discoverIE Group — Moving into the next growth phase

On 11 September, discoverIE hosted its first capital markets day in six years. Management took the opportunity to review the group’s performance since it entered the design and manufacturing market in 2011, revisit the group’s strategy and explain how it continues to execute on this. It also provided the opportunity for participants to see a variety of its bespoke-made products and meet the management of individual businesses.

discoverIE’s strategy has been broadly unchanged for many years, with net zero targets a more recent addition. The company aims to:

Its successful buy-and-build strategy has resulted in strong revenue growth and margin expansion, driving earnings at a CAGR of 19% between FY15 and FY24.

Exhibit 2 shows the company’s medium-term targets. It also estimates the potential growth in EPS based on different levels of organic revenue growth combined with varying levels of acquisition spend. For comparison, over the last five years, the company spent £288m on acquisitions, generated an organic revenue CAGR of 7% and EPS growth of 94% (CAGR 14%).

With the group having achieved so much since the design and manufacturing strategy was launched more than 10 years ago, the question now is how this performance can be maintained over the next 10 years. The rest of the CMD was focused on explaining how management intends to maintain growth and drive profitability. This splits broadly into two areas: organic operational management and acquisition strategy.

discoverIE operates a decentralised business model. The group splits its businesses into two divisions: Sensing & Connectivity (S&C) and Magnetics & Controls (M&C). Where appropriate, the company groups similar businesses together in clusters to achieve optimum benefits. Exhibits 3 and 4 show the constituents of each division and cluster.

Management discussed how it drives growth and profitability across the following four areas:

The company spends c 2% of revenue on R&D each year, with the focus on product development rather than research. Sales led by engineers with detailed knowledge of applications and design results in a unique understanding of customers’ needs. Solutions are then based on custom designs or engineered standard products to meet specific customer needs.

The group recorded a CAGR for organic revenue of 6% over the last 10 years and 7% over the last seven years. Revenue growth depends on two factors – the number of design wins and end market demand. The chart below shows the trend in revenue versus the estimated annual value of design wins. They tend to move in sync apart from during periods of stocking up and de-stocking (customers are currently in a de-stocking phase). The company has recently reported strong design win activity and noted that some of its largest de-stocking customers have recently awarded the company multiple design wins, which bodes well for future revenue growth.

End market demand is highly dependent on the verticals that the company supplies. As we have written before, the company’s target markets are renewable energy, transportation, industrial & connectivity and medical, and these made up 75% of FY24 revenue and 90% of FY24 design wins. These markets have been selected for their potential to grow ahead of GDP – revenue from target markets grew at a CAGR of 7% over the last seven years. At the CMD, the company announced that it had added a fifth target market – security – which covers areas such as access control, detection systems, surveillance systems, and aeronautics, space and defence. This market currently makes up c 9% of group sales (up from 2% in FY21), of which defence makes up 2%. Around half of security sales were previously reported in the transportation segment and the remainder in ‘other’. Examples of designs won in this segment include access control for datacentre cabinets and an X-ray detection and high-speed image processing unit for airport security.

The group is able to price its solutions for value rather than on a cost-plus basis because of its differentiated products, ability to provide design support and bespoke solutions, and its ability to work to urgent timescales.

Many acquired businesses bring their own manufacturing facilities to the group. In recent years, the company has reduced the number of sites in similar locations (eg reducing from three to one site in Mexico) and developed shared production capacity in certain geographies, resulting in annual savings of c £4m. It has also relocated production, for example, from the UK and Western Europe to Hungary, resulting in lower labour costs, volume efficiencies and in some cases moving production closer to the customer. This has generated c £2.3m in annual cost savings.

The chart below shows how the group has increased operating profitability from FY18 to FY24. Improvements to the organic business were almost as big as the contribution from M&A (acquisition of higher-margin companies plus the benefit from selling lower-margin businesses). The company has a margin target of 15% by FY28 and expects to achieve this roughly 50/50 through organic development and acquisitions. We expect further operational efficiencies to be achieved through the collaboration programmes described in the next section.

This is an area that has recently been given more focus – while the creation of clusters has helped increase collaboration within a division, the group is keen to exploit synergies across the entire group. Neale Sutton, previously managing director of Cursor Controls, was appointed group development director in January 2023 and is responsible for identifying and developing technological and commercial synergy opportunities across the group. These fall into three broad areas:

Management has had the same approach to M&A since it made its first design and manufacturing acquisition (Hectronic) in 2011. It looks for the following in an acquisition target:

Acquisitions will either be bolt-ons, with attractive synergy potential, or platforms, which bring new capabilities and additional scale and have the potential to create a cluster. The company has no interest in buying companies that need restructuring or turning around.

From a valuation perspective, the group is disciplined, turning deals down if the pricing is too high. The price paid will reflect growth track record and potential, margins, scale and potential synergies. The charts below show the spread of EV/EBIT multiples paid and the average EBIT margins acquired each year since FY14, demonstrating how the company has sought out higher-margin companies since FY19.

As described above, the group operates a decentralised business model. When a business is acquired, if appropriate it joins a cluster. It usually retains its own brand and management team and continues to operate as a standalone business. The main areas that the group will get involved in include:

The business can take advantage of group services such as IT and, in the longer term, could make use of manufacturing facilities elsewhere in the group. This light-touch approach means that an acquired business can be integrated quickly with little disruption to operations. It is also an attractive selling point for potential targets as founders can feel confident that the business they have built up over years will not be subsumed into a larger entity but will continue to thrive as an independent business.

Once acquired, the business will be expected to take part in the collaboration efforts described above, to optimise revenue synergies, scale up efficiently and drive operational improvements in areas such as working capital and manufacturing.

Despite having made 27 acquisitions since 2011, management is confident that a wealth of acquisition targets remain in what is a very fragmented market, with many founder-run businesses operating in limited geographies. It estimates that its addressable market is worth c $30bn (a sub-set of the $300bn non-semiconductor electronics market). Currently, it has a market share of c 2% with ample room to grow this.