Riddle me this, riddle me that
January 14, 2022
Reflecting on 2021 and the TIC-related developments it brought during the festive break, I found that five developments stood out in particular – making them the five topics that, at least in my mind, TIC executives and investors should pay attention to and on which they should devote a bit of thought.
Neither am I a historian nor a politician, so I take China’s quest for power as a mere fact – nor do I have a crystal ball to forecast what is going to happen in terms of Chinese Covid-policy in the light of Omicron and potential shortcomings of Chinese vaccines. Therefore, three more fundamental thoughts.
In the past two years, we have witnessed a significantly more authoritarian attitude and policy-making of Xi Jinping and the CCP. Just think of the Hong Kong protests, the radical “Zero Covid” regime sending millions into super-hard lockdowns after just a handful of cases, the numerous crackdowns on tech companies, video gaming or footballer’s tattoos, or the sudden disappearance even of celebrities such as Jack Ma or Peng Shuai. In such an environment, I wouldn’t expect any form of leniency towards most Western companies (except towards the very few “national crown jewels” e.g. such as Airbus enjoying maximum political protection by the resp. home country’s government – which is certainly not the case for TIC).
Personally, asking myself where all this is heading, I see remarkable similarities with another country that had risen to massive economic power quickly and that, at its peak, was expected by many to play a dominating role going forward: Japan – more precisely the Japan of 1989 with its powerful keiretsu, extremely strong position in electronics and microelectronics and mighty carmakers. Apparently then, a country conquering the world with never-heard-of-before but soon iconic brands such as Sony, Panasonic or Toyota, whose people flooded the world’s disguised as tourists, affluent enough to buy any piece of fine art, and with massive cultural impact. Seemingly invincible, but also faced with an insane property market/asset bubble and starting demographic decline. We all know how the story continued, in the case of Japan.
And with only an estimated 200-300 thousand foreign nationals remaining in China, predominantly in Beijing and Shanghai, today even North Korea is home to more foreigners per capita than China. In other words: it is very unlikely for the average Chinese to meet a non-Chinese person. Combine this with steady government reminders that foreigners are health threats as they potentially bring back Covid-19, and those reports on growing xenophobia in China shouldn’t surprise anyone. To this end, maybe not the Japan of 1989, but the one of 1639 provides the more relevant historical analogy: a country deliberately turning away from the world, sealing itself off, choosing total (yet splendid?) isolation.
The question for TIC: Whereas further liberalization of the Chinese domestic TIC market was presented as a major opportunity a few years ago, the industry has grown quiet on this, for good reasons. However, against the new political backdrop, which fate will await the existing foreign TIC operations in China? Are they destined for a “death by a thousand cuts”, a piecemeal souring of business conditions with steadily increasing bureaucracy and with more or less implicit and more or less drastic discrimination?
Considering the above mentioned, unsurprisingly what was hardly more than a theoretical concept three years ago has now become bipartisan mainstream in the U.S., with the Uyghur Forced Labor Prevention Act as the latest example. The true extent of Decoupling remains unclear and probably is not too pronounced – yet. However, the political will is there, most likely both in D.C. and in Beijing. And China’s tenacious implementation of “Zero Covid” even against such a contagious virus variant such as Omicron could disrupt production and supply chains further, maybe unnerving trade partners up to a point at which they might start looking for alternative sources.
The question for TIC: To which extent and how can the industry benefit from Decoupling, e.g. by providing prove that goods are slave-labor free and so enabling importers to rebut the UFLPA’s default assumption, i.e. “clearing an item”? And is this going to offset potential losses in the “China exports business”?
It went almost unnoticed by the broader public outside the UK that Amazon last year started offering PCR tests, at a competitive price of GBP 34.99, through its Salford testing lab. While this lab at first had a purely internal focus, providing Covid testing for Amazon‘s workforce, the company chose to expand to the (for the time being) flourishing market of Covid testing, further utilizing the lab’s capacities. The move was much welcomed by consumers and government as it created a reliable “go-to”-address in the wild-west-style Covid testing market with many questionable/not very reputable providers.
Ultimately, this could be the first real step towards “Prime Health”, as forecasted e.g. by Silicon Valley veteran John Doerr of Kleiner Perkins about three years ago. And as with “Amazon Prime” in general, this could pose a massive challenge for all others, as Amazon’s business case tends to be a distinctly different and predatory one, not necessarily requiring full direct cost coverage due to significant cross-selling effects, income generated from general platform-related services (e.g. Alexa) and data analytics services and revenues.
The question for TIC: If Amazon really developed an appetite for lab testing services, and if Amazon really did not need to recuperate the cost directly, what would this mean for lab testing-heavy TIC players such as Eurofins? Would they be able to contend or would they have to succumb, sooner or later? And wouldn’t it be convenient for Amazon to just buy a large lab tester such as Synlab?
