Focus
Arvin Smith and the amazing, ever-growing
Thermo Instrument Systems
I
f thefinancialpredictions are correct, Thermo Instrument Systems will supplant Perkin Elmer this year as the world's number one analytical instrument company in terms of total revenues. The Thermo Instrument name may be unfamiliar to many analytical chemists, but its subsidiaries, which include Finnigan MAT, Thermo Jarrell Ash, LDC Analytical and Nicolet are not. Thermo Instrument Systems' march to the top has taken place at a remarkable pace. The company ranked 28th in revenue in 1987, the company's first year on its own. Since then, Thermo Instrument's revenue, net income, and stockholder earnings per share have grown more than 20% annually. Much of that heady growth has come through the acquisition of troubled instrument companies that are revived and strengthened under Thermo's ownership. Many people credit the success of this unusual strategy to Thermo Instrument's president and CEO, Arvin Smith, who has led the company since it was formed in late 1986 by its parent corporation, Thermo Electron. "Smith is considered a master at buying underperforming instrument companies and quickly transform-
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A new type of instrument company is poised to bb number one ing them into profitable operations," according to an article in Fortune (2). Rather than merge acquired businesses into a single structure, Smith allows each company to retain much of its original corporate identity and to freely pursue deals and sales that best serve the individual business. This unique approach to building a company has been dismissed by some people as a house of cards. Others rebut this view as "sour grapes" and say that Smith has "confounded the experts." Smith and Thermo Instrument are now undertaking their largest merger yet. By the end of this month Thermo hopes to take over most of Fisons' scientific instruments division, adding more than $300 million a year in revenue to the Thermo coffers. The acquisition should be the final step to bring Thermo to the top.
Analytical Chemistry News & Features, March 1, 1996
Analytical Chemistry talked to Smith in early January in his office outside Ft. Worth, TX. On that day the secretary was not in the office, and Smith answered his own phone with the simple greeting, "Thermo Instrument Systems." Indeed, Smith's style defies the usual image of a CEO running a $1 billion a year business. When traveling, he refuses to fly first class and stays only at inexpensive hotels. Asked what a rival company should do to revive its bottom line Smith replied that the CEO should first get rid of his chauffeured limousine A facetious answer admitted Smith but it's indicative of a downto-earth management style in which money is spent carefully The Thermo w a y
Smith likens his role within Thermo Instrument to that of an admiral who commands a naval fleet and leaves the handling of each ship to the captain. "Managers [of the various businesses] have a lot of autonomy," asserts Smith. "In the long run they have infinite freedom to be successful but very little authority to fail." To observers, however, Thermo Instrument looks more like a fleet of ships sailing in different directions. "What are
the plans to integrate into a cohesive business?" asks a competitor's marketing expert. "These independent companies with duplicate facilities must cost a lot of money." Yet such independence is what Smith covets. Eleven years of working for NASA left Smith with a distaste for large bureaucracies (see box on p. 188 A). "We are only a large company in consolidation," he says. "We don't have to merge [new acquisitions] physically [into a single business], but philosophically." That unique approach has shaken up the analytical instrument business and caught the attention of Wall Street. Investors who bought Thermo Instrument stock when it first hit the market in 1986
have seen their investments grow at nearly 32% compound annual return, according to Thermo Instrument numbers. Thermo Instrument Systems is one of several businesses directly spun out from a central source, Thermo Electron (see Figure 1). Like a parent, the Thermo strategy is to "raise" a reasonably successful business, then send it off on its own. Other companies typically spin off weak businesses they want to shed—Thermo spins them out as successes. The spin-out strategy is credited to George Hatsopolous, who founded Thermo Electron as a high-tech company in 1956. Hatsopolous holds a Ph.D. in engineering and thermodynamics from M.I.T. He and his brother, John, run
Thermo Electron. "The two are as smart about finance as they are about technology," said a recent Forbes srticle (2). The spin-out strategy has been so successful for Thermo Electron that the children are now producing grandchildren. Thermo Instrument has spun-out four: ThermoSpectra, Thermo Bioanalysis, Thermo Optek, and ThermoQuest (Figure 2). The plan is to have a total of seven by the year 2000. The spin-out strategy also fits Smith's notion of a decentralized business. Thermo Instrument's four children will now pursue their own acquisitions. "Most people say that if you are as large as Perkin Elmer or Hewlett Packard, it would be hard to make acquisitions," Smith ar-
Analytical Chemistry News & Features, March 1, 1996 185 A
Focus
Figure 1. The Thermo empire: children and grandchildren.
