Valuation of NKT Holding A/S

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Valuation of NKT Holding A/S

Master's thesis

Finance and Strategic Management Department of Finance Copenhagen Business School

February 2014

Author: Allan Andreasen Supervisor: Peter Schrøder

Pages: 80 Total characters: 141,352

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Executive Summary

The purpose of this thesis is to find the fair value of NKT Holding A/S as of the Oct 1, 2013.

The analysis is based on publicly available information only.

The analysis will be based on both a strategic analysis and a financial analysis of the different parts of the company followed by the valuation. In the strategic analysis the three business units NKT Cables, Nilfisk-Advance and Photonics Group will be analyzed seperately as the nature of them are very different from eachother.

NKT Cables have in later years invested to increase capacity. But right now they are suffering from increased competition and overcapacity in the Northern European market which puts a pressure on prices. At the same time fewer of the large offshore projects come through due to political uncertainties. NKT Cables are meeting this situation by trying to adapt prodution facilities and become more competitive. Nilfisk-Advance is benefitting from a very effective business model with high operational gearing. Even now in a low growth environment Nilfisk- Advance delivers earnings growth. Their focus is on expanding business on the existing

platforms by acquisition and increased presence world wide. Photonics Group are in an industrialization phase and they experience growth in most business areas.

The financial analysis is based on the consolidated income statements and balance sheets.

NKT Holding A/S has experienced decreasing ROIC through the analysis period. A

decomposition of ROIC shows that the turnover rate on invested capital falls back primarily due to overcapacity in the cables industry. The decreasing profitability in the consolidated holdings can in general be attributed to the challenges in NKT Cables.

The valuation of NKT Holding A/S is performed applying a DCF model and the fair value of the company is DKK 248,65. The value was checked by performing a second valuation through the residal income model and the result matched the first one.

A final sensitivity analysis indicates that the value is sensitive to changes in beta and WACC and a bit less sensitive to changes in the long-term stable growth rate.

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1. Introduction

1.1 Choice of topic

The 15th of september 2008 has become a historical date. This was the day when the american financial giant Lehman Brothers filed a chapter 11 bankruptcy¹ to start the biggest downturn in global economy since the 1930s. The consequences of this crisis has been many. One of them was the great losses on the balances of many banks which led to an unwillingness to give credit to companies making it difficult for the companies to run their business. As a further

consequence companies in general has had to cut their staff to a minimum and to cut the level of cost just to stay alive. This has had a hard impact on growth worldwide.

Today the world is in a better state. The IMF² is forecasting world output growth to reach 3,25% in 2013 and 4% in 2014. But this does not necessarily mean that the crisis is over.

Several western countries are struggling with very high levels of soveign debt leaving them with very little room for initiatives to boost growth.

The better trending economies around the world has also led the stock market to higher levels, although under higher than average volatility. Most industries are hit, but some more than others.

NKT Holding A/S operates in the B-t-B market within industrial machinery. The stock price has not performed very well over the last couple of years compared to the danish stock index OMXC20 and the american S&P500 index (figure 1).

Figure 1 - Performance - NKT Holding vs. OMXC20

Blue line = NKT Holding Source: www.morningstar.com

1 http://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Chapter11.aspx 2 The International Monetary Fund

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By performing a strategic and financial analysis followed by a valuation of NKT Holding A/S this assignment will analyze whether the stock price of the company is undervalued or

overvalued.

1.2 Research question

The purpose of this master's thesis is therefore to estimate the fair value of the danish company NKT Holding A/S. The research question is therefore:

What is the fair value of NKT Holding A/S as of October 1st, 2013?

The answer to this question will be found by going through different analytical stages where the situation of the company will be addressed. The headlines of the stages are seen from figure 2 below.

Figure 2 - Thesis build-up

Source: own creation

1.3 Delimitation

The research question of this thesis is to find the fair value of NKT Holding AS as of October 1st, 2013. Therefore only things that happened up until this date will be taken into

consideration when answering the research question. As basis for the financial analysis are the yearly financial reports from 2007 to 2012.

Although NKT consists of three very different units the financial analysis will be done based on the numbers of the entire consolidated holdings. The thesis will also not assess the fiscal numbers of each unit seperately, but only the total fiscal numbers of NKT Holding A/S.

Strategic

analysis Financial

analysis Forecasting Valuation

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The currency effects on the company reports have not been analyzed in depth. The figures from the consolidated reports have been applied assuming that any currency effects on the result have already been accounted for. This also applies for the future estimated figures.

The sale of joint-venture NKT Flexibles to National Oilwell Varco will only be addressed in sections of the thesis where this event has had an effect on the analyzed financial results.

Besides that it will not be addressed.

No insiders have been interviewed in order to answer the research question, hence the angle of the thesis is the angle of an external analyst having access to no more than public information.

Because of the page limitations the competitors of each business unit will not be described in detail.

I have chosen to apply a cash flow model and an excess return model in the valuation of NKT Holding A/S. A multiple approach to valuation will therefore not be applied, hence the

financial statements of the peers have not been assessed.

A calculation of the beta value will not be carried out in this thesis. Instead a beta value will be found using a respected provider of financial data.

In the strategic analysis the applied models will not be describe in detail in the respective chapters, but will instead be described in short in section 1.4.

1.4 Methodology and applied theory

The perspective of this thesis is to analyze NKT Holding A/S in terms of the companys strategy and the financial state and through that give a best estimate of the fair value of the company. Only publicly available information has been applied to perform this analysis and therefore the thesis are to be viewed from an investor angle.

The thesis contains 7 sections that will take the reader through a process from analysis to valuation of the company.

