Spirax-Sarco Engineering PLC Acquisition of Chromalox for US$415 Million Call
May 26, 2017 AM EDT
SPX.L - Spirax-Sarco Engineering PLC
Spirax-Sarco Engineering PLC Acquisition of Chromalox for US$415 Million Call
May 26, 2017 / 08:00AM GMT
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Corporate Participants
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* Kevin James Boyd
Spirax-Sarco Engineering plc - Group Finance Director and Executive Director
* Nicholas J. Anderson
Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director
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Conference Call Participants
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* Andrew Douglas
Jefferies LLC, Research Division - Equity Analyst
* Andrew J. Wilson
JP Morgan Chase & Co, Research Division - Analyst
* David Alexander Larkam
Numis Securities Limited, Research Division - Analyst
* Henry Rodney Power Carver
Peel Hunt LLP, Research Division - Analyst
* Jonathan Hurn
Deutsche Bank AG, Research Division - Research Analyst
* Robert John Davies
Morgan Stanley, Research Division - Equity Analyst
* Sandeep Gandhi
Exane BNP Paribas, Research Division - Analyst of Capital Goods
* Stephen Swanton
Redburn (Europe) Limited, Research Division - Research Analyst
* Wasi Rizvi
RBC Capital Markets, LLC, Research Division - Analyst
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Presentation
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [1]
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Good morning, and welcome to all those who are joining us for this conference call and on the audio webcast. I'm Nicholas Anderson, Group Chief Executive of Spirax-Sarco Engineering plc. And I'm joined here today by our Group Finance Director, Kevin Boyd.
We are very pleased to be announcing the acquisition of Chromalox, which is the most Spirax-like related business we have managed to encounter. Therefore, I like to start this call by highlighting the strategic rationale and driving principles behind this deal.
Chromalox represents an excellent opportunity to expand our addressable markets through the acquisition of a clearly related business that shares our strong direct sales business model. As we invest in strengthening Chromalox' direct sales channels and leverage our global footprint and expertise, this acquisition will enhance our growth and sustainable value creation for customers and shareholders.
Historically, our group's growth has been primarily organic, supplemented by smaller bolt-on acquisitions that have fallen broadly into 1 of 2 categories: either expanding our capabilities through the addition of new products, technologies or skills; or expanding our geographic coverage into new territories.
Following on our 2014 corporate strategy review, we have also openly shared with all of you our desire to: first, increase the inorganic contribution to our growth by the acquisition of more sizable company; second, expand our addressable markets by the acquisition of related businesses that also share our business model; and third but not last, we have decided always not to expand into unrelated businesses, also referred to as third legs.
I would like to point out, actually, that the latest Watson-Marlow acquisitions of Aflex, Bio Pure, ASEPCO, Flow Smart have all been in this related business category.
In addition to our strict financial requirements, we also outlined in our 2014 annual report the key criteria to assess the strategic fit of any potential related acquisitions. These are summarized in the current slide, and you will see that Chromalox clearly meets all of these strategic criteria.
A few points are worth highlighting.
Chromalox is a highly complementary business to Spirax-Sarco's drive for growth in thermal energy management. It operates a direct sales model with applied engineering focus. It derives a significant proportion of revenues from customers' OpEx budgets. And it supplies products, services and solutions where there is a high cost of nonperformance to the customer.
Also, and in a similar fashion to the growth history of Watson-Marlow under our ownership, Chromalox represents a significant opportunity to drive value by leveraging Spirax-Sarco's global infrastructure to accelerate Chromalox' geographical expansion and increase its direct sales focus, extending the reach of their niche market leadership from the U.S.A. into other parts of the world.
Okay. So let me provide a bit more background on Chromalox.
Chromalox is a very well-established U.S.A.-based global provider of electric products, systems and solutions for industrial process heating and temperature management. Its focus is to deliver thermal energy management solutions through a direct sales force that is supported by a large contingent of specialist application engineers. As you can see, this is the very same model we apply in the Spirax-Sarco group of companies.
As I will explain shortly, the choice between electric energy and/or steam as the medium to transfer heat energy into an industrial process is mostly driven by the needs of the specific application or the customer circumstances. Therefore, these 2 technologies are largely complementary. And by acquiring access to these electric technologies, we're respectively expanding our addressable markets in thermal energy management.
We first identified Chromalox as a possible related opportunity back in 2008. Following our corporate strategy review in 2014, Chromalox rose in our priority list. And when we were approached earlier this year by the sellers, we quickly concluded that we shouldn't lose out on this opportunity.
This transaction is subject to the regulatory approvals of merger control authorities in the U.S.A. And we expect these conditions to be met by the end of June.