gues. Many analysts agree that these smaller Thermo companies will maneuver more nimbly in the marketplace. According to Forbes s2), another key driver in the Thermo system is that it rewards those who are successful: "The [Hatsopolous] brothers turn the management over to the people who developed the technology, binding them to Thermo Electron and discouraging them from striking out on their own." Certainly that arrangement has been true for Smith, who has been with the Thermo business since 1970. According to the most recent figures, Thermo Instrument accounted for more than 40% of Thermo Electron's revenue and nearly half of the operating income in 1994. Speaking to shareholders last May, John Hatsopolous singled out Thermo Instruments as "the biggest success we've ever had." Rebuilding a business
"My job," states Smith, "is to remove all excuses [as to why various units] don't have a financially successful organization." That process may involve helping company managers or working out a severance agreement. In the past, he has moved his office to the site of a new purchase where he "lives with the acquired business for a while." Newly acquired companies are given five years to turn their operation around and begin performing at the Thermo Instrument goal of 30% annual growth. ("A goal—not a guarantee, not a forecast, not 186 A
a projection," Smith points out.) The old management is not replaced, but it is expected to adhere to the Thermo strategy of rapid growth. "Aspirations have to change quickly," says Smith. "There is a touch of genius in it," says Gordon Wilkinson, editor of the Analytical Instrument Industry Report. "Many executives would have eliminated some of these product lines." Yet how can Thermo Instrument be successful if it continually buys poorly performing businesses? "Many managers don't look at their financials to see where their money is going," says Smith, referring to the complex details of running a business. Smith says that he compares the new business to the operation of other Thermo entities. Everything is evaluated, from phone bills to the number of people working in marketing. Unnecessary travel is cut, and R&D is focused. Smith instructs managers in the art of safe budgeting: Make realistic projections of growth so as not to overestimate expenditures. To reduce overhead, many of the legal, financial, and employee benefit services are centralized within Thermo Electron. Thermo Instrument pavs an annual fee of 1.25% of its revenues for such services. "When all is said and done, if vou have 20% less people, 20^ less soace, and so on, when we meet fthe comDetition's] price, we get 20% mnrp."
and Associates (St. Petersburg, FL). He credits Smith with setting the style. "They are so lean, so mean, they are taking the instrument world by storm." Sassouni points to the centralization of services in Thermo Electron as one of the keys. "I've never seen a company crunch those numbers down to one and a quarter percent. All that is left is marketing, R&D, manufacturing, and the CEO." Many of the business units operate at an annual pretax margin of 20%, says Wilkinson. "It is a very good performance figure compared with the rest of the instrument industry." Some people have argued that Smith's frugal operation provides short-term benefits at the expense of long-term growth. "We have not mortgaged the future," Smith says. "People have to learn to work with limited resources." Indeed, Smith views many other companies as short-sighted in their management "Some of our competitors [seem content] to run at a break-even point" he argues
Finnigan MAT is a good example of Smith's management style in action. When the mass spectrometer manufacturer was acquired by Thermo Instrument in 1990, it was stuck in a cycle of two good years followed by a disastrous year, recalls Smith (Figure 3). "They couldn't keep their expenditures in line." Rick Chapman, who was a marketing manager when Thermo Instrument purchased the company, remembers that Finnigan's management was shocked when Smith first outlined his five-year goal. But, he said, "Arvin had a believable track record." The following weekend they held a meeting to map out their strategy. Most companies expect to keep growing and build accordingly, says Chapman. Finnigan in 1990 was no exception; it structured to grow at double digits "We had people than we needed " Chapman says that Smith taught them to take profit as a constant and operating costs as a variable—the opposite of how many companies operate. Under this model they eliminated overhead, much of it through the centralized legal and benefit services of Thermo Electron. "If I knew then what I know today, Arvin "Everyone in these companies is cheap, cheap, cheap," says Chris Sassouni, would never have been able to buy Finnigan," Chapman jokes. a market analyst with Raymond, James
Analytical Chemistry News & Features, March 1, 1996