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Figure 3 - Sections of thesis

Source: own creation

The analysis has been performed applying various recognized models both within the strategic and financial analysis. These models will in short be described in the following section.

After this introductory section where the reader will be introduced to the thoughts behind choice of topic and more I will give at short presentation of the company. The presentation will take the reader through company history in short and the structure of the organization and ownership.

After that the strategic analysis will be performed. The purpose of the strategic analysis is to identify the drivers behind the companys value creation. NKT Holding A/S consists of three units that each are very different. Therefore the strategic analysis will be performed on each of the units and not on NKT Holding A/S in one.

First the products, customers and competitors of the each unit will be described. After that the macroeconomic environment will be analyzed using the PESTEL-model.

To sum up this section the different findings from the analysis will be listed in a SWOT framework.

Subsequent to this the financial analysis will be conducted. The purpose of the financial analysis is to estimate how the future will look like for NKT Holding A/S in terms of

profitability. After measuring and commenting on historic profitability the future profitability are forecasted as a ground layer in the following valuation. The forecasting has been performed using 7 different ratios. These ratios enables me to only forecast some of the numbers from the income statement without compromising the validity of the forecasts.

1.

Introduction 2. Company

presentation 3. Strategic

analysis 4. Financial

analysis 5. Valuation 6.

Sensitivity analysis

7.

Conclusion

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After that the actual valuation will be commented. The primary valuation will be done using the discounted cash flow model (DCF) but a valuation using the residual income model will also be conducted in order to check the numbers.

To see how different factors affects the price of the stock a sensitivity analysis will be performed using growth factor, WACC and beta as the factors.

2. Company presentation

2.1 History

NKT Holding A/S (NKT) was founded in 1891 by H.P. Prior as Nordisk Elektrisk

Ledningstraad og Kabel-Fabrik but was 7 years later taken over by a newly formed limited³ company, Nordisk Kabel og Traadfabrikker. From then on NKT only became bigger an has for many years been one of the leading industrial companies in Denmark.

Figure 3 - Company highlights 1991-2012

Source: NKT website, own creation

3 A limited company has 'members' -‐ people or organisations who own shares in the company (https://www.gov.uk/business-‐legal-‐

structures/limited-‐company)

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In the late 1980s the company changed the way it was set up. This happend when NKT acquired first Nilfisk in 1989 and then Lauritz Knudsen in 1990. This marked a shift where NKT moved out into the whole world to become a global player.

In 1991 NKT Holding A/S was formed and the new structure of the Group as we know it today was formed. This structure was setup to prepare execution of a strategy that should lead NKT Holding to become a global player within its fields of operation.

Focus since then has been on acquiring companies that would diversify NKT Holding A/S' product portfolio, especially in the cleaning division, but also to acquire companies that would streghten R&D within crystal fibers and fiber lasers.

During the last 20 years NKT Holding has divested part of the company. Latest in 2012 when National Oilwell Varco acquired the joint venture NKT Flexibles from NKT Holding and Subsea 7.

Today NKT Holding is a global business conglomerate that consists of three main areas of business which are represented by three seperate divisions, NKT Cables, Nilfisk-Advance and Photonics Group. The business units are represented in more than a 100 countries worldwide.

Figure 4 - NKT Group structure

Source: NKT website

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2.2 Owners

NKT Holding is a publicly traded company owned by its shareholders. The total share capital of the company is DKK 478.593.580 and the shares are divided into shares of DKK 20.00 each⁴. The shareholders consists of several types. ATP Denmark is the largest single owner of shares holding around 5%. The rest of the shareholders are comprised of private investors and institutional investors in different sizes (figure 5).

Figure 5 - Shareholder distribution

Source: NKT website, own creation

Approximately 0,3% of the NKT shares are held by NKT Holding. The share capital of NKT Holding is 100% free floating. NKT Holding A/S owns the three business units entirely.

2.3 Management

A new gorvenance structure in NKT Holding A/S was published with the company's 2nd quarter interim report 2013. The new structure entails that each business unit has its own CEO that refers to the Board of Directors of the entire holdings. This was a changed from before where one CEO was in charge of all 3 units. Photonics Group has consists of further

companies that each has its own CEO that refers to the Chaiman of the Board of Directors of Photonics Group.

4 According to NKT Articles of Association

ATP Denmark

DK institutional investors > 1 mDKK Foreign institutional investors > 1 mDKK BoD & Management

Other registrered DK shareholders < 1 mDKK

Other registrered foreign shareholder < 1 mDKK

Unregistrered DK shareholders

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3. Strategic Analysis

To conduct the valuation of NKT Holding A/S future years of growth needs to be forecasted.

Before doing the forecast a thorough strategic analysis of the company needs to be done.

The 3 different units of NKT Holding A/S are different from eachother in terms of products, customers, competitors and so on. Therefore the following strategic analysis of the company will be done seperately on each business unit.

The first part of the strategic analysis will describe the products of each unit, the customers these products are sold to and whom the competitors of the units are. After that a PESTEL⁵ analysis will be performed to learn more about the nature of the external environment surrounding each business unit.

Subsequent to that a Porters Five Forces analysis will be conducted to see how the industry looks and find out how intense competition are.

The inputs of this analysis will be summed up in a SWOT analysis.

3.1 NKT Cables 3.1.1 Company profile

NKT Cables is a leading supplier of cables to the energy sector. NKT Cables manufactures a wide range of cables to serve several different purposes in different industries. Sales is primarily based in Europe with Germany and Eastern Europe as the primary markets. Asia accounts for about 13% of sales. NKT Cables employs about 3,700 employees and accounts for

approximately 56% of the groups aggregated revenues.

