Whitney, Bradley & Brown, Inc. (SRP) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to today's Serco conference call regarding the acquisition of WBB. [Operator Instructions]. I must advise you that this conference is being recorded today on the 16th of February 2021. I would now like to hand the conference over to your first speaker today, Rupert Soames. Please go ahead, sir.

Good morning, everybody. It's Rupert here. And joining me on this call, we have Angus and Nigel and Paul Checketts and Jamie Hastings from U.K. group, and also Tom Watson, who has got up especially early, who's our SVP of Defense Services in the U.S. I would remind you that our presentation is on our website if you want to follow it. I'm going to go through that. It will take about 15 minutes going through that and then I'll get into Q&A. It is not often that I use the word excited. But genuinely, we are excited about this acquisition because it is a vital piece of the jigsaw that we are creating around our presence in the largest defense market in the world. It's the acquisition of WBB, Whitney, Bradley & Brown, for a consideration of $295 million on a cash-free, debt-free basis payable on completion. I'm now on Slide 3 of our presentation. In terms of size of the business, we expected to have revenues in calendar '21 of $230 million and to produce UTP of about $28 million. It made -- had margins of 13% in 2020. But we are planning on them being a bit lower than that, 11% to 12% probably going forward, which will -- and they do decline slightly after that, well, fine because we've got about -- we've got synergies that will maintain them at that level. So we're reasonably confident we'll be able to keep margins up at that level going forward. In terms of acquisition multiples, it's more expensive than other acquisitions that we have bought. You all remember that we bought the health care business of Carillion on almost no multiple, I think it was 4x. The acquisition that we've recently done in the Australia with an FM business, we paid 6x. METS, the NSBU acquisition, we paid about 8. This one, we're paying about 10.2x EV to prospective EBITDA. And the reason why we're paying more is because we think that's justified by the higher margin of the business, the significant amount of capability and technology it brings us. And I would say it is still a substantial discount to what the quoted peers who are in this space would be in the U.S. In terms of EPS accretion, we expect 10% in '22 and to achieve ROIC in -- greater than WACC in the third full year of ownership. Being paid for out of debt, it will take our leverage up to about 1.6x at the first half of '21, which will then decline thereafter. And that also takes account of the share buyback that we've announced in December. So we'll be comfortably within our 1 to 2x range. Going over to Slide 4. The strategic rationale for this business. You all know that when we bought the naval business of Alion, the Naval Systems Business Unit, we are very keen, were and remain very keen on Navy as probably as generically the fastest-growing part of naval -- of U.S. defense expenditure. But that doesn't mean to say that we don't want to be present in other areas. And we had it in mind that if we were to get into places like the Army and the Air Force and increase our presence there, these are areas of business that are incredibly hard to enter from an organic point of view. We have quite small businesses in those areas, but it's hard to get traction. And we had it in mind that we would have to do 2 or 3 discrete acquisitions along the way of smaller businesses to build up a portfolio. And actually, WBB have done that for us. They have built up this reach across Army, Air Force and the Department of Defense as well. So it grows the scale of our defense business in the U.S. by about 20%. It increases our reach because it brings new customers and hard-to-reach customers to us. And critically, it brings a whole raft, a stable of new capability, which is probably at the higher end of what we've got in Serco. I mean they are strong in video analytics, data analytics and AI and machine learning. They're strong in cyber consulting. And this take gives us a whole step-up in capability in terms of our defense business. In terms of cost synergies, we are expecting synergies of around $4 million a year. If that sounds like a small number on an acquisition, the answer is the gross synergies are about $9 million. But half of that goes back to the customer in terms of the lower rates. And those lower rates should make us more competitive. But the amount that we see coming into our own P&L from those $9 million of synergies would be about $4 million a year from 2023. And the -- a large proportion of those synergies are actually related to property rather than people. Going on to Slide 5, the overview of WBB. Well, the thing is it does much the same that we do throughout our business. It does a lot of acquisition and program management. It does systems design and engineering. And it does through-cycle asset management just as we do for the Navy. We have actually -- we are in the process of bidding on a couple of jobs together. So we feel there's a very good cultural fit, and there's a very good understanding of each other's business. The difference of -- with WBB, as I say, they are at the higher technical end. In terms of their customer base, it's reasonably well balanced between Air Force/Space Force, U.S. Army, U.S. Navy and Marine Corps and Department of Defense and Homeland Security. They've got about 1,000 people, including about 200 people who are what's called subject matter experts. These are highly technical people, many of them ex-forces. Of the 1,000 employees, about 80% of them are cleared, have some sort of security clearance, which is a very high proportion for a business of this type. They have a great reputation for quality and excellence. And we've been able to confirm that in DD. And also, as I say, a lot of our people know a lot of their people. And so we're comfortable with their reputation. And they've got these strong relationships through these SMEs in customers who are really hard to get into, like the Missile Defense Agency and the Army's Space and Missile Defense Command and in the Pentagon and in various security agencies that dare not speak their name. In terms of their financial record, they've had about 10% revenue CAGR over the last 3 years. They've got a very respectable order book for this type of business, including options for extensions. And we don't normally include those in our own order book. It's about $430 million or 2x 2020 revenues. But if you exclude the options, it's about $100 million or 6 months' forward order book, which for this sort of consulting business is actually pretty good. They have themselves done acquisitions. They bought a company called Decisive Analytics and another one called BRTRC for -- back in 2019. And those brought with them revenues, respectively, of $56 million and $41 million. So this is what private equity does, they go and assemble these businesses. But what we are doing by acquiring the business a year after that, I think a lot of the -- they have integrated these pretty well. A lot of that initial pain and risk of integration, we think, has now