The enterprise value of this transaction on a cash free, debt free basis is USD 415 million, which is approximately GBP 319 million at the current exchange rates. In their last fiscal year ending September 2016, Chromalox had revenues of $201 million and an EBIT of $37 million. This agreed enterprise value therefore represents a multiple of 9.7x trailing EBITDA.
This acquisition will be funded through new debt facilities supplied by existing banks. And following the completion of the acquisition of Chromalox and the recent acquisition of Gestra, we will remain focused on maintaining a strong balance sheet and would expect the ratio of net debt-to-EBITDA to be in the region of 1.5x by the end of 2017, falling to around 1.0x by the end of 2018. This acquisition will clearly be accretive to group earnings in 2017 and onwards. And finally, as we focus on embedding both the Gestra and the Chromalox acquisitions, we do not anticipate any significant acquisitions occurring during the next 12 to 18 months.
Now over the next 12 slides, I will provide more information on Chromalox as a company, including a couple of customer case studies, to exemplify how they provide bespoke industrial heating solutions. I will also provide more clarity on how Chromalox expands our addressable markets and how it will fit within our corporate reporting structure.
As this presentation is now also available on our corporate website for your future reference, I will actually move through these slides at a faster pace, only highlighting the key elements of each slide that I feel will be important on this call.
So on this first slide about Chromalox, it's good to highlight that it was established 100 years ago in 1917, and since that time, has built a market-leading presence in the U.S.A., delivering innovatively engineered electrical heating solutions to industrial customers. Today, its product range falls into 3 distinct categories: industrial heaters and systems, heat tracing and component technology. I will expand further on these products in the next slide.
It is, however, also worth noting that, in the U.S.A., Chromalox' vast product catalog, known as the Red Book, is the market reference for industrial heating elements and components. This is very similar to the global market reference effect of Spirax-Sarco's product handbook or our Steam and Condensate Loop Book.
Finally, I'd like to highlight that Chromalox has an active product pipeline and 15% vitality index. This company has a strong reputation in the market for innovation and quality.
Now on this next slide, we will provide further details on the Chromalox products and services, as well as the key markets that they serve.
Industrial heaters and systems accounted for over 50% of the company's revenues in 2016, with the balance of the business equally split between heat tracing and component technologies. But the real important element to highlight from a product and technology point of view is that Chromalox' key competitive advantage is their deep knowledge and expertise of material sciences, thermal engineering and fluid dynamics associated with electric heat transfer.
You can see from this chart that Chromalox is a highly complementary business to the Spirax-Sarco's Steam Specialties business, as both businesses are involved in delivering thermal energy, either via steam or electricity, to specialist industrial applications.
There is little overlap between these technologies, with the decision between using steam or electricity as a heating medium being driven primarily by the needs of the application or of the customer circumstances.
Steam is likely to be the energy transfer medium of choice where a customer has a large heating load and where steam has multiple potential applications on the customer site. However, electric heating is typically used where higher temperatures are required, responsive start-stop heating is needed and where an easy installation and point of use heating is valued.
Chromalox operates in the premium end of electric heating -- industrial heating and heat transfer, with an estimated addressable market in 2016 of $2.9 billion or GBP 2.1 billion. This acquisition therefore expands the Spirax-Sarco addressable market in industrial heat transfers from GBP 4.5 billion to GBP 6.6 billion, taking our group's total addressable market to GBP 7.9 billion.
Chromalox is -- currently estimates a 7% share of the global addressable market, which obviously has the potential to expand as it accelerates its presence across new geographical markets.
As I mentioned on the previous slide, Chromalox has a 7% market share of the $2.9 billion market for electrical industrial process heating and temperature management.
72% of the company's sales are in its home market of the U.S.A., and 78% of sales in the Americas region as a whole. This gives the company an 11% market share in the Americas region and a 15% market share in the U.S.A.
In EMEA and Asia Pacific, the company's direct presence is less developed, so they address a smaller diversity of end market, with the company securing a 3% market share in each of those regions. This obviously represents a significant headroom for growth as we invest in this direct-sales capability and leverage Spirax-Sarco's global footprint.
Chromalox also employs a direct-sales approach, creating customer value through its engineered solutions that help their customers overcome challenging process heating needs. Direct sales to end-users, engineering contractors and OEM customers account for 68% of revenues, with most MRO and replacement business served primarily through its distributor network.
Chromalox has a similar profile to the Spirax-Sarco group, with about 2/3 of their revenues coming from their customers operating in maintenance budgets and the remaining 1/3 of sales derived from their customers capital budgets.
