Thread by @stocks102

THREAD: Long Judges Scientific #JDG and SDI #SDI

Charlie Munger once famously observed that you need to buy a company with a high ROCE to ensure good share price performance.

Judges Scientific and SDI group both have high ROCE’s (of c 20%+).

What Munger didn’t spell out,..

..is that it’s even better if a company with a high ROCE has a long reinvestment runway. After all, if you have a high Return on Equity, but no place to invest that Equity into, you won’t get far.

Judges Scientific and SDI do both have long reinvestment runways.

So, what do...

...they do?

They both buy up small private UK companies in the field of science instruments. For example, a recent acquisition by Judges was of the leading tester of lithium batteries worldwide. (After lithium batteries in Teslas blew up, and after mobile phones batteries did

likewise when used in aeroplanes, this has become a ‘hot topic’ if you’ll excuse the pun.)

Before going into why JDG and SDI bother doing this – buying up these small companies – we need to acknowledge that this is a story primarily of financial engineering. That the targets...

...are scientific instrument makers, is irrelevant in a way. What is relevant, is that SDI and JDG pay an average of 5x EBIT for the businesses, and this is how they make a that 20% ROCE on each investment (if they spend £1m for a business, and pay 5x EBIT, they will make £200k

per year, or 20%, out of it).

Both SDI and JDG finance these acquisitions out of bank debt, paying 3% interest, or out of net cash. Then they pay off the debt incurred and find a new target to buy, borrow more debt, then pay it off again. And so on. There’s a reason Jim...

...Radcliffe is, on and off, the richest person in the UK. He pulled off this trick – getting the bank to finance his acquisitions, then paying them back fast before reloading – but bought chemical companies instead of scientific instrument companies.

There are 2,000 targets in

the UK for JDG and SDI with 100 coming up for sale each year (most of the targets were founded 20 years or so ago by people in their 40’s who are now wanting to retire, 20 years on – so every year there is a steady stream of sellers).

JDG and SDI are very disciplined in the...

...price they pay (sticking to 4-6x EBIT). As they are for the kind of targets they are looking for. Those with: a 25% EBIT margin (showing there’s no price war going on with peers, else margins would be hitting the floor)). A dominant position in a niche (targets usually...

...export c 90% of turnover, proving the niche global. Niches in the UK alone aren’t big enough). Cash generative. And with steady but barely growing profits.

Once bought, JDG and SDI invest c 5% of sales in R&D. To produce new products. Which then blasts the target’s sales..

... higher. Thus 9% organic growth rate per year is usual for the group.

There is no attempt at extracting synergies. Newly acquired businesses are left alone – apart from being asked to send HQ monthly accounts. And to create a budget once a year. And if they want more R&D

money – and can prove the products planned will have a fast payback – they get it fast.

All of this has led to spectacular earnings growth and share price rises. For example, JDG has seen eps go from 31p in 2016 to 156p last year. With the share price going from £14 in 2016 to

£82 today. Over the same period, SDI has seen eps go from 1.2p to 4.6p, and the shares from 13p to 200p.

Is there a moat? Yes, in the form of the reputation of the companies. Whenever SDI or JDG agree heads of terms, they do eventually pay the vendor the sum promised in...

...those heads of terms. That’s unusual. And is a world away from VC’s who change terms as the process goes on. And another attraction is that JDG and SDI have never sold a business, ensuring the vendor’s legacy continues, untampered, post sale. Contrast this behaviour with..

... that of VC’s who load a newly acquired target with debt – thus risking its survival – and then hawk it on soon afterwards to a new bidder the vendor will never meet.

I can’t see why the financial wizardry of both can’t continue, and bought shares in both in December.

/end