Intertek/Alchemy: The name tells it all
Nov 23, 2018
There are a number of aspects that could be debated concerning Intertek’s acquisition of Alchemy, a US-based provider of what has been labeled “People Assurance solutions”. First, the still ambiguous term of “Assurance” itself, which in our view to a large extent only subsumes a number of established TIC services under a fancy and cool-sounding new term – in the case of Alchemy e.g. what others call “Training”.
Second, how significant the opportunity of transferring the service to other industries really is, because it’s far from being novel there. And third, whether the strong demand of the North American food processing industry with its large share of unskilled (and in some cases illegal) low-pay workers for such a “learn, train and monitor how to do the job right”-solution translates into similar demand in other industries with considerably different, higher-skilled and trained workforces.
While these points may or may not be subject for debate, it is another point that caught most of our attention: the strikingly high purchase price of almost half a billion USD that Intertek was willing to pay for a USD 66m business.
In its press statement, Intertek provides a 5-year forward guidance, to shed a bit of light on (and justify?) the economics of the deal. Double-digit growth rates may arouse a certain suspicion in the current TIC industry environment, but let’s leave this aside for a moment and believe in 20% growth in every year until 2023 and an EBITDA margin of 33.3% then.
Even with this, Intertek will have paid an 8.8 EBITDA multiple (based on 2023 financials as calculated above) – not mentioning the stunning EBITDA multiple of 21.8 based on 2018e financials. This dwarfs even many of the aggressive Private Equity deals in the industry and the USD 730m Moody acquisition (11.1-13.4 EBITA).
That being said, there might be powerful hidden synergy potentials unbeknown to somebody not involved in the deal. Hence, we might systematically undervalue the target and come to unfair and misleading conclusions. However, after looking at the target’s business model, we arrived at the questions pointed out above, which we consider as valid ones.
From our point of view, the rationale behind this acquisition is not straightforward, the business plan is ambitious (to say the least) and the purchase price looks very high (both in absolute and relative terms). In other words: this deal feels like quite a big bet and in our opinion is another clear indication that M&A in TIC seems to spiral out of control.
JSTI/Eurofins/TestAmerica: Money talks
Nov 16, 2018
When Eurofins recently announced to acquire the US environmental testing laboratory TestAmerica from its Chinese parent JSTI, an engineering and infrastructure monitoring and testing specialist, one of the TIC industry’s most interesting stories came to a sudden and surprising end. JSTI had acquired TestAmerica only two years ago in September 2016, in a deal that was hailed as the first major China-US cross-border deal in environmental testing and that JSTI had described as “genuinely strategic” and as a building-block and key step in the global expansion of its business.
In these heavily politicized days, it may seem likely that this Sino-American business combination was finally overwhelmed and thwarted by the growing economic tensions between the two countries. In such a narrative, JSTI finally realized that the deal is unlikely to work going forward in an environment of mutual disadvantaging, and “opted for the bird in the hand”, i.e. selling the business for a decent price while still possible. Indirectly, this would imply a “cave donaldum”-logic – “Trump as the trigger”.
The truth is probably a lot less dramatic and less influenced by politics, as far as we are able to tell based on the facts available.
Deal rationale 1: It seems that JSTI increasingly lost the belief that the idea can be implemented successfully and that the cooperation will work in the end and deliver the envisaged results . A clear indication can be found in the Executive Summary of JSTI’s 2017 Annual Report, where management admits that “a significant difference exists between the two companies reg. relevant laws and regulation, accounting and management systems, business styles and corporate cultures” and that “it is uncertain whether the integration will be successful and whether the economic goals of the transaction can be attained”.
Deal rationale 2: The achievable return on investment probably was too tempting. With Eurofins paying an acquisition price of USD 175m, by rule of thumb JSTI has made a USD 50m profit on its initial investment in TestAmerica – an impressive 40%, even though the company has hardly grown in the last two years. Who could resist such a payback that, especially if the outlook (both operationally and strategically) is rather dim?