Chromalox has over 20,000 customers. And as with the -- is the case with the Steam Specialties business, average invoice values are generally low, between $1,000 and $3,000.
Being suppliers of process critical components where cost of failure is high for the customer, Chromalox also has a good degree of business resilience.
This map indicates that Chromalox has a direct-sales presence in a number of countries worldwide. Although, as I've pointed out before, the U.S.A. still accounts for over 70% of their revenues. Their 5 manufacturing plants are located in the U.S.A., Mexico, France and China. This international footprint provides excellent opportunities for growth as we invest in extending the range of Chromalox' direct-sales footprint into new territories by leveraging our own global infrastructure.
Chromalox also has a wide diversity of end markets, with about 1/3 of its revenues derived from Defensive markets. We have a good understanding of Chromalox' end markets, as these are also the key markets for the Steam Specialties business, with a great similarity in customer needs.
Industrial applications that typically require the higher temperatures that electric heating provides are more prevalent in the Oil & Gas or Power Generation sectors. This is the main reason behind Chromalox' higher exposure to those industries, with about 18% of sales derived from the Oil & Gas industry and 14% of sales coming from the Power Generation sector. Nevertheless, post-acquisition, our group will maintain a strongly diverse market presence. And we estimate that at least 48% or close to 50% of our overall revenues will continue to be generated from typically Defensive industries.
Now looking at this business from a financial performance point of view.
This acquisition is driven by the exciting medium- to long-term growth prospects and the potential to improve already good profit margins. Consistent with peer companies that have a high exposure to more cyclical industries such as Oil & Gas, we expect Chromalox revenues to decline in 2017 and settle around the $190 million level. However, the latest monthly order intake levels at Chromalox added to our extensive diligence work and independent market analysis support our conclusion that these markets are returning to growth. And Chromalox' medium- to long-term prospects look very positive.
In the same manner, as we have supported Watson-Marlow's growth over the past decade, we will invest in Chromalox to strengthen its direct sales channels globally, leverage our worldwide footprint to grow Chromalox' presence outside of its core markets in the U.S.A., and support the company's research and development program to ensure it continues to deliver innovative new products to customers.
Consistent with this year's expected sales decline, the 18.4% operating profit margin of 2016 is estimated to be a still very good 17.1% profit margin in 2017. Our investment programs will also underpin the profit margin improvements of this business over the medium to long term.
And so finally, I'd also like to highlight another point of similarity between the Spirax-Sarco and the Chromalox businesses, in that they are also have low capital intensity and high cash generation.
Following the completion of this acquisition, Chromalox will maintain its strong brand and will be reported as a separate segment within the Spirax-Sarco business group. Chromalox is led by a strong long-serving executive team who will remain with the business post-acquisition and continue to run it as a stand-alone global business unit. While we anticipate many opportunities to support Chromalox' growth over the coming years, this organization arrangement minimizes the need for significant integration activities.
Okay. So to better illustrate how Chromalox delivers value to customers through its engineered solutions, I have included in this presentation 2 brief customer case studies. However, in the interest of time, I do not anticipate going through them on this call as you can read more about them on this slide or by accessing the Chromalox website.
I would, however, like to draw your attention to the strong similarities between these customer case studies and those from the Spirax-Sarco and Watson-Marlow businesses that we have been sharing with you over the past presentations that we have made.
This first customer case study relates to an industrial heater and system application in the U.S.A. And this second case -- customer case study exemplifies the benefits of Chromalox' self-regulating heat tracing cables at an oil production facility in Indonesia.
Okay. So we arrive at the last slide of the presentation.
And in conclusion, I'd like to highlight that we are delighted to be bringing Chromalox, its management and employees into the Spirax-Sarco family. Chromalox has a highly complementary business model, broadens our technology offering and expands our total addressable market by GBP 2.1 billion. The companies will benefit from the group's global footprint and experience in direct selling. And we believe that this, along with compelling financial returns, will deliver enhanced value to both customers and shareholders.
Thank you. That is what I had to share with you today, and I would now be pleased to take any questions from those members on the call.
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Questions and Answers
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Operator [1]
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Okay. We have one question coming through the line, from the line of Sandeep Gandhi from Exane London.
