Windy City Wire Cable & Technology Products, LLC (DPLM) Earnings Call Transcript & Summary

Thank you very much. Good afternoon, everyone. Welcome to our call. Thank you for joining us at such short notice. I'm joined by our CFO, Barbara Gibbes. I hope by now you will have had access to an RNS, and hopefully, our presentation, too. So we'll run through the 15 or so slides and hopefully have plenty of time for your questions at the end. So we'll get started. Turning to the second slide. We're very, very excited to be acquiring Windy City Wire and Cable, which is a fantastic U.S.-based controls business. It's absolutely consistent with our business model, which, as you know, is about strong differentiating value-add customer propositions. It's about exciting organic growth potential. And it's about strong management teams and cultures that will deliver that for us. And this business has that in [ spades ]. It's also right in our strategic sweet spot. So expanding into the U.S., which I believe is the best industrial market for our seals and controls businesses. And it's in a core product range that we understand well. They have an incredible track record of performance and with a platform to deliver market share gains in structurally high-growth end segments. We'll pay consideration of GBP 357 million with a funding structure that allows us to maintain a conservative and flexible balance sheet. And in year 1, the deal will be both significantly earnings enhancing, and it will cover comfortably our cost of capital. So turning now to the next slide, and a quick reminder of our strategy to put the deal into some context. We've built the group on some very strong foundations of value-add distribution. We look to grow into core, large developed markets with both current and adjacent product ranges. We look to develop scalable businesses that can sustain exciting and resilient organic growth. And of course, we support the development of capability required to effectively operate those businesses at scale, too. All of this while retaining a strong balance sheet, as I said. And Windy City Wire and this transaction hits on all of these strategic points. Turning the page now to Slide 4 and an overview of the transaction itself. It's a highly attractive business, and I'll come on to talk about it a bit more in a second. Windy City is majority-owned and led by the founder, Rich Galgano. And along with a strong management team, he will be staying with the business. It's a distributor of premium, low voltage, wire and cable with a strong service component and reaches across all of the U.S. They have a track record of double-digit revenue growth and 26 years of uninterrupted profit growth. Revenues are expected to be, in 2020, $190 million and EBITDA of a little over $44 million. So the consideration of GBP 357 million is at a multiple of 10.5% EBITDA and 11.5% EBIT. And the group's return on capital will be in the high teens next year after the transaction. We'll fund with a 10% placing and the rest in debt, and Barbara will cover that in more detail in a minute. Turning now to Slide 5. It's right in our strategic sweet spot, as I said. The importance of the U.S. in our future is significant. I believe it's the biggest, best and most potential industrial market for us. And of course, it gets controls into the U.S., a core product range that we understand well in Europe. I just love the value proposition of this business. It's simple, it's highly effective and it's truly scalable. On top of that, it's accretive to the group's future organic growth and earnings. So it's in structurally high-growth end segments with a differentiated proposition driving market share gains and a fantastic platform of technology -- facilities, network of facilities and some control of the supply chain on which to build real scale in the future. On top of that, as I said, it delivers very strong financial returns for the group. So now turning the page, I'll take you through this in a little more detail in the business itself, Slide 6. So Windy City Wire was founded in 1994, and it's headquartered in Bolingbrook, which is near Chicago. We've been aware of them for some time and been building relationships with the people around them. And in fact, managed to circumnavigate a formal process, which was great. We've done extensive due diligence, as you would expect, spent a lot of time together, got to know them well. It's a really impressive management team and a strong customer and performance-orientated culture. It supplies product that is designed for customer convenience and for productivity with a high speed-to-market and high-touch customer relationships. It operates with a diverse customer base in structurally high-growth segments like building automation, audio, video, fire, security, data centers. And it has an incredible performance track record with revenue CAGR of 12% in the last 10 years and EBITDA margins now over 20% and growing. Moving now to the next slide, the value-add customer proposition. The model, as I said, is simple and yet very, very powerful. They have patented products that are essential to customers and yet at low component costs. So products that are built for convenience. As I said, they have SmartWire as wiring that has especially designed compound for a reduced friction. They have what's called RackPack. Wire reels are stored in custom sized and labeled boxes, which can be easily transported, conveniently stacked for an organized workspace and then the wire pulled from the multiboxes simultaneously as the technician works. And this convenience leads to productivity gains for the customers, 20% to 30% normally on their labor costs. The business has been built for speed to market with the same-day dispatch policy based on technology and network of facilities and some control of the supply chain, and they maintain close contact