Sensing Opportunity: Building a Marquee Industrial Sensor Company

In a previous article, our senior bankers discussed the Industrial Internet of Things (IIoT), exploring opportunities for private equity in this growing ecosystem of smarter, more-connected industrial processes. In that piece, we highlighted five segments of that market that are especially attractive (Figure 1) for private equity investors seeking to benefit from this long-term transformation to data-driven, smart manufacturing.
 
One of these segments is the sensors and infrastructure space, which includes devices fundamental to the IIoT. Companies in this segment typically trade in the 11x-14x EBITDA multiple range, with size, sophistication, intellectual property and end-use application driving enterprise value. With simple business models, relatively high industry fragmentation, and favorable industry trends driving greater use of sensors, this space is fertile ground for investors with the right vision and approach.
 
In this article, we take a deeper look at this segment. In particular, we’ll explore how investors can assess potential acquisitions and create marquee companies that will generate optimal interest at exit. We will also discuss how private equity groups have done so successfully.
 

Figure 1: Five Promising IIoT Segments

Based on recent analysis and deal activity, Harris Williams believes there are five industrial segments ripe for IIoT-related investment by private equity firms: Extraction & Heavy Industry, Transportation & Fleet, Manufacturing & Supply Chain, Sensors & Infrastructure, and Utilities & Smart Grid.

Onicon Case Study: Target Assessment and Platform Development

As described in Figure 1, sensors and infrastructure solutions include physical detection devices and network gateways that allow data to be collected and transmitted. This collection and transmittal are becoming more important with the advent of high-speed, low-latency wireless networks, miniaturization of electronics, and advances in low-power processors. Such technologies use sensors, in combination with software-driven supervisory control and data acquisition (SCADA) systems, to increase productivity in modern industrial processes while simultaneously reducing the human element.
 
This industrial sensor segment offers compelling opportunities for investors looking to build leading platforms. That’s due to the wide variety of sensing technologies in use, the success sensor companies have achieved by specializing in niche applications, and the segment’s high degree of fragmentation.
 
Onicon’s growth story illustrates how investors can build such a platform. The company is one of the leading players in sensors used for flow, level and pressure measurement. Onicon’s application-specific technology enables its customers to reliably and accurately measure resource usage and increase process efficiency, often in complex and regulated environments.
 
The company, founded in 1987 and purchased by Harbour Group Industries in 2012, was recently sold to TASI Holdings, a portfolio company of the Berwind Group. Its maturation into a market-leading platform highlights three principles buyers should consider when seeking to replicate that success.

Principle One: Be Flexible on Size

Many private equity funds have clear mandates to stay above a certain size, and in some cases, lack the capabilities to handle multiple small acquisitions. As a result, they typically will not be interested in a company until it hits their “sweet spot.” Similarly, strategic buyers generally seek a certain level of operational sophistication, proven technology, and, more so than ever, enough scale to “move the needle” in their business.
 
Sometimes, however, it’s advantageous to be flexible on size. That’s certainly the case with the sensor segment, says John Arendale, a managing director in the Harris Williams Industrials Group. “In this industry, small and large companies dominate—there are very few companies operating in the middle, where there tends to be the greatest demand among investors and buyers,” explains Arendale.
 
Given this market vacuum, there is an inherent benefit for business sellers to scale a platform to a size which the most buyers, strategic or financial, would aggressively pursue. In particular, investors with a view of their eventual exit can benefit from building a medium-sized platform out of a small niche leader, says Eric Logue, a managing director in the Industrials Group. “Starting with a small company with strong core technology and brand, investors can scale the company and broaden its appeal via new product development or strategic tuck-in acquisitions—ideally, a combination of both.”
 
Attractive smaller companies abound in the segment, says Jeff Perkins, a managing director in the Industrials Group. “There are many smaller companies intensely focused on providing niche technologies that occupy addressable markets barely eclipsing $100 million in size. Despite being small, they compete well against the big guys by being nimble, innovative and experts in their verticals.”
 
It’s also important to not be deterred by a company’s current total addressable market, says Jenson Dunn, a vice president in the Industrials Group. “The sensors market is highly fragmented across technologies and applications. Successful sensor companies have built their platforms by taking a core technology serving one application and re-engineering it for another one. Onicon, through its acquisition of Seametrics, a niche leader in electromagnetic technology for irrigation applications, was able to develop a new line of high-accuracy electromagnetic flowmeters for the HVAC market, instantly tripling its effective addressable market for that technology. As long as the engineering and new product development strength is a strong core competency, it is an effective organic growth lever that can be amplified by technology-focused M&A.” 
 
In addition to looking at smaller targets, investors in the sensor space should get more comfortable with certain imperfections—such as cycle exposure. For example, says Logue, Onicon's core business—providing flow meters for commercial HVAC systems—could be perceived as correlated to building cycles.
 
“While underlying industry trends can be challenging, Onicon’s investors had a thesis around a macro shift towards smart infrastructure, which will continue to emphasize installing technologies that aim to optimize building efficiency, driving efficiency and cost savings,” he explains. “As such, Onicon’s value proposition will remain compelling regardless of what the underlying market does.”

Principle Two: Look for Strong Core Technology and Applications Expertise

Niche category leaders have often built their business around strong core, application-specific technology (and not necessarily intellectual property), says Dunn. “It’s common to associate value with a company’s intellectual property (IP)—typically measured by the number of patents a company owns. However, in this space, deep intellectual property portfolios are not how companies win. In fact, in the sensor segment, applications expertise is arguably just as valuable.”
 
The application could be industry-specific or for a particular type of end-use. “When technology is highly tailored to a specific application or use case, it’s the design and systems engineering required to customize it that underscores its value proposition for the customer,” adds Logue.
 