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Sandeep Gandhi, Exane BNP Paribas, Research Division - Analyst of Capital Goods [2]
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Just a couple. First one, are you expecting any cost synergies to arise from this deal? And if so, over what time frame? And secondly, so EBIT margins currently at around 17%. Can you just give us some kind of numbers of how you expect this to evolve at Chromalox over the next 2 to 3 years?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [3]
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Sandeep, thanks for being on the call. Look, this deal is not driven primarily around cost synergies. Yes, there will be a few. But actually, the driver of this opportunity is more about the cost -- the revenue synergies and the opportunities for growth. So we're not really -- it's not about taking costs out. It's about growing this business and expanding, accelerating the business globally. And on the margins point of view, obviously, those margins which we think are already quite good and not too dissimilar from our own margins just a few years ago, have this opportunity for growth. So they will expand over the coming years in a similar fashion to how we have expanded the margins of our group in the past. And again, this is -- we are taking a medium to long-term view on this, and we're not too concerned about the short-term improvements. But we do anticipate these margins to progress in line with growth and with the efficiencies that we will be helping Chromalox increase, and that's it.
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Operator [4]
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Okay. Next question comes from the line of Wasi Rizvi from RBC.
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Wasi Rizvi, RBC Capital Markets, LLC, Research Division - Analyst [5]
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Just a couple from me, if I could. So firstly, I'm interested in what the top line growth of Chromalox has looked like over last few years. I guess I see it as an Oil & Gas effect currently, but I think if I go back to when Emerson sold it, I think it was said to be generating $150 million of sales nearly 15 years ago, so it doesn't look like it's moved on that much since, so can you talk about the dynamics there? And then, I'd also be interested in the competitive situation in Chromalox' market, and whether that's more similar to Spirax and there is few direct competitors and lots selling indirectly or whether they're slightly different.
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [6]
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Wasi, yes. So the past sales trajectory is, yes, not dissimilar to what you would have expected. Look, if I go back to 2011, 2012, you would see a consistent growth of this business from 2011 to 2015, so that 5-year period, you would have seen them grow from -- yes, at least about 10%, 15% over that period of time. Obviously, in 2016, because of the Oil & Gas cycle coming off, they are still some declines, so they peaked at about $226 million of sales in 2015, come down to about $201 million, 10% decline, not inconsistent at all, but pretty equivalent to what other competitive companies in this sector have been seeing. And as I said earlier, this year, we would expect them to be settling around $190 million. Again, 2 years of decline, very consistent with other peer companies in that same sector. And we are quite confident, as I said on the call that we're catching them now at that turning point. Difficult as it is, of course, to catch -- to try to identify turning points, but we're quite confident about that. Nevertheless, on the competitive dynamics of -- the second part of your question, yes, the competitive landscape is very fragmented, very similar to what -- to the Spirax-Sarco businesses. So we don't have any other big 800-pound gorillas that they are up against either in the U.S.A. or in other markets. It is all about bespoke solutions, and it's quite fragmented in this case. And in the heat tracing parts of the business, which, as I've said is less than 1/4 of Chromalox, you do have some bigger players, market leaders like who will be Pentair or Thermon. But other than that, the rest of the competitive landscape is quite fragmented.
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Wasi Rizvi, RBC Capital Markets, LLC, Research Division - Analyst [7]
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Right. And then just to follow-up on that first question. And so I think just a back of the envelope would suggest that at the peak, was Oil & Gas around 1/3 of revenues?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [8]
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Sorry?
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Wasi Rizvi, RBC Capital Markets, LLC, Research Division - Analyst [9]
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At its peak, did Oil & Gas represent around 1/3 of Chromalox' revenues just for -- so in 2015?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [10]
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No, I couldn't be precise about that. I don't -- I haven't done that exercise. It does represent about 18% of their revenues today, but the average is -- yes, might have come down a bit. But I wouldn't subscribe to that estimate (inaudible)
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Operator [11]
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Okay. Next question comes from the line of David Larkam from Numis.
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David Alexander Larkam, Numis Securities Limited, Research Division - Analyst [12]
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Just a couple of questions. How are you going to maximize the distribution, particularly sort of outside the U.S. if you're going to run it as a separate division within the steam area? How are you going to get the leverage of the sales force, have you got to build a sales force?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [13]
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Okay. David, look, we will run it as a standalone business unit alongside our steam business, but we're not going to integrate the sales forces. Because although we have shared customers, we are usually operating at different ends of the processes or many times even talking to different people within a big, large customer. So we don't see the need to integrate the sales force. We can grow this in the same way that we've grown the -- and support the growth in the same way that we supported the growth with steam and the Watson-Marlow businesses globally, leveraging the footprint that we already have around the world, putting more direct sales people, signing up new distributors where that makes sense, so our distribution partners are important for us in every company in the steam business and in the Watson-Marlow business. So we'll follow exactly the same model. This is a very Spirax-like business, and we will continue to expand this for the medium and long term in the same way as we have grown our other existing businesses.
