Opinion: Paul Vanstone

Two new deals in the automotive diagnostic market in recent weeks, with the secondary management buy-out of Autologic and the acquisition of SPX Service Solutions by Bosch for a healthy 12.7x EBITDA.

Whilst both companies operate at different points in the automotive diagnostic market, having been part of the Catalyst team that completed the Autologic deal, I am sure that the sector will continue to grow on the back of the increasing number of control units and sensors in passenger vehicles. Also, as I wrote in my last piece on the sensors market, the notable but rapidly narrowing technology gap in Chinese versus Western produced cars is expected to further compound this demand.

As the wider industrial landscape adopts new technology the requirement to be able to monitor, upgrade, diagnose, and repair control units and sensors will become increasingly important. We expect technically differentiated companies to be able to demand a valuation premium within attractive niches.

In recent weeks, I've spent a lot of time on the phone talking to my contacts about our latest industrial electronics research report, which focuses on the sensors market.

With sensors now being core components in almost all technology products, it is clear that the demand for sensors will grow despite the uncertainties in the world’s economies. For example, one of the interesting statistics produced by our research team is that there is potential for major growth in the sensor market in China – with the current sensor content of a Chinese manufactured car for example at 50% less than that in North America and Western Europe, it does not take a rocket scientist to work out that growth in this market is possible!

The majority of deals to date in the sensor market have been under £100 million in value, and with Private Equity investors active (completing a fifth of all transactions since January 2010) along with significant international corporate acquirers, it perhaps is not a surprise that valuations have been above the average for the industrials sector, our research showing that it isn't untypical for buyers to pay 8 x EBITDA for a sensors business.

With growth in short supply in most markets in early 2012, I think next year may well prove to be an opportune time for those operating in the sensors market and I am expecting valuations to hold up well in the light of this research.

I have been reading through the detail of VP plc’s recent half-year results announcement, and it makes for generally good reading for shareholders in an altogether tough market.

Strong growth in both the oilfields and trackside divisions, newer parts of the Plc’s services umbrella, masks much more difficult times in the core hire and construction markets, which is no surprise given our own recent work with others in this tough marketplace.

Whatever 2012 brings, there is no doubt in my mind that the early part of the year will continue to be tough for all those involved in the hire market in the UK, and VP looks in better shape than most. I am not sure I’d want to become a shareholder mind you, however at some point this market will turn, and with a number of competitors in trouble and valuations at a relative low, VP may well emerge all the more stronger when construction finally picks up in the UK. It is just a question of when!

As you might expect, I am often asked by existing and prospective clients in the engineering sector - "is now the right time to sell?"

It is, of course, a critical question – with the wider economic outlook uncertain and broader engineering growth expected to fall next year, "no" might be the obvious answer, however... on the contrary. Now may indeed be the best time to sell a business in this sector.

So, why might that be?

Firstly, larger industrial firms (as a buyer group) are on the acquisition path again. As we have commented on several times recently, engineering firms, like those in other sectors hit during the downturn, have taken substantial costs out of their businesses and, according to our research, have reduced debt burdens from approximately 3 to 2 times EBITDA since 2007.

Secondly, UK engineering firms often have a substantial proportion of their revenue derived from overseas customers and sterling’s generally sustained weakness has inevitably helped to inflate earnings. Coupled to this our regular conversation with overseas acquirers confirms that they are using their restructured balance sheets and sterling buying power to accelerate their acquisition led UK growth strategies. Indeed those that are capable of being more acquisitive will, if properly executed (REAL synergies are more important than ever), be in pole position for the eventual wider recovery. The importance of overseas buyers should never be underestimated – about 50% of our sell side mandates are to this audience and we use our international network extensively to ensure we fully tap into this often critical buyer pool.

Thirdly, good quality businesses are still attracting solid multiples that mirror 2007 levels, in part helped by the lack of such companies being marketed at present. The wall of mid market private equity money (admittedly with a more limited debt market in play) is further underpinning competition for such assets.

We are currently finishing our latest selection of the fastest growing private UK engineering and industrial products SME’s. This shows some excellent examples of high growth quality businesses, particularly in the oil and gas, automotive and defence sub sectors.

So is now the right time to sell an engineering business? Depending on your buyer audience, it may never have been a better one!

Our routine conversations with international engineering firms have increasingly centered around the need for companies to expand their product offering and the importance of having one foot in cleantech has never been more relevant.

