Friday, 18 March 2011

Company Focus – Edwards Group Ltd – Catching the Eco-Tech Light & Implying 'Strategic Stretch'.

As has been aired before, the last web-log piece questioned the ability of various well publicised clean tech solutions and companies to make the fundamental eco difference.

As seen historically, any ideal of a metaphorical 'eco-tech train' which sees inter-relating, conjoined solutions provide powerful real-world 'eco-traction', is all to often philosophically 'derailed' by the PR noise of capital-seeking fringe technologies publicised as the great new hopes.

This then has become the norm, and almost expectant, where science meets money; a potential gold-mine for the 'commercial arbitragers' previously mentioned.

Hence, the investment-auto-motive's call for greater capital markets' emphasis on those established and emergent 'paradigm developers' / 'paradigm shapers' who are either proven in their field, and/or comprehend the commercial realities - as opposed to those 'paradigm shifters' who either may be over-optimistic and nave, or at worst deploy charisma, apparent virtue, dynamic ipad presentations and idealised business projections.

This then re-orientates eco-focus away from the big scheme ideologies that typically abound much hyped within Palo Alto, and looks toward Germany's characteristically low-key Mittelstand originating from which came many of the 20th century technical advances. This philosophical re-orientation must obviously also encompass a fly-past apprehension of pertinent eco-tech activities in the locales of Cambridge, Massachusetts and Cambridge, England. So as to gauge the scientific near-horizon and identify meaningful solutions that can practically link to our technical past, which itself created our technical present, that present linked to the global future.

In essence, not so much a flight from American optimism, more a draw toward European pragmatism and EM realism.

However, this does not necessarily mean prohibition from general logical exploration, nor restriction to only the evolutionary refinement of conventional technology and business templates. The on-going structural re-shaping of sectors such transportation (with its “M&A Deal Appeal”) and the inter-mingling of interests between energy providers and 'rail & road' operators, should create opportunities for new longer-term business models which can progress new technological developments.

[NB With such a scenario the use of PHEV bus technology which used rail-side e-charging for zero-emissions urban travel and ICE for motorway travel might eventually become feasible].

But, for the most part, without such large-scale 'sector re-formatting', technological solutions and user expectations go hand in hand. The speed of step by step advancements made typically via the equilibrium between consumptive demand and competitor-set pace. In addition to this a sector's own level of maturation must be considered since when an economic, operational & expectancy norm has been reached, the sector model itself becomes a component part of the national, regional and international economic good.

[NB This is why the UK's antiquated, labour intensive house-building process which was technically bettered by the 1920s remains virtually unchanged, an entrenched method & materials plus limited competition at the local level means little evolutionary progress].

Hence those companies positioned at the leading edge of the paradigm are arguably best placed to evolve the technological practices of the sector, with the forces of competitive threat/advantage and what will be soft regulatory demands creating the necessary impetus.

One such company seemingly arguing its case as such is Edwards Group. This British name harks back to 1919, its owners (American) CCMP Capital Advisors & (Asian) Unitas Capital, now wishing to (re)float on the LSE after a 40 year absence.

Its long held core competence is the manufacture, retail and after-sales service of vacuum-generating machinery and gas abatement systems, primarily consisting of pumps, valves & seals.

These for use in a plethora of well established industrial activities spanning steel foundries, various metallurgical methods, metal coatings processes, chemical-plants and power-plant energy generation. These heavy-industry activities were latterly joined by providing vacuum solutions for other 'intermediate' arenas, such as: scientific instrument production and use, academic & corporate laboratory equipment, 'thin film' coating of lenses and architectural glass and pharmaceuticals And latterly Edwards has focused upon 'emergent technology' spaces involving: semi-conductor manufacturing (which although not new evolves quickly), Nanotechnology, FPD (Flat Panel Display) and in the clean-tech arenas of: Solar PV (photovoltaic)and LED (Light Emitting Diode).

However, it must be stated that whilst the company serves a broad and technically intriguing client base, its primary activity is in producing vacuum-creating equipment is undoubtedly deep yet relatively narrow in its own right. Edwards is then the archetype specialist which comprehensively understands a field, the roots of which go back to the physical scientific explorations of the late 17th century.

