Judges Scientific, Geotek, & GDS Instruments

Judges Scientific (JDG) is a UK-listed serial acquirer focused on niche scientific instrument businesses. Just as Constellation acquires vertical market software companies or Halma niche industrial engineering products, JDG specializes in UK-based design and production companies in the instrumentation business.

In 2005, David Cicurel, JDG’s founder and current CEO, listed the company as an investment vehicle to buy stakes in small public companies and flip them to PE at a premium. Due to rapidly increasing public market valuations prior to the GFC, this original business model quickly became out of date.

However, after Cicurel’s first acquisition of Fire Testing Technologies, he discovered the advantages of UK scientific instrument businesses that dominate a tiny, niche global market. JDG pivoted from a public-to-private arbitrage strategy to buying and holding quality, private companies that dominate a small market.

Cicurel effectively stumbled upon the UK scientific instrument business and has since made 20 acquisitions and grown FCF per share at 22% per year. In 2005, from a blank cheque, JDG’s has returned 30% per year including dividends, an 81x return. Cicurel also still owns 11% of the shares outstanding.

We recently interviewed a Former Sales Director at GDS Instruments, a JDG portfolio company, to better understand the instrument business and the quality of JDG subsidiaries.

GDS Instruments designs, develops and manufactures equipment and software for computer-controlled testing of soils and rocks. The specialized equipment is used to evaluate the mechanical properties that are key in geotechnical and earthquake engineering design.

You can get a sense of GDS machines from the image below:

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GDS was acquired in 2012 for £7.65m, a ~6x EBIT multiple, and seems to be typical of JDG acquisitions both in terms of business attributes and valuation. Judges has a strict acquisition criteria; global scientific instrument leaders in niche markets, high operating margins, and a valuation of 3-6x EBIT, ~50% financed with debt.

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Similar to Halma, most of Judge’s companies develop and design the equipment and outsource manufacturing to reduce capital intensity. Over 85% of JDG’s sales are from outside of the UK, highlighting the specific strategy of buying UK intellectual property and driving export sale growth.

The major customers for instrument manufacturers are academic research institutions like universities and corporate customers. In 2017, JDG reported ~60% of revenue from universities, 30% directly from corporations, and 10% from global testing firms.

GDS is the highest quality player globally and, although there is competition in the more commoditised shear tests, it's the only reputable company offering specialised, dynamic shear systems globally. GDS is effectively a monopoly in a very small global market.

GDS is renowned in the industry for having the top equipment for particular tests. Imagine you have to develop a new system for a particular application, versus systems that have been around forever and which everybody makes. In the latter, you are dealing with a much more competitive area and a known technology so it's difficult to make a difference. Triaxial and consolidation tests have been around for a long time so this is more of a bulk sales of smaller value systems in a more competitive market - Former Sales Director at GDS Instruments

However, there is one attribute that is somewhat unique for Judges relative to other serial acquirers we’ve studied such as CSU, HLMA, or ADDTB: lumpy and unpredictable sales.

GDS and many other JDG subsidiaries seem to sell high-quality but large-ticket, one-off system sales to customers. There is very little, if any, consumable or service recurring revenue.

The average system life time is literally decades. Support is not restricted to components but also extends to applications. When a user wants to perform a test and has questions, they usually call GDS and get support on how to perform the test on GDS machines…There are very specialist tools sold in small numbers, two to five system per year, or even one. For such expensive systems, the buyers know that GDS is their best chance to get the right results. Whenever GDS brings a system to the market, users are sure they have done the best possible to make a great system that works and gives precise results, with all the support they need. They won't be left on their own because GDS excels at both high-end engineering and support. - Former Sales Director at GDS Instruments

Systems with long-lifetimes and little requirement for maintenance reduces future revenue visibility and increases the lumpiness of revenue growth. When you also add the fact that GDS mainly sells to universities, the revenue visibility and predictability is highly uncertain.

GDS’ individual cash earnings are illustrated below and are typical of JDG opcos; somewhat lumpy and cyclical sales, structurally high EBIT margins, low capital intensity, and a monopoly in a tiny market.

Since the 2012 acquisition, GDS has earned a stable 15-17% EBIT margin and over 60% ROE with 9% revenue CAGR. It requires very little capital to grow and has earned 38% ROIIC over the last 8 years.

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Even with such high profitability, at 6.5x EBIT, the IRR on the GDS investment is only 7.85% (excluding any terminal value). Although the cash flow can be reallocated, JDG needs to hold the underlying assets for a long duration to earn its required return.

But this is exactly why JDG earns the returns it does; GDS as a standalone entity isn’t that attractive. Few have the knowledge or capacity to buy and run such a technical business with lumpy, uncertain cash flows. Yet when rolled up into a holding company with other similar but slightly different instrument manufacturers, the returns are incredible. The sales lumpiness is smoothed out and the aggregate result is stable, growing free cash flow.

JDG's robustness is illustrated by two of its largest acquisitions that seem to be mistakes: Armfield and Scientifica.

Armfield was purchased in January 2015 for £8m and the IRR has been -21%. The business is still profitable, but revenue has plummeted. Armfield’s huge pension liabilities also doesn't help.

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Scientifica, purchased in 2013 for £12m and JDG’s biggest acquisition at the time, has been even more challenging with a -30% IRR.

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It’s unclear what exactly went wrong with these acquisitions. However, the chart below highlights the robustness of JDG as a holding company. The diversification and high ROE of each subsidiary outweighs two of JDG's largest acquisitions that were both mistakes.

