break into some new and high growth areas too, such as data center development, digital antenna systems for 5 g, really exciting technological developments in these areas. Which really only increases the needs for premium wiring and cabling. It's really the infrastructure around that technological development. And finally, we will be exploring some revenue synergies. We can help windy city wire break into Europe through our existing channels. And vice versa, I believe they can help us take some of our existing controlled products into the US. So I think it's incredibly exciting, and we believe the growth story will continue. And it will be accretive to diploma. On the next slide now, 13, a bit of context on the short term as we start on that journey with some current trading. So diploma has been very resilient through COVID. We continue to generate strong profits and cash. And we've seen revenues recover in recent months. And we're on track to hit, the market expectations as we outlined in the August, trading update. So as a result of that and our confidence in the future, the board is recommending a combined half and final dividend in respect of 2020 at 30p, just slightly higher than last year's full dividend. Windy city wire at said is also demonstrating the real resilience of its model this year too. The business will be flat top line, incredible in this environment environment with strong profit growth. And as we progress through 2021, the prospects therefore for both together are really very, very encouraging. So on that note, I'll hand over to Barbara to say a few words on the financials. Thank you, Johnny. I'm now on slide 14. Let me fill you in some of the details and valuation and deal structure. On valuation, we are buying windy City at 10.5 times EBITDA or 11a half times EBIT. This is an attractive multiple for a US business of this scale of the sheer quality and the excellent organic growth prospects. For us specifically, this means double digit earnings accretion in year 1 as well as returning in excess of our cost of capital also in year 1. Roxy is a key metric for us mathematically this will come down initially. Remember, we're buying organic growth at scale. So we're looking at a ROTCE in high teens post transaction, which is strong. This is the right thing to do for us, the right thing for diploma. As for smaller bolt ons, we'll continue with those with the same discipline and the same returns hurdles we have always applied. On deal structure, we have a conservative approach to our balance sheet, which is why we have chosen a combination of debt and equity also bearing in mind that we have visibility over an attractive pipeline of potential bolt on opportunities. We're expecting to fund the transaction with the proceeds of this payment of around 1,000,000 and approximately 1,000,000 in debt. The new financing package is a total of $260,000,000, which allows for Hedrib and flexibility into the future. Interest cost is around 2.2 percent at a blended rate. Now on to slide 15. After the transaction, we'll have a balance sheet that's at the right level for a business such as diploma, and the strong balance core of our financial model. In terms of leverage, both businesses are highly cash generative which means we'll be de leveraging rapidly. I expect net debt of the combined business to be around one time EBITDA at the end of the full year 2021, which for us is next September. That means we'll have the headroom to continue with our bolt on acquisition, which remain a key element of the diploma business model. So overall, we'll maintain balance sheet strength. We'll retain our conservative approach to leverage and will have built the flexibility to take advantage of both homes. This structure also allows us to have enough liquidity to pay a progressive dividend, as Johnny just mentioned. Now back to Johnny to sum up. So summing up on slide 1616. We're really excited about this deal. It's a high quality business, which fits perfectly with our model. It's well prepared for scale and has exceptional growth prospects and exposes us more to the US The earnings accretion and returns profile are outstanding. And we can, as Barbara said, retain the conservative balance sheet for future dividends and bolt ons. It's a great deal. Thank you very much. And I'll now hand back to Orlando to take your questions. Thank you. You. And we will move on to our first question, calling from Will Kirkness with Jefferies. Hi there. Thanks. And just to couple of quick ones, please. Could you just confirm whether, all of that growth, that revenue growth there is organic? I think you said it was. Whether they've done any M and A in the past at all? And then just lastly, sort of what the owner rational hours for selling? Thanks. Sure. Well, just on the growth profile, yes, that growth is organic. They did some very, very small deals, I think, very early in their history, but what you see there is organic. The rationale, yeah, I'm able to take you through very quickly the the the deal process. We've been, we've been trying to get close to them for some time. I've built relationships with some of their advisors over the last year or 2, and they contacted me early in the summer to say that he was ready to discuss the sale process, after which we had numerous Zoom calls. And his rationale is Firstly, that he believes that U. S. Capital gains tax will increase post election into 2021. And therefore, he feels that now is the right time for him to take his cash, off the table. He also was very keen to talk to us because He was still keen to stay on in the business and warranted a partner that could work with him on developing their business model, their growth strategy into the future. And and clearly that fits in with diplomacy. So, he was keen to talk to us. And as a result of that, we managed to circumnavigate a competitive process and have a bilateral negotiation and discussion, a clearly due diligence over the last few months. Okay. Is he tied in for a year then or longer? Oh, sorry. Yes, he tied it for 3 years, as is the top 20 or so of the management team with some retention packages. Great. Thanks very much. I should just say on that if I may just add to it, Will, but, it's really, really important that he is part of the future as the leader in figure head, as founder of the business, and we're really glad to have him on board. I'd also just say that, you