Specialist sensor and testing equipment maker Spectris (SXS) surprised the market with the recent announcement (19 Apr) it was selling its Omega Engineering division and returning most of the proceeds to investors via a share buyback.

The shares, which had been languishing close to 12-month lows, jumped 5% to top the FTSE 250 on the day but we believe there is much more to come from this high-quality business.

STATE OF THE ART PRODUCTS

Spectris is one of the world’s leading manufacturers of high-tech instruments, test equipment and software for industrial applications.

Most of its sales come from its ‘platform’ businesses, with a third of generated by its GBK (Hottinger, Bruel & Kjaer) division which provides sensing, testing, modelling and simulation solutions to help customers speed up product development.

GBK’s core products are sensor hardware and data acquisition and analysis software which enable manufacturers to physically and virtually test their products at each stage of development.

Customers mostly come from the automotive, aerospace, industrial and electronics sectors, where products have to rigorously tested and inspected for reliability, durability and high performance under a range of conditions.

Just under a third of group sales come from the Malvern Panalytical division which specialises in the advanced measurement and analysis of materials.

Its technology is used by scientists and engineers to maximise productivity and develop better products by analysing materials right down to the level of particles to get a better understanding of their chemical, physical and structural composition.

Customers include heavy manufacturers, makers of advanced materials, pharmaceutical makers and food producers.

The last of the ‘platform’ businesses is Omega Engineering, which makes sensors for measuring temperature, humidity, flow and pressure and accounts for around 10% of group sales.

Three other divisions make up the rest of its revenue, serving the industrial automation market, life sciences and electronics with products for controlled environments such as laboratories and clean rooms.

ASTUTE CAPITAL MANAGEMENT

The disposal of Omega to US investment firm Arcline for $525 million (£403 million) demonstrates skillful asset management and at the same time how the wider group is being undervalued by the market.

The price represents a multiple of 20.4 times Omega’s adjusted 2021 EBITDA (earnings before interest, taxes, depreciation and amortisation), a considerable premium to Spectris’ own valuation of 11 times last year’s EBITDA according to Shore Capital.

Omega is in good health and will be a ‘highly complementary’ fit with Arcline’s existing controls business Dwyer, but its margins were below those which Spectris considered acceptable.

Faced with the choice of allocating capital to grow the business to a size that was ‘essential to deliver acceptable levels of profitability’, the board decided to offload it to a more suitable owner.

The disposal takes Spectris’ gross sale proceeds to more than £1 billion over the last three years, typically at valuations above the group’s multiple, and leaves it with a much-improved financial profile and a focus on high-precision measurement solutions.

WELL-TIMED BUYBACK

With its strengthened balance sheet, Spectris is now well placed to invest to drive organic growth as well as to invest in R&D (research and development).

It is also eyeing what it calls ‘value-enhancing M&A (merger and acquisition) opportunities, from early-life technologies through bolt-ons to larger-scale acquisitions’ as well as collaborations with third parties which meet its return criteria.

However, given its confidence in the business over the medium term and the low market valuation of the company, the board has decided the best use of its surplus capital right now is actually to buy its own shares.

Therefore, the firm will buy in up to £300 million of its own stock, or nearly 10% of its current market cap, in two tranches of £150 million, the first to be launched shortly and the second dependent on shareholder approval at its AGM on 14 May.

EXPERT VIEWS

Analysts at Shore Capital applauded the sale of Omega given its lower profit margin than the group average, and said the deal ‘highlights the undervaluation of the group’.

With the shares down around 30% year to date and more than that from their high above £40 in September 2021, Shore Capital estimates on a sum-of-the-parts valuation the group trades at a 30% discount to its peers, which implies at least 40% upside from today’s price.

Investment bank Berenberg lowered its current-year earnings estimate to account for the loss of sales from Omega but raised their 2023 and 2024 profit forecasts.

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