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A Steeper Ascent: Growth in the Testing, Inspection and Certification (TIC) Industry

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A Steeper Ascent: Growth in the Testing, Inspection and Certification (TIC) Industry A steeper ascent Growth in the testing, inspection and certification (TIC) industry A steeper ascent 1 Growth at different speeds 2 Who said scaling is going to be easy? 3 An industry on a shopping spree 4 M&A still has a long way to go 5 What lies ahead — being a TIC player in a digitized world 6 How we can help 9 A steeper ascent Providers of testing, inspection and certification (TIC) services have been fortunate to see their playing field grow for many years now. But achieving growth appears to be increasingly challenging, as organic growth of the large and increasingly complex TIC players is slowing somewhat. Not surprisingly then, the pace of acquisitions in the TIC industry is notably high, mostly driven by the top 12 TIC players as well as by private equity-owned growth platforms. We take a look at how competition As growth becomes harder to achieve, it has evolved over the last years, which is even more important to make the right factors have been driving markets and decisions about what to focus on in the who performs best in an M&A-driven future and how to tackle the challenge environment. Interesting targets are still of adapting the proposition in a world of plentiful, few players benefit from M&A in rapidly evolving technology. We therefore terms of profitability, and some are more take a look at key technology trends focused on working to round out their relevant to the TIC industry. service portfolio. A steeper ascent Growth in the testing, inspection and certification (TIC) industry | 1 Growth at different speeds Top 12 working hard to sustain their pace For many years, TIC market growth appeared to be unshakable, and Top 12 organic vs. acquisition growth, 2014–16 its trend knew only one direction: up. Market size has now reached 2014 2015 2016 approximately EUR140b–150b and is estimated to be growing at 6.9% 7.2% an organic rate of about 3% to 4% per annum (p.a.), still above GDP 4.6% 2.4% (please see charts on the right). We estimate that more than 50% of Organic growth 3.0% 1.7% the broader quality assurance market is still captive. Growing globalized demand for regulation of materials, products, Acquisition growth 2.8% 4.4% 4.7% systems and processes; ever-increasing trade flows; globally Exchange rate effect1 1.1% 0.4% integrating supply chains; and increased corporate outsourcing of -1.8% R&D activities as well as of quality assurance work to third parties have supported the long-term expansion of the TIC industry. # of acquisitions1 (2014–17) 60 63 71 Ø size of acquisition1 (€m) 9.7 15.5 15.8 Revenue growth of the larger 50 TIC players has been significantly Impact of depreciation higher than market growth, with 6.8% p.a. growth since after of both CHF and GBP 1. Based on available M&A data of top six companies vs. EUR and USD the financial crisis. While overall growth slowed somewhat from Source: Capital IQ; annual reports; EY-Parthenon analysis 2014 to 2016, the top 50 TIC companies still grew at 4.7% p.a., outperforming large economies by about 2 percentage points p.a. Upon closer inspection, however, growth of the largest companies Top 12 vs. other top 50 TIC players’ growth, 2014–16 was driven increasingly by acquisitions while organic growth slowed 9.0% to below 2% p.a. for the largest players in 2016. 6.9% 7.2% 8.1% Ø YoY 5.8% 4.6% Within the top 50, smaller TIC players have caught up to the top 12 growth and have significantly outpaced their larger peers in 2015 and 2016. 2014 2015 2016 14.4% 14.1% 13.6% Growth comparison, TIC top 50 companies vs. GDP of large 11.8% 11.8% 12.2% economies, 2009–16 Ø EBITDA Index (2009 = 100) margin 2014 2015 2016 160 TIC Top 12 Other top 50 155 +4.7% top 50 150 145 +6.8% Source: Capital IQ; annual reports; EY-Parthenon analysis 140 135 Canada 130 US UK 125 DE 120 115 FR 110 105 Acquisitions compensate 100 95 for lower organic growth. 