Acquisition marks next stage for Techtronic

Its $105 million acquisition of Royal Appliance is the latest in a brilliant foray by a company whose share price has more than doubled this year. But what is Techtronic and why does it have global significance?

It may seem strange that a company run and owned by a German engineer and a Hong Kong Chinese should symbolise one of the most phenomenal trends driving the world economy.

And yet medium-sized enterprise, Techtronic is a microcosm of a manufacturing and branding revolution that has the China story at its core. And with a stock price that started the year at HK$3 and ended it at over HK$7, investors obviously agree - indeed, it ranks as one of the few stocks in Hong Kong to double in what is agreed by all to have been a very trying year.

When you look at the annual report and the graphs of the company's turnover and profit growth since 1990 it looks like a business school case study. While profit has grown at a 45 degree angle; turnover has grown at close to 70 degrees. In 1999 the turnover was HK$2.6 billion; in 2001 it was HK$6.1 billion; this year it will be closer to HK$10 billion, according to a recent UBS Warburg forecast.

"China is the reason for 90% of our success," says chairman, CEO and major shareholder Horst Pudwill. "We have tried producing elsewhere. We have a presence in Mexico, and Indonesia; but there is no place in the world that is efficient as China."

So what is Techtronic?

The company was founded by Pudwill (a former Volkswagen engineer) and current managing director and fellow major shareholder Roy Chung in 1985 as a manufacturer of powertools. In the first year its sales amounted to HK$1 million; but each year the company added six new products; and likewise got more and more savvy at using Hong Kong's Chinese hinterland as its manufacturing base.

Horst PudwillHaving become an extremely low cost producer, the company had specialized in manufacturing on behalf of others, who then added their brand to the product. However, Pudwill and Chung knew that the future was in controlling not just the manufacturing but also the brand.

The new era for the company began in 1999. One of its former customers was Japanese powertool company, Ryobi. It had tended to sell its product in overseas markets at a high price. Pudwill negotiated with the Japanese company to buy the rights to the Ryobi name in the US, Europe and Australia.

It then rolled out a massive marketing campaign in the US, and cut prices. Ryobi soon became associated with very high quality at a low price. The growth in sales has been exponential; and has been driven by the manufacturing cost advantages that China provides.

Ironically, most Americans who buy Ryobi powertools think that they are Japanese. A China-based company is thus leveraging off American assumptions about Japanese quality - while doing everything in China.

"We did a survey and the name Ryobi has 80% recognition as a Japanese name; but 90% said they thought it was really good value for money," says Pudwill. "Originally Ryobi started in America with a high price and was a high end product. They had low sales volume. We made it more affordable. You make the money in the mid-range."

This is all part of his bigger ambition. "I want to be the number one or two in the world," says Pudwill of his ambitions in the powertool sector, which in the US alone is worth $9 billion of sales a year. "Next year we will take over the number two spot [held by Bosch]. We are close to Black & Decker We will be the number three this year."

As Marc Faber has said in his recent book, Tomorrow's Gold: "I would not rule out that, just as Lancashire was the workshop of the world in the early 19th century, China will one day assume the mantle and produce with its 1.2 billion people, more manufactured goods than the rest of the world combined."

Techtronic is a company that epitomizes that trend. The fact that it took over a Japanese brand, also emphasizes the way in which Japan's industrial sector is being hollowed out by China at a ferocious speed. As Faber adds: "Increasingly, Japan will be forced to shift its production of manufactured goods to China."

Pudwill agrees: "China is giving Japan a tough time. A lot of Japanese companies are going to China."

Also helping the growth of sales at Techtronic was the company's diversification into a related area. It acquired a company called Homelite that makes appliances used in gardens such as lawn mowers and strimmers.

When it bought Homelite it had been losing about $50 million per year. Within one year - by moving manufacturing to China - the company had moved into mild profitability.

Pudwill now expects that profitability to soar. That's because last year the company was unable to sell to the enormous Californian market due to its tight environmental regulations. Homelite's products did not use so-called clean engines, which have low emissions.

With a 40 million population, California was a key market to crack and so at the beginning of 2002, the company signed a licensing agreement with Japan's Komatsu. The Japanese firm had the clean engine technology; Techtronic then stripped it down to a much lower-cost model.

Techtronic then hired an English engineer from Black & Decker to help set up two factories in China to do just this. They began in April and by October the factories were complete, and at the time of writing had made around one million engines.

To put the sheer efficiency of this process in perspective, Komatsu told Pudwill that it would have taken three years to do the same in Japan.

The company currently makes 74% of its revenues from Powertools, but with the new technology in place at Homelite, this number may shift.

The other new area of expansion is in industrial and domestic vacuum cleaners. Using its cashpile, Techtronic has just bought Royal Appliance for $105 million to obtain its Dirt Devil vacuum cleaner brand.

What is interesting about Pudwill's approach to M&A is the shareholder value that has been achieved in very short periods. Unlike most M&A - which has a mixed track record - he and his team have been highly successful. In part this is down to his exhaustive focus-group polling to find out a brand's worth; and then once purchased he is happy to spend large amounts on marketing.

The company currently has a gearing of 20% and is still looking for acquisitions. To avoid further shareholder dilution, Pudwill says if the company buys anything more for over $100 million, it will issue a bond to fund the acquisition.

It has had a 15 year house bank relationship with HSBC - and has a former HSBC banker on its board of directors - so it seems obvious that HSBC would manage the bond issue. Pudwill is aware that interest rates are at attractive levels, although it is not clear whether he would want to borrow in Hong Kong dollars or US dollars. Given that 86% of its revenues come from the US; the latter may be preferable.

But what is the company looking to buy? Pudwill says there are opportunities in moving further into floorcare or very high-end powertools. In the case of the latter, companies such as Milwaukee, Porter Cable and Metabo could be targets. The latter comes from Pudwill's native Germany and is a 75 year old family business.

It would be a nice irony if the German engineer who went to Hong Kong to build his business, ended up using the efficiency of China as the currency with which to go back to his homeland to buy a prestigious engineering company.

Once again it would say much about the future of global manufacturing and China's role.

With sales in the US doing well in spite of the California blockade, Pudwill is just about the most bullish man I have spoken to in the last 12 months.

He and Chung have major stakes in the company. Both stakes are worth the types of sums that would make any private banker salivate (Pudwill's stake is worth around $120 million). The company has a 61% free float.

And as his company earns more of a global profile via its brands, how much longer can it be before this home-grown Hong Kong/ China success story gets admission to the Hang Seng Index?

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