Shares digital

The broadcast equipment maker’s attractive picture is not reflected in the price, presenting a possible buying opportunity

by Timon Day

Chief executive Gareth Rhys Williams is credited with making Vitec (VTC) an international force to be reckoned with. Since he took the reins in 2002 the firm, which manufactures imaging and photographic equipment for everyone from ordinary folk to television companies, has seen profits zoom from £15 million to £25 million. A further leap to £34 million is expected in 2008, boosted by the Olympic Games, and a rise to £35 million is forecast by analysts for 2009.

Despite such progress the Surrey firm’s shares have collapsed from last October’s year high of 675.5p to 377p, leaving the shares on a derisory forward PE of 7 and a yield of 5%.

Yet Rhys Williams still waxes lyrical over lunch about a new robotic camera system starting to replace camera operators – there is one in the House of Commons. ‘It is much better than CCTV as it can do on-air moves controlled from the studio,’ he says.

Also on his mind is the strength of the dollar. Half of Vitec’s profits come from the US and, though the dollar seems to have stabilised against sterling, its weakness last year lopped around a sixth, or £4 million, off profits.

Williams is keen to hammer home the message Vitec is a fine company – and massively underrated.

Of course, chief executives are not prone to saying their stock is overvalued, but help is at hand from independent analyst Michael Blogg at brokers Arbuthnot. He says Vitec now has some of the strongest international market positions of any UK-listed business, a robust rate of growth and excellent opportunities for further expansion.

Why Vitec is undervalued

Blogg is not alone. According to Really Essential Financial Statistics four of the six brokers covering Vitec have ‘buy’ ratings and the other two are ‘overweight’. This makes the past year’s crunching de-rating from a peak PE of 20 more baffling, though four factors could explain the share price decline.

A bear market is no help, especially for small and mid-cap stocks. Vitec is not that small with a market value of £159 million (it peaked last year at £270 million) but compared with customers such as CNN or the BBC it is tiny.

Secondly the economic slowdown has put pressure on customers to cut spending, so 2009 profits might not rise much on 2008 – consensus estimates call for a mere 2% rise in earnings per share, after 9% growth in 2008.

Thirdly, profit growth has owed much to acquisition, which can be risky.

Finally, the company may simply not be well understood. FTSE classifies Vitec under Industrial Engineering, which cannot help the market grasp what it does and how it operates. Vitec could be called a services business.

‘Our business is to make content and production easier and cheaper for television companies. We also sell loads of kit to independent professional and amateur photographers. Our aim is to sell more stuff to the same customer,’ Rhys Williams explains. ‘Vitec is not difficult to understand but there is no other company for us to compare with so it is more difficult for investors.’

Courage of his convictions

He and two fellow directors clearly feel concerns about dollar softness, this year’s Olympics flattering profits and weak investment patterns at key clients are overdone. They put their money where their mouths are by recently increasing their shareholdings, although directors still own less than 1% of the company.

Vitec’s three operating divisions cover the market spectrum. The smallest – broadcast services – saw profits slip last year, but accounted for just 6% of group income. Rhys Williams admits he would not buy the business now, were it not already part of the group. But he adds he would not sell either, as it provides vital customer information through renting kit to broadcast companies for outdoor events. ‘We obtain a lot of feedback as the rental business touches the customer hundreds of times a day.’

Vitec’s imaging products division provides most of the profits. Some 15% of sales are to keen amateurs and most to professionals. Growth has run at 10% compound over the past five years, with success based on establishing or acquiring leading brands ranked in the top two in their global niche markets, then stringent cost-cutting – without any loss of product quality. Top sellers include robotic camera support, tripods and camera bags, where Vitec dominates, with global market shares of 80%, 70% and 40% respectively. Robotic camera supports cost from $50,000 to $100,000 and the most expensive products of all are movie cameras costing $500,000.

Sales of digital single lens reflex cameras rocketed in a market where prices range from $1,000 to $20,000 despite recent steep falls. Revenues jumped 40% last year and are set to rise 25% this year.