Products

NKT Cables markets a wide range of different cables and accescories for industrial use. They present solutions within electrical infrastructure, construction, railway and the automotive industry offering both whole projects and single cable sales. The most important fields of

5 Political, Economic, Social, Technological, Environmental and Legal

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application are electrical infrastructure and construction accounting for respectively 67% and 19%.

Figure 1 - Sales by fields of application

Source: NKT annual report 2012, own creation

The cables are primarily used for leading electricity from utilities to housing areas or commercial areas and for industrial purposes. The process of leading electricity starts with transmission where NKT Cables supplies high voltages cables used for leading power from production plants or wind farms to the primary distributors. From the primary distributors electricity is led both onshore and offshore to large industrial plants or secondary distributors before ending up in communities with residential and commercial areas. NKT Cables supports the process with different types of cables and accessories.

NKT Cables splits their products up into the 5 following lines.

Special Cables

Within this product line NKT Cables markets a variety of special cables that meet several special requirements that enables them for special use, fx. the ability to stay flexible and elastic at extreme temperatures. Products under this subgroup are amongst a number of purposes used for interconnecting ignition nets in the mining industry, for winding motor coils for sumersible pumps, for interconnecting high-voltage circuits in electric and diesel-motor trains and for use in combustion engines in vehicles and airplanes.

Electricity infrastructure (67%) Construction (19%)

Railway (5%) Automotives (4%) Other (5%)

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Low Voltage Cables

In another product line NKT Cables markets low voltage cables for different markets. Low voltage cables with a nominal voltage around 1kV⁶ are primarily used as the last stage before the consumption of electricity. Low voltage cables are mainly sold through wholesalers to the installers and are used for leading power to industrial areas as well as residential areas.

The cables primarily contains cobber as conductor while aluminium is used as the screen of the cable⁷.

NKT Cables are able to produce cables that meet todays standards in terms of safety. Their new range of products does not contain PVC and halogen which means that in case of a fire the cables does not emit harmful fumes and smoke.

Medium Voltages Cables and Accessories

Medium Voltage Cables are used for distributing electricity between the larger primary distributors to the smaller secondary distributors. The range of voltage is between 6kV and 50kV and as the low voltage cables the medium voltage cables live up to the international standards. In some projects the medium cables can also be used as a direct link between the primary distributors and larger bulding sites or industry plants leaving the secondary

distributors. The medium voltage cables also contains both copper and aluminium.

The delivery of medium voltage cables comes with a number of different accessories that is sold together with cables in projects. Accessories are cable joints, connectors for switchgears and transformers. They also market their own tools that can be used exclusively to mount the different products from NKT Cables. They also have special silicone rubber accessories that have excellent properties.

High Voltage Cables and Accessories

The High Voltage Cables are used for transmission of power directly from the power plant to the primary distributors. High Voltage Cables are supplied worldwide up to 550 kV and comes

6 http://www.nktcables.com/solutions/construction/1-‐kv-‐cables/

7 http://www.nktcables.com/dk/products/low-‐voltage-‐cables/

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with special XLPE⁸ technology that entails less weight and smaller dimensions. This enables NKT Cables to supply longer cables leading to less installation of joints ending up being more cost efficient.

In both the medium voltage and the high voltage product line NKT Cables also manufactures submarine cables for offshore wind farms and for island connections. Submarine cable systems can be supplied in extraordinary lenghts for all voltage levels.

These cables also contains both copper and aluminium conductors depending on which type of project is setup and if it is onshore or offshore⁹.

All high voltage cables including submarine cables also comes with several different

accessories ranging from cabinets for offshore cable distribution to different terminations and joints.

Railway

NKT Cables also supply a number of different products for railway companies all over the world. They market cable conductors made from primarily copper and magnesium-bronze for a number of different railway applications. They also produce and market different contact wires depending on the use. In addititon NKT Cables makes special devices for installing contact wires which makes installation more efficient and precise.

Cabinets

NKT Cables also has a long history of manufacturing and marketing house service boxes and cabinets for cable distribution. NKT has a leading edge of manufacturing the cabinets in the right materials living up to the best standards with high quality.

8 Cross-‐bundled polyethylene

9 http://www.nktcables.com/products/

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Customers

The customers of NKT Cables are primarily based in Europe although about 13% of sales in 2012 came from Asia. The customers can divided in to three groups: wholesalers, utilities and industry.

Figure 2 - Sales by customers

Source: NKT Annual report 2012, own creation

Within electrical infrastructure the customers are primarily distribution and transmission companies based in Denmark, Germany, France, Benelux and the United Kingdom with DONG Energy, Vattenfall, E.ON being some of the more well-known companies that buy products at NKT Cables. China is a growing market and as NKT Cables' production facility in China starts to get approval for more products the potential for an increasing sale in China is present.

Also within the railway segment NKT Cables primarily has its customers in Europe and China. Customers are for example railway owners and operators including the Chinese Ministry of Railway and the European-based Siemens and Alstom.

In the construction segment it is a bit different. Here the primary customers are based in Northern and Eastern Europe. Sales are primarily made to electrical wholesalers who sell it to the end-users in the construction industry.

Wholesalers (28%)

Utilities (47%)

Industry (25%)

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The automotive segment is more a niche market for NKT Cables. Many carmakers base the production facilities in Eastern Europe to keep costs low. Therefore it is suitable for NKT to have production in the Czech Republic to be close to customers. Customers are mostly suppliers for large carmaker companies.

Competitors

The global cable market is around 880 bn DKK a year¹⁰ in turnover and NKT Cables estimated share of that is around 1% which puts them in the top 15 cable manufactorers amongst the hundreds of companies existing worldwide¹¹. The largest competitors are italian company Prysmian, french Nexans and the american company General Cable. The revenue of the companies ranks in the same order with Prysmians revenue being the largest in 2012 with General Cable and Nexans having about 40% lower revenues and almost equal to eachother¹². The revenue of NKT Cables is about 85% lower than Prysmian. All these three large players on the market has a comparable product range to NKT Cables.