2009 2010 2014 2011 2012 2013 2015 2016 Source: BvD; Capital IQ; BEA; BACH; Statistics Canada; ONS; EY-Parthenon analysis 2 | A steeper ascent Growth in the testing, inspection and certification (TIC) industry Who said scaling is going to be easy? Bottom-line growth not keeping up In most industries, consolidation drives Some of this is due to the impact of The fact that large TIC players have corporate earnings. Although margin sectorial specialization. Companies with grown their top line much faster than expansion is a secular global trend across higher shares of their business within oil GDP but their bottom line (in several all large economies, it is somewhat and gas, mining and metals, and marine cases) more slowly than the broader surprising that earnings growth of the TIC have underperformed their peers. economy indicates that average TIC sector has underperformed some of the margins, despite being attractive, are not broader economies. Increasing size does expanding like those of other sectors. not fully translate into earnings power. This points toward limited pricing power and poor efficiency gains of TIC players. Corporate earnings1 growth, TIC companies vs. large economies, 2009–16 Furthermore, TIC enjoys fewer of the structural benefits of other industries Index (2009=100) that can optimize their supply chains and 260 manufacturing, e.g., through offshoring. 250 Within TIC, employees have some 240 230 negotiation power, operating leverage is 220 limited for many services and capacities 210 200 Canada can mostly not be relocated abroad. 190 DE 180 FR Governance and ownership structures 170 160 TIC top 501 also play a strong role for margin levels 150 and indicate that there is room for 140 US 130 improvement, especially for nonpublic UK 120 companies, including (somewhat 110 Significant net income decline in 2015 mostly surprisingly) larger TIC companies 100 driven by impairments for 90 oil and gas businesses owned by private equity investors. 2009 2010 2011 2012 2013 2014 2015 2016 1. Nonfinancial institutions 2. Based on 33 complete time series Source: BvD; Capital IQ; BEA; BACH; Statistics Canada; ONS; EY-Parthenon analysis Top 50 TIC players by governance, 2014–16 17.5% 17.3% 16.7% 9.3% 9.2% 8.8% Weighted 7.1% 7.4% 7.4% Ø EBITDA margin 2014 2015 2016 Publicly listed Nonpublic Private equity Source: BvD; Capital IQ; BEA; Bundesanzeiger; annual reports; EY-Parthenon analysis A steeper ascent Growth in the testing, inspection and certification (TIC) industry | 3 An industry on a shopping spree Because M&A plays a key role in large TIC companies growing M&A drives strong growth for players and supports mid- faster than the broader economy, we have taken a closer look tier TIC companies such as Socotec, Trigo and Kiwa in at the activities of the largest firms. their internationalization efforts as well as their pursuit of operational leverage. Their M&A activity is staggering: the top 12 TIC players by revenue in 2017 have acquired more than 370 companies While driving top-line growth, M&A appears to rarely be margin- over the last five years — counting only acquisitions that have accretive, with only a few exceptions. On the contrary, some been made public. We think the actual number of takeovers is acquirers appear to be struggling after bigger M&A moves, and significantly higher. margins of the large firms are on a slight downward trajectory. Among the largest companies, Eurofins stands out in many aspects. Its strategy is different, and its growth and margins Acquisitions, top 12 TIC players, 2013–17 are higher compared with other large players, driven by TIC company Published acquisitions, 2013–17 acquisitive growth and specialization in the very attractive life Eurofins 135 sciences TIC sector. SGS 69 We observe three key characteristics regarding M&A in the Bureau Veritas 39 TIC sector: DEKRA 32 DNV GL 20 • Small national specialists in North America and Europe are TÜV Süd 17 in highest demand. TÜV Rheinland 15 • The acquisition frequency of the top three acquirers is Applus+ 14 accelerating; their acquisitions made up more than 80% Intertek 13 of the number of transactions in 2017. Lloyd's Register 7 Team Inc 6 • Average acquisitions are fairly small and are estimated TÜV Nord 5 to be approximately EUR10m–15m in revenue. Total 372 Source: Capital IQ; Mergermarket; Crunchbase; company websites; annual reports; press releases; desk research; EY-Parthenon analysis High and rising flow of deals 100 80 68 60 64 Top 3 acquirers are accelerating efforts Specialists wanted 2013 2014 2015 2016 2017 100% 100% 30% 19% 15% 40% 27% 24% 23% 17% 48% 47% 1 or 2 TIC M&A 81% sectors 85% 60% 70% 73% 76% 78% 83% Top 3 52% 53% covered 60 64 68 80 100 100% 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 25% Other 40% 34% 31% 33% 45% Europe and Europe 40% 44% 49% 47% North America North America 30% 26% 25% 13% 18% in focus 2013 2014 2015 2016 2017 Source: Capital IQ; Mergermarket; Crunchbase; company websites; annual reports; press releases; desk research; EY-Parthenon analysis 4 | A steeper ascent Growth in the testing, inspection and certification (TIC) industry M&A still has a long way to go High degree of fragmentation Acquisitions by sector, top 12 TIC players, 2013–17 presents further opportunities Others 13% Despite the continuous consolidation activity of larger TIC Energy players, the industry is still remarkably fragmented in its long 9% tail.
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