Meggitt is confident it can still be "a world leader in specialist engineering"; the City's view is less optimistic. Geoffrey Foster.
At 1pm on Friday 10 April the sun was shining out of a cloudless sky - literally and metaphorically. All over Britain businessmen were hugging their euphoria at the news that the Tories had got back with a clear majority. Whether they had really deserved to was another matter. But at last there were some positive signs that the recession might be on the way out, and John Major's unexpected triumph helped to sweep away a load of uncertainties. Perhaps now recovery would gather pace - the stock market had already taken off - and restore some of the buoyancy that had been missing since the late 1980s. Yet at the head office of Meggitt plc, down among the green hills of Dorset, the mood was distinctly sombre.
During the morning the engineering group's share price had put on 1p, then lost it again while other stocks went into a vertical climb. Three days earlier top management had been up in London, giving a presentation of the 1991 results to a City audience. It was not ideal timing - just before the election - but that couldn't be helped: the date had been fixed long since. Anyway, management reckoned it had a good enough story to tell. Despite the recession, both turnover (at £302 million) and profits (£23.5 million pre-tax) were almost unchanged. Since the successful rights issue in November, Meggitt - for the moment at least - had surplus cash to jingle. The company was therefore well placed to "take advantage of the growing number of high quality acquisitions that are becoming available," etc.
Somehow the message didn't seem to get across. Analysts saw the economic slow-down in Germany, not the openings for industrial controls that still remain in the east. (Controls are Meggitt's second biggest division). They focused on the present troubles of the airlines, not on the long-term growth in air travel, and hence in demand for aircraft. (Aerospace is the biggest division, and the most profitable). But chairman Ken Coates was not altogether surprised that Meggitt watchers should not accept management's view of its own prospects. What amazed him was that the City also seemed to think the company had no place in the Tory victory celebrations.
"The price will come back," said Coates, as if stating the obvious. Then why worry? "It's partly a macho thing," observed managing director Nigel McCorkell. But there's more to it than that. Meggitt's story since its rebirth eight-and-a-half years ago (which was when Coates and McCorkell completed the first-ever management buy-in of a British public company) has been one of extraordinary headlong growth. In 1983 Meggitt was already an old inhabitant of the little Dorset town of Wimborne Minster, and in a minor (and unprofitable) way of business as a supplier of machine tools. In that year it made a pre-tax loss of £180,000 on sales of under £4 million. The growth since then has overwhelmingly been based on acquisition. And for any acquisitive company, a strong share price is a prior condition of its progress, not simply a cause for swagger.
Moreover, if Meggitt has come a long way, it still - it reckons - has far to go. The group already refers to itself as "a world leader in specialist engineering." Yet management knows that it is not yet big enough - either in sum or in its parts - to justify the claim properly. "If you're a £5-million company it's difficult to convince Boeing or British Aerospace that you're a reliable, credible, supplier," says McCorkell. Most Meggitt subsidiaries are more substantial than that these days, but the aerospace division is still no more than a third tier supplier to the plane makers, trailing after Lucas and GEC and Smiths - not to mention the vastly bigger Americans.
Unlike aerospace, industrial controls is a highly fragmented sector worldwide, one which is disputed - often on a local basis - between hundreds of medium-sized manufacturers. "There are going to be amalgamations," McCorkell promises meaningfully. Here, as in electronics, and in the area of filters, valves, heat exchangers, etc - "energy engineering" - the group's presence is patchy. Some units are well entrenched in their own product or geographical niches. A few, especially in the electronics field, are dangerously exposed, being producers of low margin semi-commodity components.
The patchwork is an inevitable outcome of the group's history. When a business is growing as fast as Meggitt has grown - and from as low a starting point - it can't afford to be too pernickety. Yet the acquisitions were not made without regard to logic either. Meggitt, says Coates, "is not a conglomerate" - nor ever was. Coates is an engineer, with an engineer's understanding of the workings of machines, and it was an engineering concern that he and McCorkell set out to build in the early 1980s.
The intention was outlined in a strategy document which the partners wrote for Investors in Industry- as it was known in those days. They needed 3i's backing in order to buy their initial stakes from Meggitt's shareholder-directors. At the time Coates had been MD of Flight Refuelling, the Wimborne-based aerospace business, for half-a-dozen remarkable years of growth and acquisition. By leaving Flight (currently FR Group), and moving in on Meggitt - along with McCorkell, a former merchant banker who had arrived more recently as finance director - he aimed to repeat the success of those years, acting on his own account (at least in part) rather than as a salaried executive.
Coates knew the machine tool industry well, since he had left it to join Flight. But Meggitt's original stock-in-trade had no more than incidental interest for its new masters. Having spent a full year tidying up the shop and bringing it back into profits (as the mid-'80s recovery gathered momentum) they switched into acquisition mode, and it was not machine tools they were after. Nor were they short of resources, for the buy-in had been accompanied by a rights issue underwritten by the ever obliging 3i. The first of a succession of cash calls, it not only removed Meggitt from the Midland Bank's intensive care unit, it also meant that "we had a war chest".
With their first serious acquisition, of Negretti in mid-'85, Coates and McCorkell returned whence they had come - to aerospace and defence - and more than doubled the size of their empire. A manufacturer of aero instruments and pressure-sensing devices, Negretti is still the biggest single constituent of Meggitt's most important division. What's more, Negretti's sideline in process control equipment was the foundation stone of Meggitt's controls business. Controls were not part of the original design. Electronics, on the other hand, were. When Coates and McCorkell started out, as the latter observes, electronics companies could be bought cheap. Before 1985 ended the partners had added a small Devonshire company, making resistors and such, as an initial step.