Deal rationale 3: Eurofins seem to expect “the usual” significantly higher synergies than JSTI from improved lab operations and Economies of Scale, which directly translate into higher EBITDA and valuations. But apart from the “integration machine” argument, there are also strategic reasons: With the deal, Eurofins become the undisputed No. 1 in environmental testing in the US and significantly expand the geographic footprint.
Not surprisingly, our takeaway thus is that the idea of cross-pacific Chinese-American TIC business combinations is not dead because of this – in our view, it wasn’t a wrong strategic rationale that killed the original JSTI-TestAmerica deal. Rather, it fell prey to a unique opportunity too compelling.
In a broader perspective however, the deal still raises the question whether only very ambitious, hyper-efficient and aggressive players such as Eurofins find M&A value-accretive in TIC at the moment. Price tags have reached a level that maybe only these players find palatable.
This rather might be perceived as another vivid example of a certain recklessness reg. M&A in TIC. 40% price increase at no growth in just two years, in a segment that has hardly expanded in the last years – these are the economics of a price bubble.
JSTI probably was more level-headed and cold-blooded than many Western counterparts might have been. It chose to relinquish its strategic plans because the short-term profit of a premature exit seemingly was too tempting. Sharp thinking and logical action, but at the same time not a good sign for the TIC industry if strategic investors happily abandon it.
China-US trade tensions and TIC: Collateral damage
Nov 8, 2018
SGS’ downward adjustment of its 2020 margin goals, and the fact that the No. 1 of the TIC industry to a certain extent attributes this to US/China trade tensions and tariffs, has underlined the importance of the topic. Global trade growth has been one of the key tailwinds in the “Golden Age of TIC” until 2014. Escalating trade tensions between the US and China could have the opposite effect, i.e. cause declining product testing revenues and harm the TIC industry’s growth.
The trade dispute with China has been a distinct element of the Trump presidency from his very first day in office on, when he decided to withdraw from the “Trans Pacific Partnership” free trade agreement. The trade controversy reached new heights this summer and autumn when President Trump ordered further tariffs on imports from China and the People’s Republic retaliated in similar vein. At the moment, US tariffs of 10% cover USD250bn of the ~500bn imports from China, and similar Chinese tariffs around 50% of US exports. Hence, a large share of bilateral trade is already affected by the trade dispute.
Tension will automatically heighten further by January 2019, when US tariffs will increase to 25%. Moreover, if trade talks fail in November, the Trump administration will impose additional tariffs on the remaining Chinese trade volume of ~USD 250bn so far not covered.
This is already putting the established sourcing and supply chain patterns under stress and may trigger their re-alignment, i.e. a shift or “migration” of sourcing and exports to other countries. The exact extent of this is difficult to assess, as for example one factor will be how much of the tariff-related cost could be passed on to secondary buyers and consumers. If furniture from China is still cheaper than that from North Carolina, even at a 25% tariff, then this will not affect the sourcing pattern and rather lead to (somewhat) higher prices for consumers. If not however, relocating production might make sense – unclear at the moment. This might explain why many TIC customers are still in what SGS has called the “wait and see”-mode, creating uncertainty for the TIC industry.
But what if this Sino-American trade confrontation escalated into fully-fledged trade war, with blunt import bans or prohibitive tariffs? In this next level of escalation, global supply chains and trade patterns would clearly re-align significantly. Direct, bilateral trade and sourcing relationships between China and the US would unravel and fully shift to other countries not involved – i.e. to/from Europe, Latin America and South East Asia.
Global trade relationships would potentially re-organize in two separate hemispheres / around two separate hubs. In general, “neutral” regions could benefit from such further heightened tensions, if the adversaries do not demand loyalty from their allies/partners and mutually exclude “membership in both hemispheres” in strict “negative preferential trade agreements”.