Such deep rooted knowledge of such a prime aspect engrained in the industrial process, allied with Asian expansion demonstrates the company as one of the UK's unsung heroes. However, heroes have their challenges and the heavy weather of the 2008/9 recession saw its prime activities in semi-conductor and clean-tech hard hit by the rapid contraction of both sector's activities. Massively hit consumer and business demands for all things electrical - at both systems and hardware levels - dramatically affected over-blown inventory levels held at manufacturers and retailers, which in turn had to be price-slashed to try and move stock, this endemic situation even visible by the 2010 pre-Christmas giveways of comparatively quickly aging flat-screen TVs at retailing superstores in the US and Europe. Thus a major activity shrinkage was experienced all the way down the supply chain, from Japanese, Korean & Taiwanese consumer electrics manufacturers, to their 1st tier supply-base and below - all who had previously been riding the seeming unquenchable (credit fueled) consumer boom.

Equally, we saw portions of the clean tech collapse, solar especially hit given its over-abundance of PV production, much of it the result of international government induced interventionist demands to create the new green-tech age countries would be reliant upon.

Semi-conductor and clean-tech production activity has of course re-buoyed, but with even a notionally broad portfolio of client types, this partial over-reliance on semi-conductor highlighted a macro-driven vulnerability which it felt ought to be redressed, so exploration commenced as to what other industrial sector offered a commercial middle-ground which had income stability and inherent growth. A sector which in value-creation terms sat between the essentially 'commoditised' world of semi-conductor and the 'niche' world of scientific instruments, as well as in value-adding terms sat between 'smokestack' and 'emergent tech'.

The conclusion was expanding Edwards activity in the automotive LED lighting sector, unsurprising given its basic derivation from semi-conductor physics.

LED use has been well established within automotive for almost 40 years, its first and long-lived typical application within driver's instrument binnacles as area-warning lights for many functions ranging from engine-fault to seat-belt. However, as a more recent consequence energy use concerns, visual-safety wishes and brand differentiation desires, it has rapidly been adopted over the last 5-7 years

From an energy use perspective it draws less current and provides greater light per unit of input energy in comparison to a standard incandescent filament bulb; by 2002 offering a stable 20 lumens per Watt as opposed to 15 lm/W. Whilst Cree Inc, Soeul Semi-Conductor and Nichia Corp advanced that efficiency fourfold and far beyond in recent years (albeit in laboratory conditions).

From a traffic and driver safety perspective LEDs offer a 'cleaner light' than bulbs, and were the technology of choice for manufacturers when national vehicles regulations demanded high-visibility brake lamps situated mid-centre of a vehicle's rear. It also allowed manufacturers to programme the LEDs to create light patterns dependent upon the severity of braking. However, early adoption uses in Japan and the hotter climate states of the US did see initially high failure rates, though now well overcome. Contrawise, LED lighting becomes more efficient and brighter at colder temperatures which together with its 'clean light' means greater driver visibility and observer clarity in high latitude regions which typically suffer from harsher weather (rain, fog, snow) which deteriorate vision, thus a useful technical mutuality.

With that confidence LED automotive lighting has become far more common-place, initially as a luxury segment (benchmark) feature. In parallel to this high-end adoption process LEDs also became apparent in the high-margin 'after-market' lamp retro-fit business, it seen as a car modification differentiator for younger owners of used cars. In recent years we've seen LEDs become a new near staple feature for manufacturers, using the technology as part of feature trickle-down strategy to increase attractiveness of their mainstream cars, and by doing so gaining procurement scale economies. Thus LEDs have become either central or part integrated into front and rear exterior lamp-clusters, used as day-time running 'feature lights', plus increasingly used as interior 'lighting architecture' for premium-level and special edition variants, set to similarly become ultimately standard fitment..