Vitec primarily uses its own distribution system which, coupled with continuous innovation, means the company should be very hard to dislodge from pole position in imaging products.

Lights up on broadcast systems

The fastest-growing and most exciting bit of Vitec is broadcast systems, where transforming acquisitions such as RF Systems and Autoscript plus organic growth almost doubled profits to £13 million in 2007.

Conversion to high definition programme-making and increasing coverage of sporting events have boosted sales and profits. Key success factors include Vitec’s pan-US network, with ten locations, high-quality technical support and a wide range of equipment.

‘RF has grown four-fold since we bought it in 2007. It provides microwave links between the camera and studio, has 40% of the market behind leader Vislink (VLK) with 60%, and should carry on growing at 15% to 20% a year,’ says Rhys Williams. This business focuses almost entirely on the US with only 4% of sales from the UK. It should displace imaging as the group’s biggest profit maker by 2012.

Over a third of sales are now derived from products launched since 2004, says Rhys Williams proudly. Vitec invests 5% of sales a year on research and development to ensure it remains a leader, up from 3% in 2005.

‘Innovation fuels our growth,’ he says, pointing to the 18 awards Vitec won last year for new products such as tripods, backpacks, fluid heads for camera support, teleprompting and a lighting hoist system for studios and theatres.

This year the group has already collected half a dozen awards ranging from RF’s handheld receiver/monitor to Sachtler’s on-camera LED light.

Vitec has also supplemented organic growth with shrewd acquisitions. Rhys Williams has masterminded the purchase of 14 companies since 2002. Three large deals in 2006 and 2007 cost a total of $38 million and helped drive net debt from £5.4 million at the end of 2005 to £38.4 million by December 2007. That said, net gearing is just 40% and interest cover over six times, even if the interest charge on the pension fund is included, so Vitec is in rude health.

Many of Rhys Williams’s purchases have been distribution businesses brought in-house to boost the group’s margins. The deals have also taken Vitec closer to its customers and Rhys Williams makes sure his team listens closely to what they have to say.

‘The group is assembled like a large jigsaw puzzle,’ says Arbuthnot Securities’ Michael Blogg.

Picturing the future

Rhys Williams would like to buy a few more companies now RF has been digested. He is keen to plug gaps in Vitec’s product range by snapping up a maker of special lights and also microphones, an important market.

Arbuthnot’s Blogg expects Vitec’s record of strong cash generation to continue, allowing it to cut debt and acquire more companies with complementary products and distribution channels. He also expects impressive gross profit margins of 42% to be maintained, which would put Vitec on a level with other well-regarded manufacturers such as Chloride (CHLD), IMI (IMI), Morgan Crucible (MGCR) and Rotork (ROR). This is the key to any re-rating.

If investors come to believe Vitec is the equal of these much bigger engineering groups, which command an average enterprise value-to-sales multiple of 1.3 times, its share price would soar to well over 600p, for 59% upside.

To achieve that, Vitec will first have to sail through a possible recession, get a lot larger and broadcast its message much more clearly and loudly than to date. Meanwhile, it could prove vulnerable to a takeover bid itself. Largest shareholder Harris Associates, with a 12% stake, has a reputation as a canny long-term value-oriented investor. Other key owners are Prudential (PRU) and Barings with 8% and 6.6% blocks respectively. There is a suspicion Rhys Williams would prefer to take the firm private rather than be taken over, but he would not stand in the way if a proper bid came in, a long way north of the current market valuation. But the firm’s strategy has been consistent and remains clear: to increase the value of products and services it can provide to markets where it already has a strong capability and reputation.

CONCLUSION: VITEC GROUP (VTC) 377p

Risk to earnings forecasts: 4 (5=upside risk, 1=downside risk)

Earnings predictability: 3 (5=very high, 1=very low)

Valuation: 4 (5=cheap, 1=expensive)

Balance sheet strength: 4 (5=cash rich, 1=heavily indebted)

Cashflow: 4 (5=very strong, 1=very weak)

Overlooked: 1 (5=all brokers negative, 1=all positive)

TOTAL 20/30

RATING: BUY