Inspicio floated on AIM as a cash shell in April 2005 and six months later acquired Inspectorate for £52 million. That was financed by a share placing at 100p a share. The deal made it one of the five major inspection and testing businesses in the world and, although it has struggled somewhat over the past few years, management remain confident of completing a significant turnaround in its fortunes.

One reason for their optimism is that Inspectorate is represented in 125 countries. Oil inspection is by far the biggest part of the business and, because of Inspectorate’s position in the former Soviet Union, the underlying growth rate here is seven to eight per cent, double the market growth.

The other main markets are metals and minerals, agriculture and food safety. Food safety is the fastest growing sector. Inspicio’s chairman Keith Tozzi and chief executive Mark Silver were chief executive and finance director respectively of Inspectorate in the late 1990s. They ran the company when it was first taken over by the British Standards Institute. At that time the business was highly profitable. BSI bought it in 1998 thinking that it would help the organisation become more commercial but the reverse happened – Inspectorate became more bureaucratic and its profits slumped. By 2004 it was losing money.

Silver is confident that he can cut costs by £4 million by reducing the number of employees and closing four unprofitable offices. Another £2 million reduction will come from IT improvements. The business has become institutionalised and Silver is de-centralising management. Additional people are being taken on in certain growth areas. The top managers are incentivised to hit the target operating margins of eight per cent in 2008. This year they should be around four per cent. Many of Inspectorate’s competitors such as fully-listed Intertek and SGS achieve double digit margins.

This is not just a cost cutting story though, as Inspectorate should be able to grow organically as well as win back customers it has lost in recent years.

Because Inspectorate has been losing money in the UK and making profits overseas, its effective tax charge has on occasion been more than 100 per cent of profit.
Charging UK head office costs to overseas operations will help. Silver believes a tax rate of 35 per cent is attainable.

In April Inspicio bought Environmental Services Group from Carillion for £16 million. This takes Inspicio into soil and waste testing as well as adding to its food and coal testing activities. Regulation, infrastructure projects and house building plans make soil testing a growth business.

Further acquisitions are planned. Although there are only five main inspection and testing companies, the market is still very much fragmented. Inspicio has bought Inspectorate’s Libyan agent and it may buy up other agents and mop-up minority interests in overseas businesses.

After the additional acquisitions, net debt of £20 million is forecast for the end of 2006. Capital expenditure should be similar to depreciation of around £5 million a year. This will enable cash to be generated to sharply reduce the debt over the following two years.

One thing to be aware of is that Inspectorate’s results are second half weighted because of the oil business. This will be particularly true this year because margins will improve through the year, meaning that the first half will produce only a small part of the £4.5 million profit forecast for 2006. Profits are then expected to double in 2007, bringing the prospective multiple down to 15.9.

That’s not high for a multi-national business with more scope for both recovery in margins and sales growth. A long-term buy.

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