The low-energy electrical draw and small size of LEDs have over the last decade provided auto-makers with increasing engineering and stylistic freedoms. Beyond reducing basic electrical voltage/wattage/ampage requirements, LEDs allow creation of both a unique night-time 'brand/product signature' for the external front & rear of a car, whilst also creating various 'mood settings' for the interior of the car, both able to be programmable for various lighting effects. BMW were the LED pioneers on its previous 5-series et al, so emphasising the famous Quad effect, whilst the face of the BMW R-R Phantom Convertible & Gentleman's Coupe perhaps most visibly shows the old tech (halogen) vs new tech difference in its roundel lamp contrasting with feature bar above. VW's Bentley uses LEDs on Mulsanne to visually replicate the large diameter & circumference of its iconic 'Blower Bentley' lamp. Ironically, the once much hated periodic initial flicker of LED (so reminiscent of fluorescent ceiling lighting) has become part of an accepted 'switch-on' character, giving a car anthropomorphic overtones.

Thus, Edwards Group noted that automotive LED incorporation into VM product lines was a very necessary strategic imperative, driven by both functional and emotional economic levers. And so attuning itself to the rise of automotive LED demand in the face of other vulnerable client bases - even if temporary – appears a natural choice. This sector offers a stable, long-term income generation stream.

Furthermore, LED tech is a rapidly advancing science, the creation of Polymer LED (PLED) revolutionised the mobile phone, smart-phone and mobile devices field by making low-cost, thin and flexible display screens available. Whilst R&D has also created OLEDs (O = 'Organic') with similar though not as well commercialised attributes.

In a 'turning full circle' manner these new generation PLEDs have made their way back into the forefront of vehicle instrument binnacle design. LCD screens are argued as a precursor to PLED, LCDs having had a near monopoly on full screen sections of the dashboard to date, able to conveying a multitude of systems information to the driver (and indeed passengers: including infotainment screens incorporated into the rear of front seats for rear passenger film & game viewing). But perhaps the best example of the trend being Toyota's use of the LCD & PLED technology in successive series and locales of the hybrid Prius, which initially used a mid-console mounted screen as an educational tool to demonstrate the flows of power delivery and re-capture.

Hence the LED world appears to offer Edwards a basket of varied clients, the simple to complex variants of LED technology allowing for a sector segmentation and targeting of potential clients.

Press reports indicate that the present owners – CCMP & Unitas - hope to set Edwards' MarketCap valuation at around £1.5bn, having since mid 2010 appointments tasked former auto-execs Matthew Taylor (ex Land Rover CEO & latterly JCB CEO) and David Smith (ex Ford and Jaguar-Land Rover's previous CEO) to seek out the LED opportunity. These appointments then provide for that all important new automotive slant, one designed to maintain or at least reduce degradation of the impressive (press reported) 20% margin in 2010.

Fortunate then that the LED sector also continue to be prospected in a week when events in Japan have dramatically changed the business terrain for Edwards. It has drastically up-ended normal business proceedings for domestic high-tech companies which also have reach into Asia, and now re-tabled the topic of power generation methods for international governments and energy companies. (As stated, the energy sector is an intrinsic part of Edwards history and operational capability)

A clear case then of strategic 'swings and roundabouts': 'intermediate' semi-conductor contracts, a new 'emergent' sector is explored, semi-conductor re-grows and now re-contracts, and an 'smokestack' re-emerges.

It is in this new light that conflicting press and web reports given opposing impressions of the expected IPO. Some indicate that the shares are for present private stock-holders only (as possibly additional buys or possibly 'paper-swaps') whilst other reports indicate that the IPO is open to professional investors.

The former scenario presents one of sound conservatism with no new liquidity sought from the broader capital markets. This then would allow the company to metaphorically and literally 're-settle' itself during this still testing but opportunistic period, demonstrating that it has the confidence to both re-organise using its own (or privately agreed) funds, and crucially illustrate that it is not using the IPO as a cynical exercise to simply 'paper-build' its market value. To quietly stepping into the public markets, and set good-governance conditions such as 'conditional dealings', would create confidence.