Consequences for Chinese exports to the US: The US predominantly buys electronics and IT equipment in China (e.g. mobile phones, computers, telecommunication equipment) and machinery. One could expect that the former would in part experience a certain “re-shoring” and in part be re-shifted to South East Asia, whereas the latter might be an opportunity for European OEMs.
Consequences for American exports to China: China’s major imports from the US are passenger aircraft, soybeans and vehicles. South American producers will happily try to fill the gap for soybeans – Brazil has already overtaken the US as the most important exporter. US-substitute soybean exports could be a lottery ticket win for Argentina’s much-battered economy and create unusual new friendships. Reg. planes and cars, China would most likely try to promote its own OEMs, albeit this could turn out to be a problem in the short-term, at least in the Aerospace sector (can’t do without Western technology at the moment). Shifting to European OEMs of course would be an option, but one that would contradict many of the Chinese government’s strategic goals.
What would all this mean for the TIC industry?
- As a result of significant re-shoring of electrics/electronics manufacturing from China to the US, the “Chinese export-driven TIC business” in this field would be hit in a core area – harming a major source of revenue and profits in “Consumer Products”. In this case, the “Consumer Products” segment as a whole could lose some of its growth potential and appeal, which would exacerbate the TIC industry’s strategic challenges. Such a re-shoring scenario is not too implausible, considering the US’ still strong industrial base in E/E manufacturing and interest to regain technical sovereignty (at least reg. computer motherboards, maybe not reg. toasters or blenders). Technically, trade-related TIC activities would be transformed into US domestic market access services.
- In addition, further fostering trade and exports does not seem to be a priority for the Chinese government anyway. Most of China’s growth has recently resulted from domestic consumption, and the Chinese government pursues additional efforts to encourage this further and to spur the shift towards an economy driven by domestic consumptions – also to counter potential “losses on the trade front”. In this context, China has even lowered certain tariffs to encourage consumption. In a nutshell: The “Chinese exports-driven TIC model” is most probably “topping out” anyway.
- This means that the TIC industry would have to adjust its lab networks and footprints – maybe a painful adjustment for some. Players with strong market position in “relocation” countries would benefit, whereas those strong in the “Chinese exports business” would be disadvantaged.
- As a side-effect, a trade-war could foster and accelerate the Chinese efforts to build a national TIC champion, in order to gain further/more control over trade and exports. A Chinese TIC champion could be a useful tool for enforcing “negative preferential trade agreements” and controlling imports.
- On the other hand, those TIC players positioned and able to support the “substitute sourcing efforts” of the two adversaries would benefit. For example, TIC players with a decent footprint in Latin American agriculture, especially in soybeans in Brazil and Argentina, might embrace and celebrate the development.
Further escalation even beyond this is of course possible. At the moment, all political wrestling affects direct trade flows, but not indirect trade. In an extreme scenario, even such products from a “neutral” country but with a considerable share of American or Chinese parts or assemblies could fall under trade rules. This would imply a further disintegration of global trade and manufacturing patterns. Sounds ludicrous? Some might have said this about Chinese spy chips on motherboards as well…
If there’s one takeaway for the strategist in TIC, from our point of view, then this: Don’t build all your dreams on Consumer Products – or they might be over sooner than you think and leave you with a nasty headache.
The Brewing U.S.-China Trade War, Explained in Charts: https://www.barrons.com/articles/the-brewing-u-s-china-trade-war-explained-in-charts-1523052689
Why Soybeans Are at the Heart of the U.S.-China Trade War: https://www.bloomberg.com/graphics/2018-soybean-tariff/
Consumption contributes to nearly 80% of China's GDP growth: http://www.chinadaily.com.cn/a/201809/20/WS5ba30475a310c4cc775e7413.html
China redoubles efforts to boost domestic demand as trade war bites: https://www.reuters.com/article/us-china-economy-consumption/china-redoubles-efforts-to-boost-domestic-demand-as-trade-war-bites-idUSKCN1M10LG
China hits back at Trump with tariffs on $60bn of US goods: https://www.bbc.com/news/business-45555749
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