been retired. We've spoken to management and we seem to get on pretty well. Moving to Slide 6 and the actual marketplace itself. I mean, clearly, it's been a strategic objective of ours to expand our position in the U.S. market. It's the largest, most liquid, most active defense market in the world. We have looked carefully and thought carefully about the impact of a Biden administration on the business. And we're pretty sanguine about that. I mean, we think that actually, where the sort of high-tech spaces where WBB operate will be well protected from any cuts in defense expenditure. And it's quite interesting to note that if you go and take the major quoted peers in the sector with like Booz Hamilton, CACI, SAIC and Leidos, none of their share prices moved significantly with the election of the Biden administration. So the market does not believe that there's going to be a major change in defense spending. There are -- the nature of the U.S. defense business is incredibly organized around communities, which, as I say, are very hard to penetrate. You could go and sit in Huntsville, Alabama for 10 years making googly eyes at the local -- of the generals there and get nowhere. The business that they bought, BRTRC in Huntsville, has about 50 people there. It's taken them 20 years to grow to this stage, where they have access to Space Force and Air Force people. And if we try to do that just by bidding for stuff, the chance of winning is pretty small. They also have some key programs that are on the F-15, the F-16, the F-35 and also on the B-52. They have a big presence in what's called PNT, position, navigation and timing, which are major programs, called programs of record, that are in the federal budget that we can see they've got secured funding. And they also operate with the Army Research Lab and the Rapid Capabilities Development Office, which I think gives you an idea of the sort of level at which they are operating. To talk a little bit on Slide 7 about some of the actual programs themselves. At the headquarters of the Department of Defense, and one of the things that we've had to struggle with throughout these presentations and statements, is defence spelled with a C and defense spelled with an S. I'm not always getting it right. But in the Office of Secretary of Defense, they are -- that's the Pentagon, that's Department of Defense headquarters, they are what's called the primary systems engineer for a number of different programs, including programs for ships, tanks, aircraft, radios and software assets. One of the reasons -- it is -- we have to be careful about what we talk about because a lot of what they do is very highly classified. As you can imagine, the U.S. Army Space and Missile Defense Command, where they help them develop counterthreats to incoming missiles. The U.S. Army, they have -- they are supporting a program called C-RAM, which I'll talk about a little bit more about in a moment. Missile Defense Agency, they are responsible for all the cyber risk assessments within the Missile Defense Agency, which -- I mean that is quite a hefty responsibility doing that work. And as I mentioned, they are very heavily engaged in what is [ deftly ] called precision timing. And those applications work across all parts of the U.S. defense force, Air Force, Army, Marine Corps and Coast Guard. If you go on to then Slide 8, this is an attempt to kind of show how the jigsaw works. And at the top, what we've got are the different capabilities in terms of acquisition and program management, capabilities development, data analytics, modeling simulation all along the top and then the particular market segments below. And you can see that what WBB bring us is reach across not only technical capability but reach as well across different customers. And that's a pretty attractive footprint to have in the U.S. defense in the services space, very few companies would have that sort of footprint. And interestingly enough, what this does, although we still have about 60% of our revenues in Navy, what we will have is businesses -- 4 other businesses with revenues of about between $80 million and $120 million in each of those spaces, in Air Force and Space Force, in Army and in the DoD. And if you're doing $80 million to $100 million of services to the Pentagon or the DoD or to the Army, you are a reasonably serious player in that space. So we're happy that it fits in well. It fills in the jigsaw well. Going to Slide 9 and some of the photographs. Top left is the F-35, our beloved F-35, because that's what the U.K. has bought in large numbers. They are involved in the F-35 program. On the satellite stuff, let's just call it precision timing that they are involved in. At the top right is a photograph of a thing called C-RAM, which stands for Counter-Rocket and Mortar and Artillery. And basically, that is the same technology that we support in the Navy on a thing called CIWS, which is basically a Gatling gun and very, very fast reaction radar that is so fast that you can actually blow up an incoming missile or an artillery round or whatever. And this is -- they are involved in the Army equivalent of that. Bottom left is the Army Missile Defense Agency, which is trying again to shoot down incoming missile. Bottom right is a very interesting program, where they are designing, along with an Israeli company called [ Elbit ], the forward communications operations base for Army deployment. That is a huge program. And the WBB are the design authority for that program, which is central to Army capability in terms of forward deployment. Not yet in production yet, but interestingly enough within our own naval business, we have the capability to go and assemble kit as we do on the CANES program. Going to Slide 10, you'll see how it changes the balance of group revenue, not hugely, it's got quite a big impact on group underlying trading profit, about 13% uplift on group UTP. And in terms of defense, it increases our defense from 28% of revenues to 31%. And it increases the scale of the North American business in our overall revenues being about 30% of group revenues. And it will give us a business in North America with revenues of about $1.7 billion and about 9,000 employees. So it's a very substantial part of the group. Moving to Slide 11, summary. We think that this is a strategically compelling acquisition. It fits really well with our existing business. It is in a space that we know well, which is the engineering and technical services space. It is in what you might call, the top right-hand corner, the bull's eye of our strategic intent to build up our U.S. defense business. And it creates this platform that allows us to credibly reach nearly all areas of defense expenditure. And we think gives us -- whilst we were delighted by the scale and size, we're happy to be in the -- maybe actually we're even happier to also have credible capability outside Navy and into these other -- into the Army and the Air Force and Space Command. It adds scale, it adds reach, it adds capability and it creates a strong and diversified platform for future growth in the U.S. defense. It's got attractive financial returns. And we can do it whilst maintaining a solid balance sheet. And at that point, to everybody's relief, I will throw it open to questions.