In our opinion consolidation is very much on the agenda and as recent transactions have shown bolt on acquisitions are, as ever (if properly executed), an effective way of expediting strategic capability.

Two deals that have caught my attention in recent weeks have been the acquisition of the wind turbine gearbox manufacturer Hansen Transmissions by ZF Friedrichshafen and the GKN buyout of Stromag, the designer and maker of drive components. The Hansen deal had a huge effect on the market with the share price almost doubling after ZF made their initial offer and the 14.3x EBITDA premium paid brings back memories of the pre crunch valuations achieved in the wind turbine sector. The ZF core business has been the manufacture of driveline technology for the automotive sector but in recent years they have diversified into the rail, marine and aviation sectors and in 2007 entered the wind sector. Last year ZF signed a deal to supply Vestas, a key client of Hansen, with wind turbine gearboxes and this proved to be the catalyst for the decision to extend their capacity in the wind sector.

ZF will hope that their acquisition is better timed than that of the previous owner Suzlon who presided over a painful period for Hansen that included restructuring, closures and job cuts. The synergies and natural fit that cleantech has for the engineering space make this deal a potential industry precedent.

Engineering and cleantech remain sectors that I follow closely and the synergies that ZF has identified in Hansen will continue to ring true for the consolidation to come that we foresee in the mid market. Whilst some uncertainty remains in terms of short to mid-term cash flows and the ability to forecast the effect that domestic and EU regulation could potentially have it is my view that fossil fuel scarcity will ultimately underpin long term demand (and therefore strategic price paid) for engineering firms that are able to demonstrate capability in the ever evolving, growing and sustainable ‘green’ sector.

Catalyst will be co-publishing a global sector report on the cleantech industry with our international partner firms, which will be available at the end of the summer. The report discusses cleantech mid-market M&A across the world’s major economies, touching on all renewables including wind, solar and energy from waste as well as energy efficiency and advanced cleantech technologies and looks at the short to medium term opportunities.

Advertising does seem to have bounced back well after a long stretch of underperformance dating back to the economic uncertainties of 2008.

Budgets are holding up well with the total amount of pounds committed by advertisers up 8% and online/digital spend on track to grow 20% this year according to some industry research I was reading the other day. I guess this is because the complexity of the media landscape has allowed media agencies to become more valuable to clients as budgets shift from TV-centric to a much greater digital spend across numerous channels.

However gloomy predictions and aborted private equity approaches have not as widely predicted seen the end of TV as we historically knew it. ITV recently reported outperforming the market by 42% since 2009 and remain buoyant despite competition from other mediums. Our German partners also report that private equity owned ProSiebenSat.1 recently agreed to sell TV and print operations in the Netherlands and Belgium for £1.225bn (10.6x EBITDA), indicating that positive trends are returning to the market and a potential exit is once more a realistic possibility for private equity and owner managed businesses.

Recently released figures indicate TV consumption has increased in all European countries (3.3% a day) and in the US (1% a day) in the last two years. In contrast the closure of the News of the World takes print media closer to a potential tipping point. Recent research has pointed to the dual consumption of TV and Online - good for advertising spend and typically seen in the case of viewers watching interactive TV shows and simultaneously commenting on social networks (Anyone for The Apprentice!?)

Interestingly it is the online players who are targeting the cash that continues to flow into TV. Reports recently of Google and Yahoo trying to capture a share of TV advertising budgets in the form of internet video and multimedia content will not surprise TV and advertising executives who predict spending on TV advertising will still be double that of online.

Media remains a market I follow closely, and in light of the above I am convinced there will be attractive exit opportunities for mid-market companies in the UK over coming months as channel divergence continues to intensify.

Microsoft's deal to buy Skype only serves to highlight M&A trends we are seeing in the wider mobile and telephony market.

With continued record levels of smart phone sales (see recent announcements from the likes of Carphone Warehouse for example) and the growth in mobile advertising, large corporate and media companies alike continue to look to build their mobile and internet capabilities. This, interestingly for me, includes not only established online players (for example Valueclick's recent acquisition of Greystripe, a large mobile advertising network) but more importantly players from outside the sector looking to build capability - Walmart's acquisition of search engine business Kosmix and in this country Morrison's acquisition of Kiddicare, primarily (per the press) for its online platform).

As sector momentum increases, there will no doubt be some fantastic opportunities for owners of quality companies in the mobile and internet space to raise capital and realise value.

Equally owners need to be aware that the valuations talked about for companies such as LinkedIn and Groupon may well be beyond belief (a separate debate)!