The new Meggitt was already beginning to appear. But it was the (hotly contested) £86-million acquisition of Bestobell the next year - while the divisional structure was still taking shape - which really gave the group substance and put it on the map. Bestobell was, Coates believes, not only the biggest but by far the best deal that Meggitt has made. It applied a multiplier of around 5 to the acquirer's sales, profits and capital employed. And it brought nothing but good to shareholders.
Operationally there was "a very, very clear fit". Bestobell made hoses and other bits and pieces for aircraft, it manufactured instruments for measuring liquid flows (which slotted comfortably under the heading of controls) and valves (under energy), and had many more interests besides. It was a widely spread distributor of its own products, for example, and of other people's. However most of its units were on the small side. "Bestobell was a small business masquerading as a large international business," says McCorkell. Meggitt managers were able to spend happy months disposing of some of their prey's further flung outposts, in Africa and elsewhere.
In addition to other charms (some genuine, some spurious), the deal brought with it a very powerful shareholder. The bid was only made possible by the fact that BTR committed its 24% of Bestobell to the Meggitt camp. Even as the battle raged, Meggitt was negotiating to buy a lesser property from the big conglomerate: this was Serck Baker, a manufacturer of water treatment plant, one of the star performers of the energy division. The upshot was that BTR came away with 22% of Meggitt's ordinary shares, and the right to nominate a director. Not every chairman would welcome Big Brother at his shoulder, but Meggitt's relationship with BTR is "unusual". Sir Owen Green has apparently promised never to launch a bid; on the contrary, he's been highly supportive. "When BTR said 'We'll take up the rights issue,' everyone else climbed in," Coates points out.
Before, between and since Negretti and Bestobell, the story of Meggitt has been one of continual dealing. There were major deals, like the £33-million acquisition of Microsystems, which shifted the weight of the electronics division away from components and towards higher added-value devices (notably ticketing machines); also the purchase of the German company Sunvic, an installer rather than a manufacturer, and a mainstay in the controls sector. There were strategic acquisitions, particularly in aerospace in the US, designed to gain both technology and access to the market. There were also disposals: machine tools finally went via a management buyout. There were cosy agreements involving earn-out formulae (which seldom worked, admits McCorkell) and hostile bids - not all of which succeeded.
But the bid which sticks in the memory of many Meggitt watchers is the assault on United Scientific Holdings (USH), launched in September and aborted in November 1989. Had the takeover happened, it would easily have topped Bestobell in capital value. Meggitt withdrew its offer at the last moment, with USH effectively in the bag. Coates is adamant that the withdrawal was for "clear financial reasons", not by any precognition of the outlook for defence contractors.
Yet why, even in 1989, should Meggitt have wanted to go overboard for a company that lived by making armoured vehicles and night sights? It already had one foot in a remunerative corner of the endangered defence industry - military aircraft. And it had very deliberately set down other feet in civil sectors with solid long-term prospects, like controls and energy. Coates is unrepentant. The fact that United Scientific was overwhelmingly committed to defence was "not a problem," he maintains. "We were going to get rid of a lot of companies. We were going to rebalance very quickly.
Looking back, he thinks that "perhaps" Meggitt was fortunate not to have lumbered itself with USH. He concedes that the episode "damaged us a lot - it created a perception that has lingered ... a perception that will linger until we do something that's highly newsworthy." But that's part of the trouble too. One reason why Meggitt has lately under-performed the market, says a well regarded engineering analyst who prefers to be nameless, is a fear among investors that it might spring another USH. "They've got to grow in a more focused way," he says. "Any move now must demonstrate the strategy they've set out."
Meggitt is a pretty well focused business, and fairly well positioned for an economic upturn. Aerospace accounted for 34% of sales and 47% of profits last year. Controls represented 38% of sales and 32% of profits, with the two smaller divisions more-or-less level-pegging in size and contribution. The company's assumptions about the future of civil aviation are much the same as those of GPA, of a sustained annual growth at around 5%. Within the aerospace sector, defence will shrink rapidly, though even here the outlook may be less than black. While UK expenditure on military hardware is scheduled to decline by 10% or so, researchers at the Royal United Services Institute say that "aerospace will suffer the least."
Controls are likely to become Meggitt's biggest division measured by turnover; with aerospace providing 30-35%, to give 40-45% of profits. "That's the sort of balance we should be looking to," says McCorkell, which also serves to indicate just how fast Meggitt hopes to move once the brakes come off. For Mike Stacey, who was recruited from Lucas to run the aerospace division 20 months ago, has been given the task of trebling its size, from around £100 million of sales to £300 million by the mid-'90s. Clearly, Meggitt anticipates a rapid return to the freewheeling conditions of the '80s. No wonder the concern about the company's sluggish share price.
But will the mid-'80s ever come back? The Meggitt watcher quoted above is one who thinks not. "Meggitt has shown it can manage in difficult times," he observes. "It will continue to grow, but the days of the go-go stock are probably over." If he's right it will make Meggitt a lot less fun both for investors and for its managers. Of course there are further benefits to come from grouping and integrating operations. But without a string of acquisitions, the aim of becoming a world class supplier (in aerospace, for example) will face into the distance. Would Meggitt then lose its momentum? Might someone else then approach BTR for its strategic stake in another company?
But the takeover of yet another electronics firm last month shows that Meggitt is by no means a spent force.