[Operator Instructions] The first question comes from the line of Paul Sullivan from Barclays.

Just firstly, could you talk a little bit more about the due diligence, given it has been fairly acquisitive? And could you give a bit more color on Decisive Analytics in particular? It sounds like that's fairly high growth, high margin within the mix? Secondly, could you just talk about renewal risk in the shape of contract attrition? And then finally, scope for revenue synergies and the size and shape of their pipeline?

Right. I'm going to ask on the DD, let me -- we felt that we got good access on the DD. I mean, they know that we wanted -- it was not a particularly hurried process. And we were able to do confirmatory DD at the end. And we got access to the materials that we needed. So -- and bear in mind that the U.S. business, this is the -- actually the third acquisition that they've done. So they will have had some experience on that. I'm going to ask Tom to just answer about the DAC, what Decisive Analytics do, and also the renewal risk, and I will come back to me for the synergies. So Tom, do you want to just talk about Decisive Analytics?

Yes. Absolutely, yes. Yes, so Decisive Analytics, what they brought, first of all, is customers present specifically in Huntsville, Alabama, which is one of the largest federal markets and defense markets in the United States. In particular, their base of business came through the Missile Defense Agency and the Army's Strategic Missile and Defense Command. Their particular capabilities revolve around big data analytics, cybersecurity, life cycle logistics, machine learning. They also had some media integration work and systems engineering. So they had, I would say, the kind of the front end of the development life cycle for their customers. The question on pipeline, they have a -- overall, WBB has a very strong pipeline. They have very, very large numbers relative to the size of the business. They've got a very strong book of business that's currently bid, waiting under evaluation, roughly 1x the business size, which is quite healthy. And back to the -- regarding the question of due diligence, I spent a tremendous amount of time in analyzing the pipeline as part of that process, got very, very comfortable around the pace of the pipeline and the maturity of the pipeline and find that it's -- like I said, it's quite healthy for the business. And it provides a platform for sustained growth over the near term and through the next 5 years.