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David Alexander Larkam, Numis Securities Limited, Research Division - Analyst [14]
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Okay. And did you look at it when it was for sale sort of 4 years ago?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [15]
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Yes. Yes, we did, actually. Good question. In 2012, when the current owners acquired it, we were given the opportunity to look at it. And at that time, we felt it wasn't the right moment. It was assessed. We felt it wasn't the right opportunity. And I think both businesses have evolved. Chromalox is in a better -- much better shape than it was 5 years ago. And so we just felt now that the timing was adequate both for them and for us.
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David Alexander Larkam, Numis Securities Limited, Research Division - Analyst [16]
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Okay. And are there any regional differences in what they do? Is there a reason why they are predominantly North American? I don't know in terms what is used in Europe or the Far East, more gas or (inaudible)
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [17]
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Yes, a good question. Now look, actually, Chromalox has been a primarily American company with an international presence in some countries. In some places like in Europe, they acquired some companies, quite a couple of decades ago. But really, the focus has been primarily within the U.S. and the North American market. One of the interesting aspects of the current ownership, Irving Place Capital, is that they did support and encourage the local management to invest in a stronger acceleration of their internationalization, and also, in new product developments and technologies and really some new products and that kind of stuff. So actually, what happens is because they are less developed outside of the U.S. or North America, they actually haven't got that strong of a footprint yet to cover the same breadth of market, end markets that they cover very well in the U.S.A. So they have focused on a smaller range of markets because of the limitation of resources over the last few years. But -- and in that sense, oil and gas is a bit more prevalent for them in those other regions than it is in the U.S.A. But as I said, it's very similar to the Spirax-Sarco businesses and Watson-Marlow businesses. And we see all of this as real good opportunities for growth in the medium and long-term.
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Operator [18]
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Okay. Our next question comes from the line of Andrew Douglas from Jefferies.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [19]
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A couple of questions from me, if I may. Can we just talk about Oil & Gas? I'm assuming that is downstream predominantly as opposed to upstream.
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [20]
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No, actually. Not only downstream, it's downstream, midstream and also upstream, so it really depends on the applications. Again, heat tracing, for example, just heat tracing elements, when you have a waxy, high viscosity fluids, oils, you would want to heat the pipes where they're being transferred along. So yes, you actually do have all through the chain.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [21]
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All right, fine. Okay. Historically, you've talked about Spirax steam business being IP correlated, or a bit better than IP, but IP correlated. Is that how we should be thinking about this business going forward? So follow the IP, but your ability to grow at more than the market by internationalizing?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [22]
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Very good question, Andy. Thank you very much. Yes. when we were studying this company and in the management presentations, I asked the management, what is the main indicator that you will use to predict the performance of your markets and et cetera? And the answer was exactly IP, industrial production growth rate. And so I expanded on that point with them, and then they later showed us some evidence of the correlations that they have, and it is very similar to the Spirax-Sarco correlations to IP. So yes, I think that is another similarity. And obviously, we're not going to get into details of how, what the correlation is, but it is -- IP continues to be the same driver. So the answer to your question is yes, you can continue to think about that in the same manner.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [23]
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Again, with a little bit of a lag?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [24]
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Typically, yes.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [25]
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Yes, fine. Okay. Then 2 just quick questions just to finish off. It looks like you -- the business is going to lose about $10 million of sales and about $5 million of EBIT, so a 50% drop-through. Is that broadly sensible in terms of modeling going forward?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [26]
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Well, yes. Absolutely, you've got the right number. It's not inconsistent with the kind of modeling you would have done for us also. Ironically, and I can't really tell you why, all my career, we've always found that on the downside that ratio is never the same as on the upside. But nevertheless, yes, I think the logic that you apply to our businesses today, you can continue to extend to this business going forward.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [27]
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Okay. And then last one for me. You've talked about using Spirax-Sarco's footprint to internationalize the acquisition. Can Chromalox give you the same in the U.S.? Because it looks like they're ahead of you in the U.S. in terms of direct sales. So does that mean you can accelerate your U.S. sales for the steam business?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [28]
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Good question. Well, as I responded earlier to David, we're not really looking to leverage. We will obviously be closely looking at the opportunities to find that, but we've not driven this deal based on those kind of revenue synergies, okay? But I'm sure there will be opportunities, and we're looking at them. We've got a couple of identified points and we'll see how we can continue to support, not only in the U.S.A., but also outside the U.S.A., find revenue synergies for both businesses, but we haven't needed to model that into the acquisition case.
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Operator [29]
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Okay. Next question comes from the line of Stephen Swanton from Redburn.