Figure 3 - NKT Cables' largest competitors

Source: 2012 Annual reports of Prysmian Group, Nexans and General Cable, own creation

10 NKT Annual report 2012 11 NKT Annual report 2012

12 2012 Annual reports of Prysmian, Nexans and General Cable.

Prysmian Group (ITA)

• Revenues for 2012 was 7.848 m EUR

• Target markets worldwide with the EMEA region being the largest accounting for 62% of sales.

Other markets are the APAC countries with 15%, North America with 14% and Central and South America with 9% of sales.

Nexans (FRA)

• Revenues for 2012 was 4.872 m EUR (at constant non-‐ferrous metal prices)

• Primary market is Europe with 56% of sales. North America accounts for 15% of sales, while the Asia-‐Paci_ic region accounts for 13% percent. 9% of sales comes from South America and 7% of sales from a group of regions including Middle East, Russia and Africa.

General Cable (US)

• Revenues for 2012 was 6.014 m USD (about 4.470 m EUR)

• 60% of sales are made in the Americas, 27% of sales are made in Europe & Meditarranean. Asia Paci_ic Region accounts for 9% of sales and Sub-‐Saharan Africa accounts for 4% of sales.

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Other competitors that accounts for a significant market share are Sumitomo Electric and LS Cables & Systems but the 3 companies mentioned above are the three largest. Besides the global players there are also some regional players.

3.1.2 Analysis of macroeconomic environment Political

At the very top of many political agendas around the world is the concern for our climate.

Politicians have been to various summits trying to agree on a plan on how to reduce green house gas emission and energy consumption in general and on how to make energy more efficient. The European Wind Energy Association put forward a report in september 2013 in which they underline the urgent need for politicians to make some kind of framework to adresse these things¹³. The reports includes the different advice and amongst them are the need to electrify much more to lower exposure to high fossil fuels and therefore to commit much more to the exploition of wind power. The European Commission has put forward a common goal of having 20% of energy being renewable by 2020¹⁴ and the member countries are on target up until now.

NKT Cables has every chance of benefitting from this trend in renewable energy by increasing sales within both transmission and distribution of power from wind energy farms, both on and offshore.

Even though the report from the European Commission concludes that the development is satisfactory up until know they have worries that it might be harder to reach the goals when getting closer to 2020. Some of the reasons for these worries are that the Commission sees a tendency that administrative boundaries and delays causes slow development of infrastructure and delays in connection to grids. These things has to be addressed when making new policies for the member countries to have a chance of reaching their goals for renewable energy. This of course also may have a slowing effect on the growth perspectives of NKT Cables.

13 EWEA report, september 2013: "2030: the next steps for EU climate and energy policy"

14 The European Commission 2013 Renewable Energy Progress Report

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Other places around the world focus on renewable energy is just as intense as in the EU. China is probably the best example. China's GDP¹⁵ has trippled since 2000 and energy consumption has doubled in the same period. Primary energy source in China is coal but since 2009 China has been a coal importer indicating that this source of power is not sufficient. The World Bank has renewable energy scale-up initiatives running to better this situation, and the China market for renewable energy is huge¹⁶. NKT Cables are present in China and it is important to still be very present there, because the chinese market has large growth potential. But the process is slow and execution of projects are not easily done. According to the World Wind Energy Association China is by far the most growing wind energy market accounting for 39% of new capacity in the first half of 2013¹⁷. After China countries like the UK, India and Germany accounts for between 8-10% of new capacity in H1 2013.

Another political issue is the focus in Europe and the US to secure energy and be less dependent on importing energy from political unstable areas. Import of gas in the EU is increasing and the European Commission has made som recommendations on how to better that situation. Interconnectivity between member states are to be strenghtened to better energy flows and lower waste of resources. Better infrastructure in EU and the connection of

electricity and gas pipeline grids are important to create stable flows. Another issue within energy security in the EU countries are the diversification of supply. EU has to get more energy from wind farms, solar energy and water created energy.

This development also creates a chance for NKT Cables to grow. Their range of products for this type of project is extensive. Cabling is necessary both with regards to establishing wind farms and bettering infrastructure between the different member countries.

Economic

Since the outburst of the financial crisis in 2008 the economies around the world have suffered a severe slowdown. Most western countries have not for some time experienced growth rates worth mentioning. Emerging markets countries still experience growth but they also have a hard time getting their growth rates to pick up pace again. Inflation is not really an issue

15 Gross Domestic Product

16 www.worldbank.org -‐ China Renewable Energy Scale-‐up Program Phase II (P127033)

17 The World Wind Energy Association -‐ Half Year report 2013

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anywhere and governments and central banks have very high attention towards stimulating growth through lowering rates and making programs of quantitative easing in many different forms. This stimulus has had an affect and leading growth indicators are trending in the right direction, especially in the EU.

Figure 4 - Global PMI

Source: Markit

The economic breakdown has had consequences for the extent of investments made in different sectors. The governments are starting up fx. infrastructure projects to try and stimulate growth but in the private sector many companies are still having a hard time

financing projects because banks are less willing to loan out money now than three years ago.

For NKT Cables this means that sales in for example the construction sector are a bit harder to come by, simply because a smaller number of projects start up. Exposure to the construction

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sector at the end of 2012 was 19% of sales. On the positive side NKT Cables has a relatively diversified regional exposure and a therefore less exposed to slowdowns in one country.

Especially their Eastern European exposure makes them less vulnerable.