know, the quality of the business also, you know, is really resilient And there isn't really any kind of customer contract dependency or anything like that because we have so many customers, across, across such a wide end of wide range of end segments, which makes the business very resilient. Thanks so much. And next we will take a question from Henry Carver with Peel Hunt. Yes. Thanks. Good afternoon, guys. Just on top of Will's query and the rationale, just wondering about the sort of integration with the controls business over in Europe and just to sort of how you see that going forward. Are you going to sort of rebrand or do any sort of, you know, how far is the integration going to come and, and, and I guess, yeah, just a little bit more color on on the cross sell across the Atlantic? Yes, sure. Well, look, if I go back to get the principles of our our our model. We're not we don't really do heavy integration. We're really buying businesses that have got, you know, unique customer proposition a strong team and culture that have got organic growth potential and that's what we're buying into. So, well, occasionally, we have some cost synergies. There's no real integration as such. And we'll preserve the windy city wire, brand. I will preserve the business, in its integrity. You know, the business will report, if you like, externally as part of controls, but will Rachel Gallo and Cal Gallo himself will report directly to, to myself. In terms of the cross sell, yeah, we're excited about that. I mean, the deal, we didn't we didn't price any of the synergies into the valuation, actually. For me, the deal stands up just on the basis of windy city wires potential on its own. However, there's no doubt that we're excited about what we can do to help them bring products into, into Europe. We have some existing wire and cabling businesses in the UK and Europe, which kind of are similar types of product similar types of end customers, but not quite this product itself. And I think we can use them and access their channels to bring that, that differentiating product range and service component into into the European market. So they're very, very excited about that. They've been looking for a European partner for some time, and so that was really one of the reasons why, why they were excited about diploma. That's great. Thanks. Up next we'll hear from Sam Bland with JP Morgan. Hi, there. Congrats on the deal. I've got two questions, please. The first one is Can you talk about how the business has managed to? I think it is EBITDA up 18% this year, I think, on flat revenue. Could you just talk about how that's been achieved And the second question is, obviously, this is quite a different scale of acquisition versus what we've seen from diploma in the past. You sort of view this scale of acquisition as a kind of one off to get a platform in the U. S? Or could we see more acquisitions of this kind of scale in the future? Okay. Just on the EBITDA question, first of all, I mean, 2 real driving factors there. Firstly, they're really carrying forward from the last year or 2 the benefits, of growth and scale leveraging into their margin as they come into this year. And secondly, they've done quite a lot of work in the last year or 2 on their operations and their facilities and processes in Bolingbrook in Chicago. They put a lot of, automation in a lot of technology in And that's allowed them to, you know, improve their gross margin, but also reduce their overhead as well. And that's come through really strong, this year as well. So it's a great performance. In terms of acquisitions of scale, yep, you know, obviously, it's it's a it's a bigger one than than we've done before. But I know saying, you know, a bit earlier, it really takes all the business model criteria. You know, it's important strategically in getting controls into to the US. And the financial returns are obviously pretty strong. And of course, as diploma gets bigger, you know, therefore, we have the financial muscle to be able to do deals of this size. Now having said all that, shouldn't expect that we're gonna do one of these, every day. You know, our pipeline is full of the normal size of diploma acquisitions. But I think occasionally on how frequently is that, I don't know, a couple of years, whatever, if the right thing comes along, you know, we should be prepared, to look at it. And, I, I, and I think that's the way I would see it. And, you know, particularly for this deal, it may be a bit bigger, but as I said earlier, significantly earnings enhancing and, covering our cost of capital, I think it's great returns. All right. Thanks very much. And next we will take a question from David Brockton with Numis. Good afternoon. Two questions as well from me please. Just in terms of the ongoing growth opportunity, are there any sort of any obvious states still to expand into or where the business can add density? That's the first question. And then tied into the last question, just in terms of the short term COVID impact, I think you've given a sort of clear explanation for the margin improvement. I'm just wondering if you can give us a feel for how much COVID has slowed revenue growth in this year. I appreciate it's flat, but I just sort of keen to understand where it was and where the expectation was pre COVID. What geography wise, I mean, really, you know, there's a slide in there which shows the, the dispersion of their 19 facilities, which gives them really good geographical, coverage, which is great. But there's still very, very low levels of penetration across almost all of those markets. So I don't necessarily sit here and point to one geography or another. I don't think it's about that. I think it's more about these exciting technology orientated segments that they're growing into. And I think they have opportunities in those across all of the geographies within the U. S. In terms of the revenue profile, I mean, I guess like most businesses, I guess, through the tough months, it was a little tougher. But the results in the last few months have been, pretty exceptional actually. So they're they're coming through it well. As I said, revenues will be broadly flat for this year. And that's down from what has been double digit. What's going to happen in the future? I absolutely believe, as I said earlier, this is a double digit organic growth business. Clearly, there's a bit of uncertainty in the