Tom, just talk a bit about renewal risk.

Renewal risk, well, in the U.S. market, which tends to have shorter contract durations, sometimes 3 years to 5 years, there's always a cycling of rebids going through. They've -- in the short run, there's not a substantial amount of rebid risk here. One of the things we like about this portfolio is just the -- just, I'd say, the diversity of the portfolio and the -- their depth across multiple customers. So you get a balanced risk portfolio, their platform from a rebid risk perspective. But right now, there's a couple of small contracts in their portfolio that are up for rebid in the short run, but nothing of material nature.

If I can just talk a little bit about synergies, so in terms of revenue synergies, we're hinting at these rather than trumpeting. I think there will be revenue synergies in the U.S. But the fact is that whilst the renewal risk may not be very high, one of the reasons it's not very high, is that these subject matter experts are experts in very limited subject matter and are also often very highly classified subject matters. So the idea that we can take some of these experts with those expertise and go and pitch it into the U.K. MOD, I think we'll have -- I mean, we'd have to be very careful about how we did that. Because naturally, this is going to be highly classified and we respect that. We've been operating under a special security arrangement for many years now in the U.S. And I think that we are respected for the way that we treat that. But there will be, within the U.S. and within the DoD, there will be the ability -- I mean, I was talking to some of their managers and one of them describing said, this -- for us, this is opening the aperture. It is giving us a greater ability, for instance, on cyber to take that into the Navy and into other areas. So I think there will be some revenue synergies. That, for us, is sort of the upside if we can get that. But we don't need those upside revenue synergies in order to be able to make our plan. I hope that answers your question, Paul.

Yes. That's very, very clear. I mean just to wrap up, in terms of your expectations for organic revenue growth there, what would you say is your base case?

Well, what you see is our base case is actually quite flat in '21 on '20 for the very simple reason that we've never seen something to do an acquisition. And there will not be some form of hiccup in the first year. So in our planning, we're not assuming a lot of growth in '21. But long term, we think that this business can grow between 5% and 10%.

The next question comes from the line of Kean Marden from Jefferies.

I've got one other quick numbers one as well. So if we look at the revenue base of the business that was disclosed back in 2012, it was about $130 million. And then if we add on the M&A contribution that you kindly provided, Rupert, that gets us to about $210 million of revenue, $220 million, which looks pretty similar to the revenue, the $212 million for the December '20 year. So is this another business that maybe declined between 2012 and sort of 2016/2017 and then restores to growth? Or is there something else that's driven the shape of that? And then secondly, on M&A. Slide 8 is really helpful. Would that suggest that you have maybe 1 or 2 other bolt-ons to round off your U.S. capability? Or are you now pretty much done in the States and therefore we should expect future M&A to be maybe in some of the other divisions?

So if I can just take that. We know the organic growth over the last 10 -- last 3 years has been about 10%. It is absolutely true that with the major drawdown and withdrawal from Afghanistan that there was a decline in defense expenditure and the whole sector went backwards. And I think that WBB, before they were bought by private equity, had a pretty a traumatic time as much with their management as anything else. But we're happy that, that is now settled. I mean, no business is immune from what happened in the defense sector from 2012. What we do know is that they've done 10% organic growth over the last 3 years, which is kind of what we're interested in looking at, which does imply that they went backwards maybe between 2012 and 2015, which wouldn't enormously surprise us. On the second thing of the -- are there opportunities to do more in the U.S. space? Sure, but it depends on opportunities. And -- but we think that this takes us to a level where we can be pretty comfortable in our own skin. And if there are other opportunities to acquire, we, of course, will look at them. But this is a -- to use that much-hackneyed phrase, this changes our game in the U.S. in terms of the scale and spread and reach and capability that it gives this business. And congratulations, Kean, on going back to 2012. That was a...

The next question comes from the line of Oscar Val from JPMorgan.

Yes. Congratulations on the deal. I have two quick ones. The first one, maybe a bit more on the characteristics of the business. Could you just comment on how much is cost-plus versus fixed price and how that differs with your existing U.S. business? And then maybe the second question on the management team, what are your initial plans? Are they mostly sticking around?

So Oscar, I'll take the second one on the management team. Tom, do you want to just talk about the difference in balance between fixed price and cost-plus and time and materials?

Yes, absolutely. I can pull up the exact numbers in a moment here. But they're -- they have a good, well-balanced...