Chapman credits T. Z. Chu with Finnigan's initial turnaround. But Chu, who was Finnigan's president for many years, spent only one year under Thermo Instrument. In 1991, Chapman took over the reigns at Finnigan and continued building the company. Chapman's success at Finnigan was rewarded last year when he was named president of the Thermo Instrument spin-out, ThermoQuest. "Arvin has an ability to reach down in an organization, put someone in charge, and give them some good advice," says Chapman. He compares his relationship with Smith to that of a major professor in graduate school, defining a Thermo MBA as "Managed By Arvin." Even Smith calls Chapman's rise in the Thermo operation "mind-boggling." Rewarding employees, however, is part of the Thermo model. The company motivates its employees through a program of stockbased compensation plans and awards. In addition to the financial benefits, Sassouni points out that employees "every single day see whether Wall Street likes what they are doing." Besides providing employee incentives, Smith says that in rebuilding a business he "tries to take the high-technology road." Chapman agrees, noting that under the Thermo Instrument regime Finnigan has introduced a number of new instruments, including a research-grade ICPMS instrument, and new GC and LC ion trap MS systems. "Thermo Instrument tends to have more high-end, hightech instruments than its competitors," says NatWest Securities (New York, NY) in a recent analysis of the company (3). Nor do Thermo's companies necessarily pick the cheapest technologies. Smith brags about the superior properties of the charge-injection devices (CIDs) in Thermo Jarrell Ash inductively coupled plasma spectrometers, despite the increased cost of these solid-state devices over standard charge-coupled devices. In true Thermo fashion, however, Smith recently acquired the CID manufacturer. "The biggest challenge is to get more innovation back into the system," Smith adds.
ade, bringing in more than 70 businesses, according to Smith. But how can Thermo Instrument pay for all these acquisitions? Once again, the secret is in the Thermo strategy. When Thermo spins outs a "child," the introduction is accompanied first by a private and then, when the market is right, a public offering of stock. Because the spin-out is already a promising business, the price of the stock quickly rises. The parent always retains a majority interest in each company. For example, Thermo Electron holds around 85% of Thermo Instrument stock; Thermo Instrument in turn retains more than 70% of its ThermoSpectra spin-out. (The percentage held by the parent is important in the complex world of bookkeeping. Majority ownership is greater than 50% but retaining greater than 80% allows Thermo Electron to file a consolidated tax form This in effect allows Thermo Electron to take lnc^ps frnrn otherThertno entitif^ and add frViptn to Thermo Instniment's profits for *. Thf> r**cii1t cmrc Saccmini is that Thermo Electron can reduce its in '
come and lower its tax bracket. The downside, says Smith, is that with more than 80% of the share held by the parent, Thermo Instrument is "thinly traded." He estimates that there are less than 15 million shares available.) Money raised by the stock sales finances the acquisitions. Thermo Instrument's own spin-out in 1986 raised $12 million and helped pay for its acquisition of what is now Thermo Jarrell Ash. These stock offerings have also allowed Thermo Electron to build up cash reserves and, in effect, act as a bank. For example, Thermo Instrument's February 1993 acquisition of Spectra-Physics Analytical for $67.3 million in cash was funded through a $69 million promissory note to Thermo Electron. However nothing is simple in the Thermo world The promissorv note TITO Q
paid off in May of that year when Thermo Instrument turned around and sold Nicolet's biomedical division to Thermo Electron for $67 9 million
Now with grandchildren being spun out, the children are amassing their own banks. An initial public stock offering of
Growth by acquisition
All told, Thermo Instrument has made more than 30 acquisitions over the last dec-
Figure 2. Family picture. Thermo Instrument's four spin-outs and three divisions w i t h some key technologies and brand names. Analytical Chemistry News & Features, March 1, 1996 187 A
Focus 1.5 million shares of ThermoSpectra in August of last year brought in approximately $22 million. This and other stock sales helped Thermo Instrument accumulate more than $400 million in cash, according to a Nov. 30 analysis by NatWest Securities. NatWest estimated that $300 million would go to finance the acquisition of part of Analytical Technology Incorporated, which was obtained in De-
