Business Breakdowns
· Matt Reustle, Andy Gardner
[00:00:00] S0: While we're on M&A, I'm always curious about integration and that is oftentimes where good M&A by the numbers turns into bad M&A because of the challenges and frictions. What would you say Amphenol does or what's their approach that maybe differentiates them in that regard? [00:00:00] S1: Their integration process, typically it's a multi-year process. They may run them largely independently at first. As mentioned, there will be some integration of primary functions. So that's things like machining or assembly or procurement, but that's while maintaining the autonomy on the client facing side. So that really preserves the culture and then the customer centricity, but while capturing the efficiencies. [00:00:00] S0: Even the patience is noteworthy. It seems a good time just to bring up, I know they've made a large acquisition recently, believe it's the largest in history. Can you just talk a little bit about that? [00:00:00] S1: They bought CommScope's Connectivity and Cable Solutions business in August, so very recently. It's a sizable move. As you mentioned, it adds around $3.6 billion of revenue, but at a healthy 26% EBITDA margin. Strategically it's a very neat fit. So CCS as it's known, that makes fiber optic, interconnect broadband, and building connectivity products. These slot directly alongside Amphenol's data center and network interconnect offerings. So essentially it deepens their presence and extends their TAM in this IT datacom and communications infrastructure domain, which as we've talked about is one of the fastest growing end markets.
· Andy Gardner, Matt Reustle
[00:00:00] S1: They bought CommScope's Connectivity and Cable Solutions business in August, so very recently. It's a sizable move. As you mentioned, it adds around $3.6 billion of revenue, but at a healthy 26% EBITDA margin. Strategically it's a very neat fit. So CCS as it's known, that makes fiber optic, interconnect broadband, and building connectivity products. These slot directly alongside Amphenol's data center and network interconnect offerings. So essentially it deepens their presence and extends their TAM in this IT datacom and communications infrastructure domain, which as we've talked about is one of the fastest growing end markets. [00:00:00] S0: If I just focus on the size, there's this debate oftentimes about as you grow via acquisition, it eventually gets tougher to move the needle. The question is, will the playbook still apply to companies that are bigger in size and that same integration effort? How do you frame this acquisition just relative to previous acquisitions? How consistent does it look? You did mention it fits pretty smoothly. That was answering part of the question there. But any other thoughts on that? Given it is always such a particular topic for serial acquirers or those that are M&A active.
· Matt Reustle, Andy Gardner
[00:00:00] S0: If I just focus on the size, there's this debate oftentimes about as you grow via acquisition, it eventually gets tougher to move the needle. The question is, will the playbook still apply to companies that are bigger in size and that same integration effort? How do you frame this acquisition just relative to previous acquisitions? How consistent does it look? You did mention it fits pretty smoothly. That was answering part of the question there. But any other thoughts on that? Given it is always such a particular topic for serial acquirers or those that are M&A active. [00:00:00] S1: We're always mindful when a deal is meaningfully bigger than some of that recent acquisitions. It is by far the largest, but it does reflect Amphenol scale. Today it's actually very consistent. So Amphenol is known for being disciplined, typically doing smaller bolt-ons. But when a large strategically aligned asset becomes available at the right price, they can and have on a number of occasions move decisively. And CCS really fits that mold. It's a very strong adjacency. It's expected to be dilution neutral or accretive to EPS in year one and has attractive margins. I would say they're really using their balance sheet strength to make an opportunistic move, but without compromising the discipline playbook.
· Andy Gardner, Matt Reustle
[00:00:00] S1: We're always mindful when a deal is meaningfully bigger than some of that recent acquisitions. It is by far the largest, but it does reflect Amphenol scale. Today it's actually very consistent. So Amphenol is known for being disciplined, typically doing smaller bolt-ons. But when a large strategically aligned asset becomes available at the right price, they can and have on a number of occasions move decisively. And CCS really fits that mold. It's a very strong adjacency. It's expected to be dilution neutral or accretive to EPS in year one and has attractive margins. I would say they're really using their balance sheet strength to make an opportunistic move, but without compromising the discipline playbook. [00:00:00] S0: I give you credit because you've been able to do a good job of getting into the nuance of the business, but also keeping the high-level broader descriptions in terms of exactly what's going on and the broader themes that they're exposed to. As we apply that same lens to the financial model and performance of the business, sometimes it can be very difficult to think about forecast, whatever it might be, the future. When you have this organic growth that is happening in so many different end-markets plus the M&A, how do you even go about framing that? And you can look back over history, whatever goes into it—but the context for the financial model and how you approach it would be useful.
· Andy Gardner
[00:00:00] S1: Let's take a step back and if you look at Amphenol's financial history, what strikes you first is the consistency of the compounding. So over the past, even two decades, revenues have grown at a low double-digit rate. Roughly two-thirds of that growth has come organically, averaging about 7%, and the remaining third from acquisitions around 5 to 6%. Earnings per share have compounded even faster, and that's in the mid-teens annually. And that reflects obviously not only that top-line growth we mentioned, but steady margin expansion as well as the disciplined capital deployment. And that's an exceptional track record for an industrial company, and it's one of very few that other peers have been able to match. So over the past 20 years, Amphenol's operating margin has gradually expanded from the mid-teens level into that close to 25% range we see today. And that's consistently outpaced peers. The company's gross margins sit around 36%. Obviously this isn't software grade, but it's very solid for this product type. It's a reflection of the value-add nature of its products. Importantly, incremental margins—so that's the profitability of each additional dollar of sales—have been running very high recently. That's reflecting strong demand in datacom and AI-related applications, but also execution. So incremental gross margins are above 40% and operating margins above 30%. In addition, the model is inherently asset-light. CapEx is modest at about 3 to 5% of sales. And the decentralized structure keeps overhead very lean. So margins, we would expect, remain best in class. Amphenol does generate a lot of cash, has steadily raised its dividend over time. The yield remains modest around 1%, but that's okay because it's based upon a prioritization of acquisitions, which have historically offered very high returns. But it will also repurchase shares if excess cash builds up, mainly to offset the dilution rather than shrink the share count float. But after paying dividends, it has historically spent around 50% of remaining cash flow on M&A and around 40% on buybacks. One of the key attractions, though, of Amphenol's financial performance is that it's been much more defensive than peers during downturns. For example, during the global financial crisis, Amphenol's revenues fell only 13%. That compares with nearly 30% at TE Connectivity.
· Andy Gardner, Matt Reustle
Then again in 2020, organic growth dipped to 1% growth, but operating margin remained 20%. Whereas many industrial firms saw revenue declines and margins subsequently plunge. And there are a number of reasons for this higher than expected resilience. First, of course, is the things that we've mentioned around extreme diversification, which we've talked about at length. In recent years when traditional industrial and automotive and aerospace have been relatively weak, broadband and datacom have surged, and in the next year or two we expect industrial and automotive to recover, while the IT side of things may start to settle back into something more normal. They are also very effective at managing costs during a downturn. So we've talked about how they're structurally very disciplined. But a significant portion of costs are variable—so materials and components and direct labor that can be flexed. So when volumes drop, costs come out fairly quickly to protect the bottom line. And we've also talked about management style and overall culture and how they manage the firm. They are also known for conservative forecasting. For investors, this does mean that surprises are usually on the upside and downside. Surprises are relatively rare and mitigated. [00:00:00] S0: If I were to put this all together, if you're coming at this from the investor lens and thinking about the go-forward opportunity, is there a specific catalyst or signpost or thing that you think matters the most? How would you frame the opportunity from the investor seat?