In the latter scenario a Prospectus for general digestion is of course all important, yet its release date was not given. Any 'tbc' date must surely be re-examined given the major ramifications of recent horrendous events in Japan on its hi-tech industrial base, and the need for strategic re-assessment.
This will be well understood by institutional investors, and unfortunately will over-shadow the 'good news' bulletin that an FY2010 revenue of £641m; with an adjusted EBIT of £130 million, yielded that 20% margin.

Investors may well view Edwards near-term fortunes in one of two ways; typical bulls and bears.

Bears may think the 20% margin a one-off, a consequence of the corporate re-bound generated across the board by previously slashed overhead costs meeting the strong demand pick-up in 2010. To them whether sustainable into 2011-2012 is unclear given the headwinds of higher input costs experienced so far and now seemingly certain tilt into a now far greater slowdown of Asian demand exacerbated by Japan's seizemic and nuclear shocks. These shocks have stalled China's own massive nuclear plant programme, and add doubt to America's, and will almost certainly put a squeeze on Asian energy costs in the interim for businesses, administrations and the public, so stifling again the previously slowed growth figures.

Bulls will see great potential for Edwards to re-deploy its core energy capability, used to counter-act the expected semi-conductor contraction, whilst also making inroads into the LED sector. They will see events as offering counter-cyclical defenses that offer horizon-line income streams.

An obvious question regards that business potential, is to what degree the company may have to re-balance operations so as to adroitly serve strategic re-positioning and expanded multi-sector focus now being so LED facing, wanting to re-prospect 'energy' and re-shape to ride 'semi-conductor'.

The time is obviously ripe, even if problematic given its IPO announcement. But markets will understand.

And given the Fukushima disaster, just how aligned is Edwards to assisting a now very sensitive the nuclear-energy sector? (since part of the radiation leak problem was seemingly caused the built-up hydrogen explosion). To this end Edwards' gas-abatement technology must be quickly aligned to uses in nuclear power stations if not already the case; either as part of normal running, or as emergency back-up devices.

This may be a vast over-simplified of a product/service offering perceptionally aligned to a possible new world-wide need, but worth basic exploration. Furthermore, is the general agreement by sector experts that gas-fuelled power stations will now dominate any new build – good news for Edwards.

Accompanying new chairman Nick Rose (ex-Diageo CFO) after the flotation will be the well-connected Keith Roberts (ex Petrofac) acting as a non-exec. He will undoubtedly assist efforts in in capturing new business regards 'oil & gas' noxious fumes abatement, with possibility a prospecting of any 'cross-over' technical systems applicable to what could also be renewed projects regards 'refurbished nuclear' or 'fail-safe nuclear'.

Thus, beyond gaining ground in serving the manufacturing process needs of automotive LED suppliers, critical internal and external questions relative to medium and long-term timelines must be asked about the potential to expand its market share of the vacuum-machinery & gas-abatement
business beyond its 17%, and how it might over-throw the incumbent #1 competitor.

Furthermore, it must also realise its very real exposure to additional, incoming competition, the company may well see itself as the NASA of vacuum pumps, but in reality the basic principles of pump-building are relatively simple, and can be gained by those countries or companies seeking greater sector integration, or indeed given vacuum-pumps broad uses, as part of a national strategy to develop indigenous industry at all levels.

In response it must strengthen any loose grasps over important Asian and South American nations, whether done with its own EM roaming agents or via the greater dedication of those 3rd parties already in place.

In parallel, it must also undertake greater R&D exploration efforts to not only replicate its 'dry-pump' advantage but demonstrate to potential investors its 'vacuum-devices' specialism – or other spin-out specialisms - can be applied in other fields.

Looking to the early 20th century for inspiration offers a various vacuum applications: from vacuum tubes for contained environment message delivery to integrated vacuum-cleaning piping within building structures to of course the vacuum cleaner. The vacuum cleaner as a lifestyle item saw a major resurgence with Dyson and his own technology story – replicating Hoover's heyday – and the market spans across from the 'classic' 1930s heavyweight to 'future-tech' styles and even includes the 'Edward' character which accompanies 'Henry'. Thus just as Dyson re-appropriated an industrial vacuum process for domestic use with a high-tech persona, could Edwards do something similar?