The macroeconomic cycles can cause challenges for NKT Cables. Part of NKT Cables plan in the latest years has been to expand through acquistions. Companies in both the Czech

Republic, China, Australia and Sweden has been bought, while in the same period also

building new plants in both Germany and China. But growing sales has to follow, which is not the case at the moment. One of their focus points are now to secure optimal capacity

utilization on the different production sites and that focus point is due to missing economic growth.

Socio-cultural

There is an increasing part of population around the world that takes a stand on green and renewable energy. The political pressure that are put on consumers in gerenal to buy ecological food, drive in cars that is less energy consuming and use sources of power that are renewable has an impact on the way people see this and form an attitude towards it. New generations will be even more keen to live by these new rules of life. This will probably also lead to changes in the business environment as demand for green products in general will increase. NKT Cables can benefit from this trend by constantly working on developing the green solutions and by being a quality supplier of submarine cables from offshore wind farms.

NKT Cables production primarily relies on workers who do not have an education, so-called blue collar workers. The economic crisis has led business around the world to cut workers to make profits look better and this has left the unemployment rate high. This also means that many workers are interested in getting jobs and therefore it is not seen as a problem to get qualified workers. But in a situation of growth picking up pace things might be different.

Technological

For NKT Cables to stay as efficient as possible the company constantly has to innovate and find out new, more lean and more green ways to produce. Partly to keep up with the growing demand for a green company profile but also to optimize costs. The plant in Cologne is a good

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example of how NKT Cables does that. Besides that they seek to modernize and develop existing production facilities to be more efficient in terms of production capacity, complexity and in terms of being energy efficient. For example NKT Cables expandend capacity for shipments on the Rhine by introducing af new barge. Besides that they are in the process of building a new assembly and turntable facility in Rotterdam. This facility will enable NKT Cables to deliver longer cables directly on to the installation vessels and the facility helps optimizing production flow in the Cologne plant. Also existing facilities in both Cologne and Nordenham is upgraded to meet increased sales¹⁸.

In larger projects there can be an element of product development to get the final solution as optimal as possible. This can at times take a while because this entails approval before production can start¹⁹.

Another example of product development is the new signalling cables that NKT Cables started production of in its Asnæs production facility in Denmark. The facility was upgraded to meet capacity needed for introducing this product to several European markets.

Environmental

The focus on a healthier environment has also increased demands for products and solutions with a green profile. NKT Cables meet those demands by focusing on renewable energy technology in their products in general. Examples of that are cable solutions that has a green profile, monitoring systems that detect efficiency shortages and the submarine cables that connect to offshore wind park projects

Legal

NKT Cables has exposure to a number of different regions and countries. Therefore the company also operates under different legal framework. Sales and production are primarily based in the European countries and therefore NKT Cables also primarily has legal exposure to this region. An example of EU legal initiatives are the EU Commissions directive

introduced in 2009 where a framework for renewable energy contained binding goals to reach

18NKT Annual report 2012 19NKT Annual report 2012

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20% of energy coming from renewables²⁰. In general the EU Commission has given a number of recommendations to the European parliament on how to improve energy security and renewable energy ratios.

As described earlier the larger projects can involve development of products. Depending on country new products or upgrades of products take a while because approvals are needed.

3.1.3 Industry analysis Threat of new entrants

For a new entrant to step into the market of cable production it needs to invest massive

amounts in production facilities and raw materials to be able to start production. That is a huge entry barrier for possible entrants. If the cable production companies such as NKT Cables and its competitors for some time experienced a profit level that is well above the normal level, then possible entrants might want to consider doing the massive investments it takes to enter the market and have a share of this profit.

But just doing the investments in production facilities does not do the trick entirely. Possible entrants need to be innovative, needs to have the right technology and needs to able to meet the increasing demand for greener solutions. It takes time and money to create this. These entry barriers primarily exist within the transmission and distribution segment, within railway and within submarine cables where a certain degree of technical qualities and competencies are needed. Within the low voltage segment the technical level are more standard-like solutions that can relatively easy be copied and taken into production, although it still takes large investments to do so.

In general the entry barriers are high. But if the money is available entrance to the cable market is a possibility. With the current state of the market in mind entry would be dangerous. The prices are under pressure and the consolidation in the industry is rising.

20 "Status rapport om vedvarende energi" by the European Commission (COM(2013) 175 final)

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Threat of substitute products

There are no real threats of substitute products in the cable industry. Research have been done for years and different alternatives are known. One of them is the possibility of taking the actual production of electricity into peoples own homes. Small magnetic power generators that are able to generate power for lighting and so on. The problem is that the efficiency and

stability of this is very bad and is actually just a small scale power plant. It makes more sense to scale up a couple of thousand times and be able to deliver power to homes and business - through cables. Another example is domestic solar panels that create power. This power source is gaining ground these years and people have their own power production. As an example the number of solar panel systems in Denmark have increased from just over zero in januar 2011 to approximately 87,000 installations in september 2013. An increase that came from a change in danish legislation that made the settlement of the power accounts much more advantegous for the danes. Around the start of 2013 the legislation was tightened back up as pace of new installations picked up to much. Since then new installations have stagnated.

Figure 5 - Solar panel installations in Denmark

Source: www.energinet.dk, own creation

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Although this power source is increasing it does not represent a possible new product that could be a threat to NKT Cables. The development of solar systems still has a lot to pick up and it is still hard to create in very large scale with high stability. It is more used in small scale as a supplement to traditional power sources.

Within telecom NKT Cables also has a small part of sales. The telecom segment are the most threatened segment where wireless solutions and satellites represent an alternative method when transferring data and phone calls.