With governments now being more serious about fighting climate change, at least in Europe, the shortcomings of the established idealistic narratives on the future of power generation have become evident. Much has been said about the fluctuating nature of Renewables; as it seems, the idea of combining them with natural gas-fired turbines as a rapid backup does not necessarily work well in the absence of Russian gas, leaving aside the massive industrial challenge of building several dozens or even hundreds of them within only a few years. With CO2 now being the prime enemy, low-carbon nuclear power suddenly becomes a viable, tempting option again – for example for the EU commission. And NPPs are great TIC assets, with all the dangerous radiation, many kilometers of pressurized piping and massive amounts of concrete – both as a CAPEX and as an OPEX business.
The question for TIC: Is it about time to re-value nuclear-heavy TIC companies such as Apave or TÜV Nord? Which TIC players will be able to capitalize on this development?
Numerous people more competent than me are trying to get their heads around my final point, so I’m not going to bore you with weakly substantiated assertions on inflation. The question remains to be answered whether or not it will turn out to be transitory or remain on higher levels for a longer period of time. In case of the latter, we know that this wouldn’t bode well for margins in many regulated TIC services, as regulators only sluggishly approve price hikes, effectively leading to negative real topline growth while cost positions such as wages explode.
The question for TIC: Is it about time to de-value TIC companies with strong exposure to/positions in regulated TIC services? If inflation persists, how are these going to deal with inflation-induced margin erosion?
Itevelesa: Facts and perception
April 7, 2021
Miguel de Cervantes is widely regarded as the greatest writer in the Spanish language, and one of the world's pre-eminent novelists. One cannot underestimate his importance for and in the Spanish culture, similar to Shakespeare’s importance for the English and Goethe’s for the Germans. Logically, Cervantes was selected for the flipside design of Spain’s 10, 20 and 50-Eurocent coins.
He is best known for his novel Don Quixote, a work often cited as both the first modern novel and one of the pinnacles of world literature. In search of adventure and glory, Don Quixote excels in fierce battles and heroic deeds – at least in his perception and memory, whereas the real events turn out to be less dramatic, but often tragicomical, such as the fight against windmills. In Don Quixote, Cervantes illustrates and reminds us that “facts” and “perception” can differ considerably.
At least until now, this is still a blog about Testing, Inspection and Certification, and not about Spanish literature. We only had to think of Cervantes when we read the news that all of the German TÜVs are considering a bid for Itevelesa, currently owned by Hayfin Capital and put up for sale.
Why this? The deal seems to be a rocksolid opportunity: a regulated activity with attractive profitability and stable cashflows, in a country “just around the corner” in the Eurozone, fitting well to existing activities. The Spanish vehicle fleet has grown nicely in the last five years and can be expected to grow at 1.5-2.0% p.a. going forward, getting closer to Italy in terms of cars per capita. Expected acquisition price multiples of 9 to 12, maybe 13, feel modest and acceptable, and acquisition price would be recouped after 8-10 years. What can go wrong with this?
It will not surprise frequent readers of this blog that we prefer to take a slightly different view on this acquisition opportunity. The very appealing stability of the business seemingly reduces risk and uncertainty, and apparently allows reliable forecasts – as one would like to believe. But even this business is subject to forces beyond Excel formulas. From our point of view, it is thus quite important to consider the backdrop on European and national level, reflecting the big picture of politics and macroeconomics.
EU enthusiasts may dismiss the following as Swiss sneer or Brexit bravado, but let’s face it: the EU is not in a good shape, as numerous episodes such as the Covid vaccine disaster or the repeated succumbing to Turkish refugee bullying have shown – leaving aside the internal fractions of North vs. South and East vs. West. At the moment, it’s a political zombie, with depressing economic growth. An inconvenient truth can be found in the World Bank’s GDP statistics: The Euro area and the US economy were the same size 25 years ago, but the latter significantly outperformed the former and is now (depending on currency base year and PPP) about 25-50% larger. Even worse, since the end of the GFC, GDP in the Euro area has more or less stagnated.
But maybe, with Mesdames Lagarde and von der Leyen, things will get better from here on, thanks to initiatives such as the “European Green Deal”. However, maybe not for Vehicle Inspection: if the European Commission is serious about moving “towards near-zero emission transport as soon as possible” (Commission Vice-President Frans Timmermans at a recent ACEA event), it might feel compelled to simply ban combustion-engine vehicles or bluntly limit the overall size of the car fleet. Why? Because according to e.g. Greenpeace, if the EU wants to reach the emissions reduction targets it has committed to in the Paris Climate Accord, it will have to get all combustion-engine vehicles off the road by 2040 – and halve the remaining fleet of fully electric vehicles.
Admittedly, this is just one potential scenario, and not even the one with the highest probability. Perhaps more likely is that Marine Le Pen takes the Élysée in next year’s French presidential elections, installing a mega-eurosceptic at the very heart of the European project. Don’t think so? 48% of French voters do. This would unleash centrifugal forces of a different kind, most likely trigger “Eurocrisis Squared” and sound the death knell for the Euro. For Spain, this would mean to return to the Peseta, which would likely instantly be subject to significant devaluation.