short term, as we all know, not just COVID, but getting past the election process. But once we do get past that, I'm really excited about I guess the pent up, industrial demand in the US, and I'm excited about that for windy city and our other US businesses. Okay. Thank you. And up next, we will take a question from James Sparrow with Barclays. Okay. Just just one left for me. It was it was if you could just give a bit more color on the the market in the U. S. For these products, obviously, given on slide 12, some detail on some of the submarkets on which operates in, but I'm just just keen to understand the this has obviously been growing ahead of the market, how that ahead of market growth has been delivered, what the competitive landscape is out there, how fragmented it is, or the, and the competitors and and and so on. Yeah. Sure. Sure. So the market for low voltage wire and cable is massive. We get pretty extensive market due diligence as part of this. The market is massive, so our share of it is minuscule. It's growing at around about 5 to 6% as a as a as a core market, if you like. As I said before, we're in pretty high growth technology based, segments. Building automation, and the growth that goes with that as a result of smartphone, energy efficiency, government regulation, government investment and residential development is really, really significant. On top of that, the investment into areas such as, data sensors in the US is particularly big right now. It's big everywhere, but the US seem to be really putting some capital behind it, perhaps trying to catch up with China from a technological perspective. So, there's real growth in that data center area. And as I said also, they're breaking into digital antenna and, you know, the opportunity there on the back of 5 g is is pretty massive because This is all about the infrastructure that goes around it. So the summary of all of that is that the market for wire and cable is about 5% or 6%. But the markets that we're in is probably in the 8%, 9%, 10% bracket. And then on top of that, as I was talking about earlier, the quality of their business model and customer proposition, the differentiating nature of what they do is taking market share. And that takes them from the 8, 9, 10, into the 11, 12, 13, if you like. So that's kinda like the profile of how their growth is made up. When you look at the competitive set and how are they taking market share? Well, they have, you know, a a cluster of very, very big high volume platform, low margin distributor competitors. So people like Belden, Anixter, W. C, Southwire, a few others. And then they have at the bottom end, you know, map of kind of regional moms and pops around around the country. And we're kind of in the sweet spot in the middle, which means You know, we're winning share from the big boys because we're able to deliver lower cost proposition a lower net cost proposition for our customers, we're able to be responsive and agile. And we've got high customer touch points and they struggle to compete with us on that basis and we take market share. And clearly at the other end of the market in the smaller, the smaller regional players, we take market share on the basis of scale, national distribution and indeed, quality of service proposition too. So we're right in the in the in the sweet spot, I think, in terms of, the market, high growth, end segments, and with the value prop that's gaining share, which I think, as I said, is really, really exciting. Yes. Thanks very much. And then sorry, I just had one extra one that I just came into my mind about the the figures that you've given for the pro form a EBITDA for this year. Is that that's after there's no sort of often with private companies, you get sort of management recharges or various things going through the P and L that wouldn't go through your P and L can you just check that's a sort of clean number that we can sort of build from for for next year's forecast? Yes, that's a clean number, Jane. And next we'll hear from Daniel Cohen with HSBC. Hi there. Good afternoon. Thanks for the call. My question is on operating cash flow. Just wondering how, that would grow, in in in the current year? Was that was that going to grow in line with with with EBITDA? Or is there some, some more CapEx involved in that. And second question is, obviously, proven resilient from what you're saying this year. And with a strong track record of double digit revenue growth, how soon would you expect that that double digit growth to resume, please. Okay. I'll take the first one and then Barbara can come back to answer the second one on cash. Well, look, I mean, it's a crystal ball, so I mean, the business is doing incredibly well. Is really well positioned. The track record is there. The end segments is there. As I was just saying, they're in a great position. You know, clearly a lot's gonna depend on how how we come through the virus, how we come through lockdowns. And a lot's going to depend probably on the US election and how, how tricky a process that turns out to be. You know, assuming that we can move into 21 and beyond who knows, in a slightly better environment, then I think they're in a great position to be returning to their historic track records. There's no reason why they shouldn't be. Barbara can ask answer on cash on cash. So it's a business similar to diploma generating very strong cash returns. And in terms of CapEx, the business is pretty well invested. Spent over $25,000,000 or so over the last 3 years upgrading that facility in Chicago and also investing in the assembly lines. So in terms of capacity, plenty of capacity there to accommodate the kind of growth we've seen over the last few years for the medium term. So we're not expecting to have to make any significant CapEx contributions. And we have no further questions in the queue. I'll turn the call back to CEO Johnny Thompson for additional additional or closing remarks. Yes, just a couple of closing remarks. As you can tell, we're really excited about it. It's a quality business fits well with our model. Well prepared for scale with great growth, potential. I think the returns criteria are absolutely fantastic. So overall, we're very, very pleased with it. We think it's a great deal. And we thank you very, very much for taking the time to, to listen to us and your questions today. I appreciate it very much at short notice. Thank you.