Bargaining power of customers

NKT Cables operates within different customer types in the four main business solutions Electrical Infrastructure, Construction, Railway and Automotive.

Electrical infrastructure contains the medium and high voltage cables and the submarine cables. The customers are large power companies that distributes power. For each project the customers demand customized solutions and if you first have a good relationship and have showed good production skills with a customer there is a tendency that the customer will choose you again for the next project. Hence, their is a certain bargaining power because of the size of the customers, but not high because of the nature of the product. Competition in this market has risen significantly in the latest years which means that customers bargaining power is much higher today. This also means that there is a high pressure on margins.

The other business solutions primarily has sales in the low voltage segment. In the low voltage segment products are much more standardized. This means that the customers has high

bargaining power and they bargain on the price parameter. NKT Cables try to meet this by producing the cables as efficient as possible to keep prices down. Besides that they try to deliver solutions that justify higher prices and better customer loyalty by fast delivery, taking input from customers and customer-joint IT solutions²¹.

21 Nordea Equity Reasearch 2007

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All in all NKT Cables customers has medium to high bargaining power due to the level of competition in the market and due to nature of the low voltage cables. This results in high pressure on prices and lower EBIT-margins.

Bargaining power of suppliers

The products of NKT Cables are raw material-based. Raw materials represent approximately 85% of the production costs²². The main products are the metals copper and aluminium, but also the plactic products are used much used for insulation.

The metals are traded through a stock exchange, fx. the London Metal Exchange²³ which means that prices fluctuate. From 2007 to 2011 we saw very fluctuating prices in both metals caused by the outbreak of the financial crisis.

Figure 6 - Price chart on aluminium

Source: London Metal exchange

22 NKT Annual report 2012 23 www.lme.com

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After recovering solidly from the financial crisis and almost reaching the level from january 2007 the aluminium prices takes a new dive from april 2011 and forth. The copper prices reacts in pretty much the same way but stays a bit more stable after falling back in may 2011.

Figure 7 - Price chart on copper

Source: London Metal Exchange

The price trend on both metals does not represent a threat to NKT Cables right now. It means that NKT Cables has lower costs on metals than earlier. If the world economy recovery picks up pace in the coming years there is a possibility that metal prices again will start to rise. This has not been considered a big risk for NKT Cables either as they historically has had the ability to transfer the costs onto its prices without impacted sales and market share. But in the light of the current market situation a cost increase would be difficult to transfer to prices. Therefore NKT Cables must focus on hedging their exposure to this. All of NKT Cables competitors operate under these circumstances as well.

The prices of raw materials reflects the level of pricing that NKT Cables needs to have when negotiating contracts. Especially in the medium voltage and high voltage segments sales prices

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are negotiated in the contract stage, while in the low voltage segment a price list with a run-out date is the basis for pricing²⁴.

With regards to the market for plastic production there are a few large players with BASF being the largest one. Therefore the market has a monopoly-like situation where the large players are able to control prices. NKT Cables do not suffer from this in comparison with its competitors as they are under the same circumstances.

Intensity of competitive rivalry

Years back the cable industry was very split up between country borders and every country had one or two large producers that supplied the country in monopoly-like manner. But new

regulation, pressure on prices and an increased competitive rilvalry globally has led to a significant consolidation of the industry.

The cable market today is estimated to be around 880 bn DKK every year. On a global basis NKT Cables has an estimated market share of around 1%. On the European market where NKT Cables primarily has its sales the market share is around 3%. NKT Cables are amongst the top 15 producers of cable in the world which tells us that the cable market is very

fragmented.

Within the low voltage segment the products are very standard and has to live up to predetermined specifications. This makes it difficult to be innovative and come up with different solutions and therefore competition is mostly on prices and delivery terms. The products are also primarily sold for construction and at the moment the construction sector is not booming, hence the price is playing a more important role.

In the medium and high voltage segment competition is intense. In this segment projects are more specialized and companies can get a competitive edge by offering the solution that fit the project best. At the same time law makers are increasing its focus on updating the power grids in Europe and energy security and every cable maker wants a part of massive market that opens.

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In 2012 though the pace of this cable maintenance and replacement process fell back especially in Southern Europe. This led the companies to focus more on Nothern Europe resulting in increased competition and are higher pressure on prices²⁵.

On the Chinese market NKT Cables is still the largest producer of cables. Earlier Chinas massive growth rate opened the opportunity for NKT Cables to be present in a very attractive market with high government spending on railways and increased spending on electrical infrastructure. But the growth rates in China in more recent years has not been as high as earlier. Hence the extent of government spending has been lower than earlier. At the same time new competition enters ongoing and altogether there is a higher focus on price now than earlier. In the railway segment pace has picked back up as the Chinese governments spending on railway projects for high speed trains are back to a normalized level. Although competitive intensity is increasing NKT Cables still has the largest market share in this segment.

3.1.4 Conclusion on NKT Cables

To sum up the conclusion on the strategic analysis of NKT Cables the most important findings will be listed based on the SWOT-model.

Strengths

 Strong presence in Chinese market and ready to gain on increased growth and government spending in China.

 Strong presence in European market.

 Good production facilities and ability to produce cables with more length than competitors on its facility in Cologne.

 No problem getting employees

 Fine regional exposure - not dependant on the growth of one single country or region.

 Exposure to Eastern Europe.

Weaknesses

 Exposure to construction sector and low voltage segment in general.

 Lower market share than competitors

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Opportunities

 Strong government focus on renewable energy on a global scale.

 Strong goverment focus on energy security and thereby a focus on interconnectivity between EU member states and the need for more energy diversification

Threats

 Policy delays - longer wait for approval of products and projects.

 A new economic crisis leading to decreasing growth rates -> slower pace in

construction sector and lower focus and spending on renewables and the maintenance of cables in Europe.