So, macroeconomically, on the European level, we’re faced with a lovely set of scenarios: either continued zombiedom, or a politically successful EU that destroys the very basis of the SVI business, or an imploding EU and Euro that leads to a massive devaluation of assets in “Eurocrisis countries”.
In addition, on the national level, things do not look so bright, either. The Spanish economy never managed to fully recover after the Financial crisis and continues to stand on a wobbly foundation. Side effect of this: Youth unemployment persistently sits above a frightening 30%. Moreover, the very fabric of Spanish state is unraveling, faced with separatist movements in Catalonia and the Basque country. The political system is becoming more and more polarized, with right-wing party Vox as the main beneficial. Spain is not a failed state, but seems to be falling apart in slow motion. Not the kind of stability you would like to have for a business so dependent on government decisions.
Seriously: against this backdrop, why would anyone invest in a low-growth business in a country like this, at such high price? Just because you have been there on holiday a few times and believe you know the country?
In contrast to word on the street, we’re not obsessed with denouncing SVI, but this just does not seem to be the best destination for deploying capital. And for the TÜVs, it would be a huge investment and mean to put many eggs in one basket. An alternative strategy could be to spread the investment across a number of targets, e.g. in Asian economies destined for further growth.
Finally, ask yourself one question: If Spanish SVI is such a great business, why does Hayfin want to exit right now, in the middle of a global pandemic? It could very well be that you have read part of the answer.
Sustainability TIC: Becoming
March 15, 2021
Sustainability is the word in TIC these days – one only has to read the FY2020 results presentations of the larger listed players. Bureau Veritas even chose to elaborate on the topic as one of its strategic focus areas, on no less than 12 pages. The only challenge so far has been that many of the TIC services performed in this field were, let’s say, “not very compulsory”. In the absence of real regulatory requirement or tangible economic incentive, it was easy to dismiss them as “feelgood activities” and “greenwashing” – and not even entirely wrong doing so.
The voluntary nature of much of “Sustainability TIC” also complicated calculating the business case, and the “Sustainability” growth story built on optional “nice-to-haves” did not appear too compelling. In a way, it was and is all built on the idea that people want to live, act and consume in a more sustainable way, fighting climate change and reducing environmental impacts, and that in their function as consumers will reward companies that live up to that expectation.
A nice narrative, undoubtedly, but maybe not fully in line with reality, as e.g. the European Investment Bank’s recently released Third Climate Survey – probably unintentionally – confirms (https://www.eib.org/en/surveys/climate-survey/3rd-climate-survey/what-to-give-up-for-climate-change). Its results in a nutshell: Only a minority is willing to commit to a permanent drastic change of their behavior and consumption patterns, with the largest group being 43% of respondents willing to reduce or abandon air travel. Maybe climate change awareness – or painful memories of Ryanair’s seat pitch, post-crisis economic necessity or the result of Instagram and #vanlife. And after all only relevant once or twice a year, for most people.
Tougher decisions with an impact on everyday life, such as giving up meat, abandoning the car or canceling the Netflix subscription, appear even less popular, acceptable for only approx. 20-30% of respondents. N.B.: Ironically, surprisingly, and in contrast to the media frenzy around “Fridays for Future” and “Extinction Rebellion”, especially the age group between 15 and 26 years is least willing to say goodbye to burgers, Ibiza, videostreaming and cars…
Can such shaky ground be a viable foundation for the future of the industry, replacing today’s rock-solid cash machines such as Oil & Gas Opex services? Doubtful. However, beyond the wishful thinking of voluntary behavioral change, Sustainability gradually becomes part of regulation and is made compulsory. And that opens the door for the TIC industry and its services.
A good example for that is the Swiss-Indonesian Agreement on Economic Partnership, finally accepted and cleared in a referendum eight days ago. The key political roadblock on the way to this agreement was palm oil: One of Indonesia’s main agricultural export products, met at least with scrutiny and often with outright opposition due to massive environmental damage it has created and creates; most of us have seen the unsettling images of burned-down rainforests and disoriented Orang-Utans lost in a desolate landscape.
Both countries were thus faced with a severe conflict of interest: For Indonesia, palm oil is a tool for fighting poverty, for Switzerland (and the rest of the West), importing palm oil from cleared rainforests is an environmental no-go. For bridging that gap, negotiators had to come up with a novel solution.
In the end, a clever mechanism was found: The agreement contains a mechanism on preventing exports of palm oil from cleared rainforests and rewards sustainable production. Import taxes are only lowered for palm oil that was certified as sustainable under the rules of a trustworthy scheme by a neutral 3rd party – economically incentivizing eco-friendly production. Suddenly, for Indonesian palm oil farmers, sustainability certification pays off, in hard currency.
Only such a gradual ingraining of Sustainability into regulation will turn it into a reliable TIC business, one that will justify the high hopes associated with it. This will happen, maybe increasingly and faster if novel ideas such as the Swiss-Indonesian accord are successful, but it will take time. Until then, we don’t believe the hype: This industry is still built on the greasy ol’ TIC stuff that unfortunately doesn’t look and sound that fancy and avant-garde.