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In 2013, Scientifica was the largest acquisition in JDG history and added 30% to revenue and over 40% in EBIT. For most companies, this could be fatal. JDG’s market value did decline ~50% from March 2014 to early 2015 and didn’t go anywhere for 2 years. In hindsight, this proved to be an attractive entry point to the equity; the two acquisition mistakes still haven't recovered and yet JDG's FCF per share is 3x higher today.

This is the beauty of disciplined serial acquirers: with scale comes diversification.

As long as management remains disciplined paying 6-7x EBIT, the opco diversity stabilises FCF and minimises terminal value risk. Also, JDG only has 20 operating companies. Halma or Addtech with 50-100 opcos are arguably even more robust and can overcome mistakes quicker than Judges. At the opco level, the underlying economics are similar for Halma and JDG; Halma has ~50 opcos and pays ~7.5x EBIT on average whereas JDG pays ~6x EBIT but has only 20 opcos. It's incredible to also think that CSU pays a similar price to JDG but owns over 700 VMS companies with recurring revenue.

In a previous analysis, we compared the risk of rolling up highly-engineered industrial products, similar to HLMA and JDG, with CSU in VMS:

Halma owns a gas detection business selling portable monitors to oil and gas customers and a cardiovascular business for ambulatory blood pressure monitors. The range of expertise and knowledge of technical products, customers, and end markets makes it very difficult for opcos to stay ahead of the curve without an experienced opco CEO with full P&L ownership. On the other hand, Vertical Market Software businesses are not only higher quality companies, but also seem easier to manage and understand. This lends itself to a higher velocity of acquisitions. - In Practise Weekly Analysis

JDG's opcos have long R&D cycles and sell systems that last decades. If the original management team leaves post-acquisition, which is typically the case, significant technical knowledge is lost and the ROI of future R&D spend could be challenged. This could be one reason why Armfield and Scientifica struggled; when a JDG or HLMA opco goes wrong, it's near-impossible to fix without the original management team's expertise.

In VMS, arguably there is less end-market specific technical knowledge required and a more frequent customer relationship drives a greater opportunity to improve organic growth. A stable stream of recurring maintenance revenue offers the opportunity to consistently push more features and add more value to customers. This lends itself to more programmatic acquisition-led growth and potentially reduces the terminal value risk relative to one-off sales of mechanical engineering products.

One counter-argument is that software is at a higher risk of disruption given the technology cycle moves relative to mechanical engineering. However, this comment below from a Former Topicus executive was interesting in highlighting how the mission-critical nature of VMS and recurring nature of the relationship actually buys the VMS business time to rescue a failing customer relationship:

At that time, a lot of customers were very, very unhappy and, when I started in 2015, that had already been going on for some time. A lot of them said that they were going to leave but they also knew that the other competitors did not have the software that they were looking for. Out of three others, with less good software, the question is, who are you going to choose and is it worth moving to a different software. That’s what actually bought us some time to improve our services, our customer relationship and our software to bring it up to speed to the needs that our customers had. - Former Director at Topicus

There is no doubt that both JDG and HLMA are run by incredible capital allocators and in aggregate own a unique asset. It just seems to us that VMS is a superior category to roll up over any other industrial product (maybe excluding TDG's sole-source parts but we will leave that to another write-up!). Especially when CSU can pay similar 6x EBIT numbers and the holding companies are trading at similar ~30x FCF multiples.

This brings us to JDG’s recent acquisition of Geotek, a company adjacent to GDS, and the largest and most expensive in JDG’s history. The total consideration for Geotek is up to £80m, which is 90% of JDG 2021 revenue. This includes £45m in cash and £35m in earn outs paid in cash and JDG ordinary shares, a total valuation of ~7.5x Geotek's pre-covid EBIT.

It’s hard to find full accounts of Geotek Limited and Geotek Coring but a few key details are set out below highlighting Geotek’s incredible profitability.

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Combining the two entities, we can see consistent 100%+ return on incremental capital employed excluding 50% of the cash balance which makes up nearly 50% of capital employed.

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Given this an acquisition that is the largest in JDG history and relies on pre-covid numbers, it was interesting that JDG rallied 20% on the news. The structure of the earn out reduces much of the risk but it is still a huge transaction. The existing management team also have ‘one-year service’ contracts and will likely leave thereafter.

We believe the comment below is the most interesting part of this acquisition:

This is the first acquisition by the Group that derives a substantial proportion of revenues from services. It will provide the Group with greater medium-term visibility but also reliance on a small number of large contracts. - Judges Scientific, Geotek Acquisition Update

This is JDG's first real acquisition that has service revenue, which exactly addresses the risks we address above with the misallocation of capital into businesses with one-off, large ticket system sales that are replaced in decades. Greater service revenue increases the touch points with customers, reduces the feedback loop to improve product development, and increases revenue visibility.

GDS Instruments currently offer support but for free; maybe GDS support can be rolled into Geotek’s fee-based service offering which should improve revenue growth. This transaction could also be an indication of Mark's influence, the Former Halma executive and now COO at JDG, who seems more operational and likely to spur organic growth at opcos.

Could this be a sign of further service-led acquisitions to come? Maybe we will see JDG group more assets together like Halma and increase the organic growth initiatives.

Either way, if JDG can add recurring service revenue on top of its portfolio of niche monopolies, it will improve the durability of the holdco even further.