However, what is obvious to any seriously analytical investor is that ostensibly Edwards – though deeply professional - is not a hi-tech company in its own right, even if it presents itself as such by capturing the kudos of its hi-tech client-base. It is ostensibly a provider of air and gas pumps used for suction and filtration, which over 92 years has created a broad base of globally located client types – reached via margin sapping agents in EM countries - and variously 'tuned' pump applications.

As such its basic business model, although seemingly ever improved technically and geographically, is still reliant upon a relatively basic product type (of whatever variation) which is relatively easy to replicate by determined competitors (especially so in China, India, Brazil & Russia) and may well be open to supplier-substitution by its clients. This danger has been partially negated or at least forestalled by Asian production, hence able to secure lower-cost manufacture – no doubt assisted by its part-owners Unitas Capital.

But unless the business is properly explored and developed it seems that ultimately it will end up either being taken-over, or majority controlled by a major EM company seeking bolt-on acquisitions or or will be see its sector coverage eaten away 'bit by bit' as such EM company's rapidly development their own competencies and leverage them in more locally compliant environments.

Depending upon its CCMP & Unitas's ultimate aims – which may obviously involve part of full disposal - one possible protection route for Edwards might be greater interaction with another Unitas held company with both operational synergies and powerful Asian / EM reach.

The most appropriate appears to be China's KD Blue Sky Technologies Ltd, a provider of environment compliance solutions for air quality compliance. This company specialises in the 'EPC' (Engineering, Procurement & Construction) of (FGD) Flue Gas Desulphurisation facilities attached to thermal power-plants.

The recent Japanese disaster has halted China's own nuclear power station programme which reported had 38 stations awaiting construction. The replacement of these with gas, oil and coal thermal plants will necessitate specialist knowledge of gas abatement.

Thus the interaction of Edwards Group and KD Blue Sky could not only maintain an autonomy by Edwards Group, but would allow KD Blue-Sky to appropriate Edwards capabilities within China. Across not only its primary focus on Flue Gas Desulphurisation, but also allow it to become a strategic element of China's own desire to develop its hi-tech electronics industry and self-created LED sector which itself requires vacuum-processes.

Importantly, investment-auto-motives suspects that the likes of KD BlueSky would also serve as an entry point for Edwards to directly serve the Chinese automotive sector, beyond assisting with LED production.

In 2009 China became the world's largest vehicle market, with 13.5m sales vs the US's 10.4m, and is expected to maintain the greatest momentum. The massive uptake of cars has caused concerns for the PRC, not only regards traffic congestion, but also of course CO2 and Nox emissions. This has created a general 'nudge' directive toward the sale of smaller cars having seen the SUV and large car trend over the last decade, which in turn typically means downsized engines. To re-dress the balance of a vehicle's power & torque expectations, a new generation of smaller engines will require a form of pressure boosting, whether turbo-charged or super-charged.

Unlike the former the latter is an integral full-time aspect of the engine, either mechanically driven or electronically, the most famous of which is perhaps the Roots 'Blower' type charger as seen on the previously mentioned 1929 'Blower Bentley' and been a periodic staple of sportscar engines ever since.. It originates from an 1860s design created to pump air into blast furnaces, but is a design principle which is as useful today for small cars in fast-moving city traffic and highway speeds as on the cars created by Sir Henry Birkin which won Le Mans a decade after Edwards' creation.

Thus the real strategic company intent of may well be to advantageously 'force-feed' the Chinese auto-sector, in which case, it really has 'seen the light', for that is the major market opportunity and would supercharge the company itself.

And who knows, at a far strategic stretch the name 'Edwards' could one day become as synonymous in the Chinese household as 'Hoover' & 'Dyson' – but of course very much automated with concomitant LEDs, and of course named 'Sir Henry'!

This then is the light-hearted metaphor toward a new era of pumping as much vacuum and gas-abatement intelligence as possible, and critically looking for those all important white-space technology applications.