with their customers, with sales reps and data from their systems, allowing them to be agile and responsive. So once you're on this platform, you'd never come off. It's a very compelling proposition and undoubtedly gaining market share. In many respects, it reminds me of the characteristics of our Hercules Aftermarket business in the U.S. Again, a simple seals product packaged for convenience and productivity in kits on a strong technology and distribution base with speed to market through same-day delivery. They're both very simple, but very, very powerful models. Turning the page now to Slide 8. And I think this slide really demonstrates the quality of this business. You can see in the pie chart, 2 critical factors, from my perspective. Firstly, very diverse range of end customers who typically transact small values with multiple repetitions. So there's no concentration nor dependency. And once they're on, they rarely leave. As you can see from the recurring base chart on the right, the retention levels are exceptional. So it's a quality business. The model is very resilient as well as truly scalable. And as an example of that resilience through COVID-19, 2020 revenues are expected to be flat year-on-year with profit growth of around 18%. Moving now to the next slide, #9. Great track record for performance, and I think this chart speaks for itself. The EBITDA growth has been exceptional at 13% CAGR. I mentioned earlier, the revenue growth, organic revenue growth at 12% CAGR. And that builds up some excellent margins, which I think represent the pricing power from the differentiated services, along with the benefits of scale. And with strong cash conversion and returns characteristics, in many respects, as you would expect, the financial model is very, very similar to Diploma's. And I'll come back in a second to explain why I think this performance can continue into the future. Again, turning the page to Slide 10. I've mentioned how the business has a strong platform to deliver its customer proposition and financial performance. It's really critical. This platform is built for growth and scale. And it's kind of what we're trying to do as a core part of the operational strategy in our existing Diploma businesses, have developed the capability to operate at scale. So firstly, they have a network of facilities across the country, and that drives speed to market. It builds customer base in local territories. Secondly, they have some control of the supply chain with some light manufacturing, which is basically insulating the wire with compound, and we do some of this already in Europe. And that brings benefits to speed, responsiveness, quality control and some margin. They have great systems, which are crucial to allow the customer servicing element to operate successfully at scale. And finally, and might be most critically, talent is a key part of the capability for this platform to operate at scale, and I'll talk a little bit about that now on the next Slide 11. I was also impressed with Rich Galgano, with the strength of the team and with the powerful culture. He's carefully built a broad and effective team. So they have a very experienced CFO, who's done public market roles before, strong and disciplined operations leads and a fantastic sales organization. The culture is built around many of the Diploma characteristics: accountable, agile, customer and performance orientated. This team is fully on board and committed to partner with us on the next phase of Windy City Wires' development, which is exciting. Moving now to the next slide, significant future growth opportunities. So I've talked a little bit about the track record, which is phenomenal. They've built a brilliant customer proposition, and there's a fantastic platform for scale. So now it's really about how they'll continue to grow. And for me, this is, I think, the most exciting part. The low-voltage wire market is huge, and we have a tiny share. The business benefits from exposure to high-growth end segments, building automation, pro-audio, video, fire security, as I said, data centers and the like. So along with the structurally high-growth rates, they've also been, and they'll continue to take market share as the 13% revenue CAGR demonstrates. They're now starting to break into some new and high-growth areas, too, such as data center development, digital antenna systems for 5G, really exciting technological developments in these areas, which really only increases the needs for premium wiring and cabling. It's really the infrastructure around that technological development. And finally, we will be exploring some revenue synergies. We can help Windy City Wire break into Europe through our existing channels. And vice versa, I believe they can help us take some of our existing controls products into the U.S. So I think it's incredibly exciting, and we believe the growth story will continue, and it will be accretive to Diploma. On the next slide, now 13, a bit of context on the short-term as we start on that journey with some current trading. So Diploma has been very resilient through COVID. We continue to generate strong profits and cash, and we've seen revenues recover in recent months. And we're on track to hit the market expectations as we outlined in the August trading update. So as a result of that, and our confidence in the future, the Board is recommending a combined half and final dividend in respect of 2020 at 30p, just slightly higher than last year's full dividend. Windy City Wire, as I said, is also demonstrating the real resilience of its model this year, too. The business will be flat top line, incredible in this environment with strong profit growth. And as we progress through 2021, the prospects, therefore, for both together are really very, very encouraging. So on that note, I'll hand over to Barbara to say a few words on the financials.