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Stephen Swanton, Redburn (Europe) Limited, Research Division - Research Analyst [30]
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I just had one question. I mean you obviously kind of have significantly stepped on the I guess acquisition accelerator over the last 6 months. And I was just kind of wondering kind of what Spirax looks like in terms of your M&A teams and whether you have had to bulk up your kind of your M&A kind of unit internally. So I guess there's a lot to integrate over the next few months. I appreciate one of the things is bring factories together, but it's kind of 3 kind of reasonably sized deals now in 6 months. I was just kind of wondering what your processes look like internally and if you had to hire people to help bring these businesses in.
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [31]
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Stephen, thanks for your question. Yes, it does feel a bit about London buses. You do a lot of work waiting and nothing comes, and then suddenly, they all come back to back. But in M&A, you can never control the timing of the deals. You have to take them when they're available. And it is purely coincidental that the Gestra and the Chromalox opportunities came up so close to each other. Obviously, totally independent of each other, but the timing was quite coincidental, so nothing that we could control. But you're right, this one is a different -- it's a related business. We don't need to do the kind of integration activities that we have planned and are starting to execute with Gestra. So it's a different type of integration. Nevertheless, we do not anticipate any other acquisitions in the coming 12 to 18 months because we do want to remain focused on embedding these 2 businesses strongly into the group. That's why I made a point of putting that observation in the slide. I think we've got enough on our hands. We're going to focus on running the businesses that we already have and bringing these other 2 companies into the fold with the group in the way that we've laid out before. So that is the focus going forward. All other M&A activities are now clearly on the back burner for the next 12, 18 months, we will not focus on any new deals, and we want to make that abundantly obvious.
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Operator [32]
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Okay. And the last question coming through comes from the line of Andrew Wilson from JPMorgan.
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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [33]
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Just a few questions, please. Just to pick up on Stephen's question. The decision to keep it as a standalone business rather than integrate it, is that purely because it makes sense strategically? Or is it a case of not having the capability to integrate that as a separate business, given that you've got Gestra and the effects as well?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [34]
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Andy, thanks for the question. A very good one, of course. Look, it's not because we're constrained -- management bandwidth constrained because we've already done the Gestra deal. That's not the reason why. All along, even before we had found these related businesses, we're always, in our corporate strategy, always assume that related businesses would not be integrated in the traditional form, or that you would integrate a bolt-on or a core business like Gestra. That's always been the principle because we think, for strategic reasons, really, the strategic rationale behind it. The exception to the rule would be if it did come along with the opportunity to integrate. So actually, all along, in our design, these related businesses would be originally standalone. And then once you get to know them better, if you can see a logical opportunity to find revenue synergies or cost synergies, you might look at that later. But that's not the design, that's not the purpose of these deals. And that was the decision -- that's why we decided actually to proceed. Because as you can imagine from the timing, you can now see that we were already well advanced with the Gestra acquisition at the time that Irving Place Capital advised us that they were putting Chromalox up for sale. So we had to make a decision. Can we manage these 2 businesses, not only the process, but more importantly, should we succeed in getting them both, could we manage to integrate them? And because the integration models for both businesses are different by design, we felt that, yes, we could do it, and we would have the management bandwidth to drive both businesses inside the group simultaneously.
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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [35]
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Okay, and very clear. Just to follow up. In terms of the investment, I think you talked a little bit in the release and the presentation about investment in the sales force. Should we be building in increases in CapEx? Should we be sort of building that into our modeling expectations over the next couple of years? Or is this -- is that kind of already looked after in the numbers that we have in our models?
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [36]
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Andy, it's Kevin. Yes. I think what we -- what that will do is potentially delay the increase in the margins going forward. So I don't think it will necessarily damage their margins. But we will be looking to increase the direct sales force, and then obviously, that cost in the year you do it and it brings benefits thereafter. But that's what we've been doing ourselves in the core business for years, and we'll just see a continuation of that within Chromalox. Yes, I think it may delay the improvement in margins, but I wouldn't see it being hugely detrimental to margins either.
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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [37]
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And in terms of this sort of CapEx investment to the facilities, is that required or...
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [38]
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Yes. They're not a capital intensive business. Like us, they're very cash generative, high return on capital employed. It would surprise me if we didn't invest a bit more CapEx going forward to improve the business, improve the manufacturing facilities and get some efficiencies there. But again, it's not a huge number. You remember, in the core business our big expense is people. We spent GBP 250 million on salaries and around GBP 30 million on CapEx. So while you might see the CapEx pick up a little bit in Chromalox, again, I don't think it will be anything hugely significant. There's no obvious things like having to build a new factory or anything like that. It's just improvements.