 The risk of being bypassed in new large project deals.

 Intensified competition in the Chinese market - and in general.

 Ongoing price pressure

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3.2 Nilfisk-Advance 3.2.1 Company profile

Nilfisk-Advance is a global supplier of professional cleaning equipment primarily focusing on the commercial cleaning market. Although headquarters are located in Denmark Nilfisk- Advance has production facilities, sales offices and distributors all over the world.

The company was founded in 1906 by P.A. Fisker. He started the company by producing motors for different aggregates but later on the focus turned to cleaning equipment. The defining moment came when Fisker invented the Nilfisk C1 vacuum cleaner which could be operated by only one person and therefore revolutionized the world of home cleaning.

In the 1980s the company's rate of growth picked up and Nilfisk-Advance became part of the NKT Group. Since then Nilfisk-Advance has become a global player on the cleaning

equipment market both through aquisition of smaller companies and through organic growth.

Nilfisk-Advance has about 5,250 employees and revenues accounts for about 42% of the groups total revenues.

Products

Nilfisk-Advance markets a wide range of different products used for cleaning and targets both commercial and industrial purposes as well as home owners. The products are sold through several subbrands worldwide and the main product lines are vacuum cleaners, floor

maintenance products and pressure washers. Besides that, the different brands also hold

smaller product groups like conveyors and detergents. The five brands all overlap productwise, but they all add to the extent of worldwide market presence.

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Floor cleaning and maintenance

Within this product group Nilfisk-Advance markets a range of cleaning products for industrial cleaning, including scrubbers, dryers, sweepers, burnishers, steam cleaners, carpet extractors, large combination machines and more. The products all come in different models suiting all sizes of cleaning tasks. Some products come both in sit-on models and push operated.

Besides that the different brands all market vacuumers in many different forms, both for

industrial and commercial use and also for home owners through the Nilfisk Consumer brand.

The vacuum cleaners both come in the traditional vacuum models but also in a wide range of wet/dry vacuum cleaners. Part of the product range is also central vacuum cleaning systems.

Pressure washers

Another product group is pressure washers. Also within this product group Nilfisk-Advance markets many different models in many different sizes for many different purposes - for homeowners, commercial and industrial use.

Other

Besides the two main product groups Nilfisk-Advance also markets a few special products and some products supportive of the main product groups. Products in this group includes

detergents, pneumatic conveyors and a number of different accessories for all product groups.

Service

When purchasing a product at Nilfisk-Advance you will to some extent be offered to add a service package along with your purchase. This can vary depending on the type of customer from a fixed-cost maintenance contract or basic annual service subscription to having access to service phones. You can also buy warranties of different length of periods and you always have access to spare parts.

"Green meets clean"

Nilfisk-Advance carries a very green profile. Their declared goal is that every new product has to be more efficient while also using less water, energy and detergents. An intensified focus on sustainability and a healthier environment from governments and environmental organizations

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means that customers have to turn their focus to not only use products that are efficient but also sustainable. By being a leader within manufacturing sustainable products Nilfisk-Advance has a good chance of stregtening their market position.

Customers

The customers are far more widespread in Nilfisk-Advance than you see in NKT Cables as sales are made to smaller business units. The products are therefore distributed through a large number of sales units and dealers in over 70 countries around the world²⁶. Nilfisk-Advance split their customers up into three types: the industial market, the commercial market and the consumer market.

Figure 5 - Sales by customers

Source: NKT 2012 Annual report, own creation

The industrial market accounts for 38% of total sales in Nilfisk-Advance and consists of industrial companies that have som kind of special requirement with regards to cleaning. An example of that could be a company within agriculture that needs to be able to remove dust and grains, or a pharmaceutical company that needs hygiene to be of the highest standards.

Within the commercial segment the customers usually demand for less complicated systems for cleaning. Commercial customers include schools, hotels, shops and also cleaning

companies to name some of the potential customers.

26 NKT Corporate Profile 2013 -‐ www.nilfisk-‐advance.com

Industrial market (38%)

Commercial market (51%)

Consumer market (11%)

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The last segment is the private consumers. The products are sold for use in homes through different types of stores includning DIY stores or retail chains. The complexity of the cleaning products are lowest in this segment.

Competitors

Nilfisk-Advance is one of worlds leading suppliers of cleaning equipment. The total global market for professional cleaning equipment amounts to an estimated 55 bn DKK and Nilfisk- Advance accounts for about 12% of that. That leaves them in top four manufacturers

worldwide. The three largest competitors are american company Tennant and the german companies Kärcher and Hako.

Figure 6 - Nilfisk-Advance' largest competitors

Source: 2012 Annual report of Tennant and homepages of Kärcher and Hako, own creation

Tennant (US)

• Revenues for 2012 was approx. 566 m EUR (739 m US)

• Target primarily markets of the Americas with 66,5% of sales. The EMEAs accounted for approx.

22,5% of sales and the APAC countries accounted for the rest.

Kärcher (GER)

• Revenues for 2012 was 1.923 m EUR

• Kärcher products are sold worldwide and are the largest manufacturer of cleaning equipment in the world.

• Holds a very large product range including more products for home owners and additional products for industrial and commercial use.

Hako (GER)

• Revenues for 2012 was approx. 400 m EUR

• The products of the Hako Group are sold through the three brands Hako, Minuteman and PowerBoss in over 60 countries around the world.

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3.2.2 Macroeconomic environment Political

Nilfisk-Advance operates in many different countries. Some of these contries are emerging economies that historically tend to be in some sort of political turmoil in periods. This can have an impact on the way businesses in the country act and delay decisions to invest - also in cleaning equipment. So Nilfisk-Advance is dependent on stable political environment in the countries where they operate.