Thank you, Johnny. I'm now on Slide 14. So let me fill you in on some of the details and valuation and deal structure. On valuation, we are buying Windy City at 10.5x EBITDA or 11.5x EBIT. This is an attractive multiple for a U.S. business of this scale, of the sheer quality and the excellent organic growth prospects. For us, specifically, this means, double-digit earnings accretion in year 1 as well as returning in excess of our cost of capital also in year 1. ROATCE is a key metric for us. Mathematically, this will come down initially. Remember, we're buying organic growth at scale. So we're looking at ROATCE in high teens post transaction, which is strong. This is the right thing to do for us, the right thing for Diploma. As for smaller bolt-ons, we'll continue with those with the same discipline and the same return hurdles we have always applied. On deal structure, we have a conservative approach to our balance sheet, which is why we have chosen a combination of debt and equity, also bearing in mind that we have visibility of an attractive pipeline of potential bolt-on opportunities. We're expecting to fund the transaction with the proceeds of this placement of around GBP 200 million and approximately GBP 160 million in debt. The new financing package is a total of GBP 260 million, which allows for headroom and flexibility into the future. Interest cost is around 2.2% at a blended rate. Now on to Slide 15. After the transaction, we'll have a balance sheet that's at the right level for a business such as Diploma, and a strong balance sheet is very much at the core of our financial model. In terms of leverage, both businesses are highly cash generative, which means we'll be deleveraging rapidly. I expect net debt of the combined business to be around 1x EBITDA at the end of the full year 2021, which for us is next September. That means we'll have the headroom to continue with our bolt-on acquisitions, which remain a key element of the Diploma business model. So overall, we maintain balance sheet strength. We'll retain our conservative approach to leverage and we'll have built the flexibility to take advantage of bolt ons. This structure also allows us to have enough liquidity to pay a progressive dividend, as Johnny just mentioned. Now back to Johnny to sum up.

So summing up on Slide 16. We're really excited about this deal. It's a high quality business, which fits perfectly with our model. It's well prepared for scale and has exceptional growth prospects that exposes us more to the U.S. The earnings accretion and returns profile are outstanding. And we can, as Barbara said, retain the conservative balance sheet for future dividends and bolt ons. It's a great deal. Thank you very much. And I'll now hand back to Orlando to take your questions.

[Operator Instructions] And we will move on to our first question, calling from -- Will Kirkness with Jefferies.

Just a couple of quick ones, please. Could you just confirm whether all of that growth, that revenue growth there is organic? I think you said it was. Whether they've done any M&A in the past at all? And then just lastly, sort of what the owner rationale was for selling?

Sure. Well, just on the growth profile. Yes, that growth is organic. They did some very, very small deals, I think, very early in their history, but what you see there is organic. The rationale, well, maybe I'll just take you through very quickly. The deal process, we've been trying to get so close to them for some time. I've built relationships with some of their advisers over the last year or 2. And they contacted me early in the summer to say that he was ready to discuss the sale process. After which, we had numerous Zoom calls. And his rationale is, firstly, that he believes that U.S. capital gains tax will increase postelection into 2021. And therefore, he feels that now is the right time for him to take his cash off the table. He also was very keen to talk to us because he was still keen to stay on in the business and wanted a partner that could work with him on developing their business model, their growth strategy into the future. And clearly, that fits in with Diploma's philosophy. So he was keen to talk to us. As a result of that, we managed to circumnavigate a competitive process and have a bilateral negotiation and discussion and clearly, due diligence, over the last few months.