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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [39]
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Okay. And then just last one, just quite a specific question on the kind of direct sales and the way that they sell. Is it the same dynamic around new products through current product, but also the system audits and the selling in that sort of unrealized demand that you talked about in the steam business? Is that a similar opportunity in the Chromalox business?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [40]
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Yes, it is, Andy. It's incredibly -- this was one of the most exciting features as we got deeper into the diligence in Chromalox was that every aspect, every facet of the business that we studied was -- if you change the name on the top of the page, you could have written Spirax on it. It is -- as I said, it's the most Spirax-like business that we have been able to look at. We've looked at lots of business and rejected all of them because we want to make sure that we would find a related business that we could truly add value to. And the reason why we can add value is because it's got a similar business model in all of its aspects. And so yes, the same business model, it's direct sales business model, selling solutions. You're looking for the unrealized needs of the customer. You are focusing on small orders but that actually are justified on the benefits that the customer can get from them. So I could go through the whole list, and it is incredibly and excitingly similar to our existing businesses today.
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Operator [41]
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Okay. We have one more question coming through from the line of Robert Davies from Morgan Stanley London.
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Robert John Davies, Morgan Stanley, Research Division - Equity Analyst [42]
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Just a few questions for me. First one, just could you contextualize in the historic margin volatility? Just give us an idea of where current margins sit within the historic context maybe is the first one. The second one was really around the sort of I guess the regions particularly you are sort of targeting when you're talking about sort of international expansion. I saw on one of the slides which I think highlighted where your current -- or where its manufacturing facilities are and where you had sales offices. Are you looking to build out further manufacturing facilities in any of those regions that already have sales offices? Or is there the case of kind of expanding further and kind of pushing sales offices into new regions? And then just the final one was around the sort of, I guess, the kind of cross-selling opportunity. You mentioned you're really sort of targeting different parts of the market when you're offering these sort of energy transfer solutions. I guess out of your current sales force, are you -- I guess you're kind of going to cross-train those guys to sell both parts of the kind of business? Or is it that you'll get a sort of salesman from one and a salesman from the other, kind of selling you the different products?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [43]
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Robert, thanks for the questions, all very good ones. Look, the historical context of the margin. I mentioned earlier in response to one of the questions about, from Wasi about how the sales trajectory had been over the last 5 years under the current ownership of IPC. And they worked with the current management team under that ownership to also improve not only the top line, but the margins. So actually, it's had a consistent trajectory. You could -- if you wanted to be really an average, you would say that over the last 5 years, the average margin of this business has been around 18% EBIT -- I'm talking operating profit margin EBIT, okay? So obviously, it started a bit lower before, and they worked it up over the years as margin improvement, and now that's come off a bit. And this year, we're expecting it to be at least 17%. Last year, it was just over 19%. But it has been coming up over the years, consistent with this top line growth. So nothing untoward there. On the geographic expansion, whether that would trigger new plants, building of new plants, we will cross that bridge when we get there. The existing plants that they have, have available capacity for further growth and expansion. We're happy, as Kevin said, and we're looking to step up the capital investments in these businesses, in this business globally, even if it's not highly capital intensive, but we're never shy to invest in our businesses because they have good returns. We don't anticipate the need for new plants at the moment. But as we've done with our existing businesses, we won't shy from doing that when we see the opportunity for that in the future. And finally, on the cross-selling opportunities, no. As I said earlier, this will be run by 2 parallel sales organizations, each one focused on the market applications, on the customers industrial process application where they have their strengths. And therefore, we're not looking to go through the pain and effort and cost and distraction, quite honestly, of trying to cross-train both sales organizations on each other's products. We think there's more value in keeping them focused on the parts of the industrial processes where they serve today and accelerate it that way.
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Operator [44]
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Okay. We have another question coming through from Henry Carver from Peel Hunt.
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Henry Rodney Power Carver, Peel Hunt LLP, Research Division - Analyst [45]
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Just a query from me is, do you have any sort of feel around who else was interested and the sort of process and bidding, and how you've managed to get the deal in the end?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [46]
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Yes. So I will not reveal any names because I don't think it will be appropriate. But we are aware or we would like to understand that IPC, Irving Place Capital, IPC, the current owner, when they decided to market Chromalox, they felt it was the right moment to move into a strategics-only process. So they selected a handful, literally, we believe it was 6 originally companies. We were 1 of 6 companies that they reached out and said, look, we're going to place this business back in the market, and we think that it will be a good fit with your businesses. And would you be interested in participating in this process? So we believe we're 1 of those 6 companies that they reached out, all strategics. And then after initial indication of interest from us, there was a second round where we believe we were 3. We understand we were 3 players. We understand that the other 2 players were large U.S. corporates, but we're not really sure the names. We suspect, but we're not really revealing what we suspect. That would be speculation. But yes, it was a competitive process. It was quite a competitive process, we had to work very hard. It was quite an accelerated process. And we are very pleased and very proud with having been able to secure it at what we consider to be good value for our shareholders.