In such instances, sensor companies can build a defensible “moat” in the form of highly valuable, fiercely guarded expertise rather than patents. In addition, because these applications tend to be very specific, the company generally will not compete against much larger companies since the space is too small to justify their attention. Application expertise also helps sensor companies avoid commoditization, and by doing so, achieving more attractive and stable margins. Finally, application expertise will generally translate into a stronger brand, making the company the provider of choice in those niche markets.
 
“The point is, despite initial small market potential and presumed limited upside, a solid technology company that’s a leader in its category while providing differentiated value through its applications expertise can be the ideal platform investment in this space,” says Dunn.
 
For example, the core Onicon platform that Harbour acquired in 2012 was focused strictly on niche HVAC applications, and effectively, one major technology (mechanical turbine flow meters). However, the products were low-cost relative to the broader HVAC system and served a critically important function: measuring resource consumption, which enabled customers to optimize efficiency, thus significantly reducing their operational costs—a movement toward smarter buildings and processes. “The company’s deep applications expertise made Onicon the established brand in the segment—the go-to company for that technology,” says Logue.
 

Principle Three: Assess the Potential for Transformational Change, Knowing it Might Exceed Current Management’s Vision or Capability

Taking a small, specialized industrial sensor company like Onicon to the next level requires a transformational outlook and proven growth tactics. Those could include:
  • Identifying other types of sensing technologies that could be applied to the company’s core applications
  • Modifying the company’s current sensor technologies to expand into new applications or new markets
  • Offering other technologies that are part of the larger system the core technology serves
  • Increasing content provided to the existing customer base and selling more through existing channels
Whichever strategy an investor chooses, building upon their initial investment requires two key things.
 
One is new ideas. “Leveraging the company’s core technology to transform it into something beyond its niche requires being visionary in looking at that platform—thinking out of the box to find new ways the company could serve existing or new customers,” says Chris Toussaint, a vice president in the Industrials Group.
 
Such innovation often requires an infusion of new talent and perspectives. This doesn't have to necessarily mean eliminating the current leadership team, says Logue. “Existing leaders may be vital to the business because they could have critical engineering expertise and institutional knowledge, and it’s important to make sure they're comfortable and want to remain after the sale.”
 

However, he adds, those leaders may not be as well-suited to carry out an M&A strategy, or identify promising adjacencies for existing products. Thus, they could be retained in different roles, with a new layer built above them: a new CEO, executive team or corporate development function with the experience needed to take the company to the next level.

From $60 Million to $1.5 Billion: The Measurement Specialties Story

During a ten-year span, Measurement Specialties (MEAS), a sensor and sensor systems provider, acquired 17 smaller companies specializing in pressure, temperature, humidity, level inertia and other variables. It grew from $60 million in revenue in 2004 to approximately $540 million by 2014, transforming itself into a truly diversified, market-leading sensor platform.

That year, MEAS was itself acquired by TE Connectivity (TEL), an electronics components company.  The $1.5 billion acquisition, at an EV/EBITDA multiple of approximately 22x, was one of the largest ever completed in the test and measurement equipment market, and remains a testament to the value creation potential of the buy and build strategy.

The second requirement is patience. “It takes time to transform a small, niche technology player into a marquee company that will generate attractive exit options and strong demand from buyers,” says Perkins. For niche industrial technology companies to achieve scale, he says, they must execute on long-term initiatives, such as developing and marketing new products, penetrating new markets and applications, and identifying and integrating acquisitions. Fundamentally, this takes time, so investors need to be methodical and make sure the pieces are in place before embarking on transformational initiatives.
 
Logue adds that for investors who do it right, it’s well worth the wait: “Single-digit valuation multiples can push into the mid-to-upper teens for pristine companies.”
 
He points out that when Harbour purchased Onicon, the company was a market leader in HVAC, but only generated about two-thirds of its revenue from proprietary technology. “Harbour saw beyond the company’s narrow focus and believed there was a clear opportunity to boost Onicon’s addressable market,” he says.
 
To unlock this potential, Harbour brought in new talent and established a centralized R&D team. Additionally, Onicon was able to acquire a series of smaller flow instrumentation companies that specialized in more advanced technologies (e.g., ultrasonic, thermal mass, electromagnetic, etc.), which not only helped to expand the platform’s technology portfolio but also further diversified its end markets into non-HVAC applications.
 
The team focused on improving the core products, substantially increasing the revenue mix of proprietary products to nearly 100 percent, and modifying acquired technologies for new applications.
 
By 2019, Onicon became a leader across multiple additional niche end markets, including agriculture and irrigation, water and wastewater, industrial processes, and oil and gas, helping to effectively quadruple the company’s total addressable market.
 
But this didn’t happen overnight, says Logue. “It took approximately six years to transform Onicon into a company that would appeal to a wide range of buyers.” That transformation included investing in talent, building out the company’s technology portfolio, aligning its sales and brand strategy, and executing on several important tuck-in acquisitions.

Conclusion

Given the widespread adoption of “smarter” industrial processes, the future is bright for companies supplying sensors that can relay critical information to improve efficiency and quality. Prospects are also good for buyers that can identify sensor companies with the potential to become leaders in their respective segments.
 
Harris Williams’ experience with Onicon reveals three key principles for buyers looking to achieve this goal: Think smaller, focus on core technology and applications expertise, and be ready to bolster the company’s ability to transform itself.
 
“If you want to attract significant demand from larger buyers, it's worth starting small, and growing thoughtfully and methodically,” reiterates Arendale. “That’s something many smaller private equity funds have recognized, as they’re actively looking for smaller, less-expensive players that they can build and grow over time. If you’re able to do that, you’ll be the size that buyers are aggressively searching for.”
 
Published January 2020