Okay. Is he tied in for a year then or longer?

Oh, sorry, yes. He's tied in for 3 years as is the top 20 or so of the management team with some retention packages. I should just say on that, if I may just add to it, Will, that it's really, really important that he is part of the future as the leader and the figurehead, as Founder of the business, and we're really glad to have him on board. I'd also just say that the quality of the business also is really resilient. And there isn't really any kind of customer contract dependency or anything like that because we have so many customers across such a wide end of -- wide range of end segments, which makes the business very resilient.

And next, we will take a question from Henry Carver with Peel Hunt.

Just on top of Will's query and the rationale. Just wondering about the sort of integration with the Controls business over in Europe and just the sort of how you see that going forward. Are you going to sort of rebrand or do any sort of -- how far is the integration going to come? And I guess, yes, just a little bit more color on the cross-sell across the Atlantic.

Yes. Sure. Well, look, if we go back to, I guess, the principles of our model. We're not -- we don't really do heavy integration. We're really buying businesses that have got a unique customer proposition, a strong team and culture that have got organic growth potential, and that's what we're buying into. So well, occasionally, we have some cost synergies. There's no real integration as such. And we'll preserve the Windy City Wire brand and we'll preserve the business in its integrity. The business will report, if you like, externally as part of controls, but will -- Rich Galgano himself will report directly to myself. In terms of the cross-sell, yes, we're excited about that. I mean the deal -- we didn't price any of the synergies into the valuation, actually. For me, the deal stands up just on the basis of Windy City Wire's potential on its own. However, there's no doubt that we're excited about what we can do to help them bring products into Europe. We have some existing wire and cabling businesses in the U.K. and Europe, which kind of are similar types of products and similar types of end customers, but not quite this product itself. And I think we can use them access their channels to bring that differentiating product range and service components into the European market. So they're very, very excited about that. They've been looking for a European partner for some time. And so that was really one of the reasons why they were excited about Diploma.

Up next, we'll hear from Sam Bland with JPMorgan.

Congrats on the deal. I've got 2 questions, please. First one is, can you talk about how the business has managed to -- I think its EBITDA are up 18% this year, I think, on flat revenue. Could you just talk about how that's been achieved? And the second question is, obviously, this is quite a different scale of acquisition versus what we've seen from Diploma in the past. Do you sort of view the scale of acquisition as a kind of one-off to get a platform in the U.S.? Or could we see more acquisitions of this kind of scale in the future?

Okay. Just on the EBITDA question. First of all, I mean 2 real driving factors there. Firstly, they're really carrying forward, from the last year or 2, the benefits of growth and scale, leveraging into their margin as they come into this year. And secondly, they've done quite a lot of work in the last year or 2 on their operations and their facilities and processes in Bolingbrook in Chicago. They put a lot of automation in, a lot of technology in, and that's allowed them to improve their gross margin, but also reduce their overhead as well. And that's comes through really strong this year as well. So it's a great performance. In terms of acquisitions of scale, yes, obviously, it's a bigger one than we've done before. But as I was saying a bit earlier, it really takes all the business model criteria. It's important strategically in getting controls into the U.S. and the financial returns are obviously pretty strong. And of course, as Diploma gets bigger, therefore, we have the financial muscle to be able to do deals of this size. Now having said all that, you shouldn't expect that we're going to do one of these every day. Our pipeline is full of the normal size of Diploma acquisitions. But I think occasionally, on how frequently is that, I don't know, a couple of years, whatever. If the right thing comes along, we should be prepared to look at it. And I think that's the way I would see it. And particularly for this deal, it may be a bit bigger. But, as I said earlier, significantly earnings-enhancing and covering our cost of capital, I think, is great returns.