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Operator [47]
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Okay. And then another question coming through from Jonathan Hurn from Deutsche Bank London.
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [48]
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Just 2 very quick questions from me. I mean, the first one, just when we look back to Gestra, I think you stated that the hurdle rate on that investment would be -- or the return of investment would be around about sort of 10% over [3 years]. Can you just give us the hurdle rate for this investment, please? That was the first question. And the second one was just -- sorry.
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [49]
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Sorry, Jonathan, yes, just add to that. What we said is -- that's one of the criteria we had is that it would make a better than 10% EBIT on investment by the third year. That's just a general hurdle we have for investments, so that was no different with this one. Other things we look at is, we try to get a -- 200 basis points buffer above our cost of capital. Again, this passed that test as well. So there are a number of financial hurdles, but mainly, it's about strategic alliance and the other sort of financial one is that it is capable of making group like margins in the medium-term, again, ticking the box for this one.
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [50]
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And just in terms of that buffer relative to the invested capital, is that year 3 hurdle as well?
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [51]
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Say it again?
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [52]
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Just in terms of making, like you say, making return above the cost of capital.
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [53]
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No, that's an IRR hurdle.
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [54]
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Yes, yes. So just in terms of timeframe -- that's what I was just trying to work it on, just (inaudible)
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [55]
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No, yes. Just to be sure. The EBIT margin of -- EBIT over invested capital is a year 3, the 10%. The 200 basis point buffer is an IRR number, so we (inaudible)
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [56]
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Okay, okay. And just a second question, just coming back to the sales channel. So I think, historically, when you -- well, when you sold through sort of a vertical sales approach, you've actually got a lot more success in terms of revenue generation. When you look at this business, does it sell more by geography or does it sell by vertical?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [57]
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I'm not quite sure I understand your question, sorry, Jonathan.
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Jonathan Hurn, Deutsche Bank AG, Research Division - Research Analyst [58]
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So I think, historically, obviously, Watson-Marlow sales by end market, so in terms of sales directly into pharmaceutical or so forth. And obviously, you've been pushing that through Spirax-Sarco steam and where you have done, you've obviously got a lot better sales. When you look at this business, does it sell by geography, or does it sell by a sort of end-market customer, in terms of how the sales force is segmented?
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [59]
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Okay, I understand your question. Thank you, Jonathan. Look, actually, this is very similar to the businesses that we have. Even Watson-Marlow it's more concentrated on biopharmaceutical and pharmaceutical industry still has a good diversity of market sectors that they sell into. And this Chromalox business is probably as diversified, almost as diversified, as -- or similarly diversified to the -- by end markets to the Spirax-Sarco's steam business. So you can correlate -- yes, they're a bit more concentrated on a couple of industry sectors, but we see the opportunities going forward in both those dimensions, both in the vertical industry sector focus, still in the U.S.A. where they're strong, similar margins to what we have in the steam business globally. But also, with the geographic expansion. It's just still very much, although with an international presence, it's still very much a North American company, so we see the opportunities on both those fronts. Over the long term, because, obviously, this is a long-term game, we're not playing a short-term game here.
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Operator [60]
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Okay. Next question comes from the line of Andrew Douglas from Jefferies.
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Andrew Douglas, Jefferies LLC, Research Division - Equity Analyst [61]
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Just quickly, is the business seasonal, like the steam business, so fourth quarter weighted given the heating season?
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Kevin James Boyd, Spirax-Sarco Engineering plc - Group Finance Director and Executive Director [62]
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Andy, yes, there is a bit of seasonality being a heating business based in the northern hemisphere, it tends to be more seasonally weighted towards the winter months, which actually works quite well for us, as our year-end spans the winter, so the winter spans our year-end.
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Operator [63]
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Okay. And there are no more questions coming through in the queue.
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Nicholas J. Anderson, Spirax-Sarco Engineering plc - Group Chief Executive, COO and Executive Director [64]
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Okay. Well, thank you very much for everybody who is on the call. And we appreciate your time, especially just before a bank holiday weekend. So thank you all very much. Bye then.
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Operator [65]
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Thank you for joining today's call. You may now replace your handsets.
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