It is on the political agenda in many countries that companies have fulfill certain demands to workplace environment. This can impact demand for cleaning equipment positively. It is also possible that politicians would want to have a say when it comes to the requirements to the cleaning equipment. The cleaning equipment has to meet certain demands and if these

demands are increased from political side it can push the manufacturers of cleaning equipment to develope products that live up to these demands. Therefore Nilfisk-Advance always has to be on the forefront of requirements to the products. These requirements could very be to the environmental standards of the products.

Economic

The economic downturn that started in 2008 and still leaves its mark on economies around the world also has an impact on the sales of cleaning equipment. The demand for cleaning

equipment is to a large extent linked to the standard of living. If the wage level in a country is high enough to justify replacement of manual cleaning with cleaning equipment of all sorts the demand for cleaning equipment is off course impacted positively. But the countries Nilfisk- Advance operates in a very different from eachother. Growth rates are higher in the emerging market countries than in the western countries like Europe and the US. Both economic downturns and upturns impact the economies differently. Nilfisk-Advance is exposed to both emerging and developed economies.

Social

It is important for Nilfisk-Advance to be able to attract employees for jobs at all levels of complexity. This is both sales force employees, engineers and leaders.

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One of the most important strategic goals for Nilfisk-Advance is to have an intensified

customer dialogue to make sure that their products meet the demands of the customers in the right way. To strengthen this dialogue with customers Nilfisk-Advance opened a new website in 2012 where it is possible for clients to interact with Nilfisk-Advance²⁷.

Technological

The product range of Nilfisk-Advance can not be defined as high tech products. Nevertheless, Nilfisk-Advance puts in significant resources to research and develop their product range. In four competence centres in different locations product development is concentrated on user- driven innovation, industrial design, sustainable products, quality and cost. By innovating Nilfisk-Advance tries to move the market to their favor and optimise the products with regards to energy use.

But focus is not on the physical product only. Nilfisk-Advance has some focus points with regards to their market appearance where quality in the products is one of them. The second one is the increased customer dialogue. The company wants to streghen the relationships with customers through dialogue to make sure product quality is right but probably also to take good care of the relationships to customers. The third point is optimizing delivery times to make sure customers are happy. It is not very important to the clients that the products get more and more high tech. It is more important that deliveries are efficient, service is good and products are energy efficient. The main technological issue for Nilfisk-Advance is to improve the existing products and not to come up with new ones.

Environmental

Customers have an increased focus on the environment. They want products that are efficient and use less water, less energy and less detergents. This increases the focus for companies like Nilfisk-Advance to manufacture new products that live up to these demands. Nilfisk-Advance targets this with the 'Green Meets Clean'-strategy. This is their way of committing to corporate responsibility of marketing sustainable products.

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Legal

Nilfisk-Advance operates in many different countries and therefore they operate under many different laws. It is important for the company to comply with relevant rules in every country to avoid jeopardizing their reputation.

3.2.3 Industry analysis Threat of new entrants

Earlier new entrants into the market of cleaning equipment had pretty easy access. A startup capital is needed to produce the machines, but once you had that you were going. The

machines were no technological miracle. Today the customers demand more from the cleaning equipment they buy. Especially the industrial and commercial customers demand good

functionality, efficiency in terms of the use of resources and good service agreements. So today it is not enough to just manufacture the equipment. You need to establish a research and development unit to make sure that the products live up to the standards demanded by law and by the customers. To establish that the new company needs to have a certain size and turnover to be able to cover the costs.

Besides that the large companies within cleaning equipment has for many years established a very large network of sales offices around the world. So distribution coverage is key to a business like this, and you do not establish that in one day.

It is also very important that a new company in the business can offer high quality service agreements that enables customers to call for help at any time and any place. This is also not easily established.

A possibility to enter this market is for an existing company that already has established the distribution network and research and development units. Such a company can take advantage of this and diversify its product portfolio to also contain cleaning equipment.

In general it is not difficult to enter the market but it takes a huge effort to become large. The large companies including Nilfisk-Advance does not only grow organic but also through an

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acquistion strategy. This consolidation trend in the business makes it hard for smaller businesses to grow large before being snapped up by larger competitors.

Threat of substitute products

The market of Nilfisk-Advance gets more and more fragmented and small businesses with a niche product are bought to supplement the existing product portfolio. This means that in detail there are probably a number of substitutes for the different types of products.

But if we base the analysis on cleaning equipment in general one important substitute product are manual work. As described earlier the crucial criteria for whether to choose between manual work or cleaning equipment is the cost of labor. In the more developed countries wage levels are higher making it more favorable using equipment to do the cleaning saving the expensive salary for manual work. In other countries its still the other way around, but we must expect that the trend is towards more use of cleaning equipment.

Bargaining power of customers

The customer base consists to a large extent of smaller companies that do not have much bargaining power. Also the private customers has not got much bargaing power. But the commercial customers are getting more and more bargaining power. The professional cleaning companies get bigger and bigger and gradually they increase their bargaining power. When it comes to public institutions it is normal these years that they establish a central purchasing unit where cleaning equipment for the whole network of schools or other public institutions are purchased. This of course increases the bargaining power.

But in general Nilfisk-Advance is a large player in the market of cleaning equipment and has a strong position when negotiating contracts with their customers.

Bargaining power of suppliers

Nilfisk-Advance products are to a large extent put together by parts that are produced at other companies. Motors, painting work and other processes are outsourced and the more

outsourcing a company does the more dependent the company are of their suppliers. Most of the processes that are outsourced can be overtaken by other smaller companies in a situation of

Valuation of NKT Holding A/S