Roots of s u c c e s s In many ways, Arvin Smith's rise to the top of the instrument business is the fabled American success story with a modern twist: hard work, some lucky breaks, and a technical background. Smith grew up during the World War II era in the small Texas panhandle town of McLean, which he describes as "on the edge of oil and gas, ranching, and poor farming." Thanks to his high school football coach, he made his way in 1948 to New Mexico A&M (today New Mexico State University) where, on a "modest" football scholarship, he studied engineering. Two years later, Smith joined the Navy where he learned electronics and radar He left the Navy in 1954 and got a job with the aerospace industry in the Dallas/Ft Worth It was the height of the cold war and Smith eventually ended UD working in a program to construct a nuclearpowered mine how much radiation would be required During those Navy and aerospace years, Smith worked on various instruments as a technician and repair person. "If you understand instruments by learning how to keep them running, it is not a bad place to start." He even became an instrument designer, building and installing a remote area neutron monitor. The nuclear bomber program never took off, and by 1959 the end was in sight. Smith, by that time, was married and had two small children. He was working a late shift that ended at 12:15 a.m. and attending college classes in the morning. Eager to move on, he completed his studies that year, earning a degree in physics and mathemat-
cember, and the pending Fisons instrument purchase. Paul Knight, who co-authored the NatWest reports, noted that because Thermo Instrument holds the majority interest in the spin-outs, the children benefit from the parent's 1A credit rating, a listing he estimates covers less than 15% of companies worldwide. In addition, the spin-outs will benefit from the "significant goodwill"
ics from Texas Christian University. Through an ad in a newspaper, Smith learned that the California-based Jet Propulsion Laboratory QPL) was hiring physicists. He paid a visit and was impressed. The lab, however, was seeking a candidate with a Ph.D. .I fou ever need someone to help the Ph.D., let me know, Smith told them. A few months later Smith received an offer. At JPL, Smith worked on the problem of generating electricity aboard unmanned spacecraft. One of the companies he dealt with was a small-time operation called Thermo Electron. In 1964, Smith moved to NASA headquarters in Washington, DC, where he headed a division in the Office of Advanced Research and Technology. This lasted until 1970. When NASA shifted most of its resources into the Space Shuttle Program, Smith moved on again to join Thermo Electron At the time, the Environmental Protection Agency (EPA) had just been formed and was charged with implementing a new clean air act. To ensure compliance, EPA and Ford Motor Co. wanted someone to develop a chemiluminescence technique for measuring nitrogen oxides in automobile exhaust into a commercial instrument. Accustomed to working on crash programs for spacecraft Smith was certain they could build several quickly. Moreover, Thermo Electron was expanding from just being an R&D company to a manufacturer as well Ford planned to build 14 prototypes in their own labs. Smith convinced Ford to let Thermo Electron construct 10 of them. The first ones were handdelivered by Smith in January 1971, about 65 days after work began on
Wall Street has for Thermo Instrument, Knight said. Acquisitions are carefully chosen, says Smith. Businesses brought into the Thermo Instrument fold generally complement each other. For example, Thermo Separation Products provides the liquid chromatograph for Finnigan's LC/MS system. With growth, however, the number of conflicts arising from acquisitions will
the project. Thermo eventually built more than 1000 of those instruments, each costing around $5000, primarily for automobile manufacturers. "We didn't know whether we were creating an instrument business at the time or just responding to Ford " Smith They found another market for their instrument in measuring' ambient levels of NO To this dav says Smith the environmental division of Thermo ment remains ttie most rtrrtfitablp
In 1979, the instrument business grew with the acquisition of Eberline Instruments. Smith's group was now a monitoring company for air pollutants and health safety. Nevertheless, Smith viewed the business in the early 1980s as still a small operation with a little more than $30 million from monitoring instrument sales and another $10 million from running a test lab business, primarily for radiation services. Smith remembers sitting in a tiny booth at Pittcon in the mid-1980s feeling "pretty much ignored because no one was interested in a monitoring companv " and watchine1 the traffic at Perkin Flmer and other hig company booths It was there that he realized the analytical biisineQQ was a big indue
Was which we could narticipate? he asked That on port "ty came in late 1985 wth th •
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High Performance Figure 3. Finnigan's ups and downs in operating income stopped after Thermo took over in 1990.
probably increase. The Fisons acquisition was held up because of U.S. Trade Commission concerns over Thermo Instrument gaining another mass spectrometer business. Smith expects that business to be excluded from the Fisons acquisition. In the last few years, more than half of Thermo Instrument's growth has been based on new acquisitions, according to Smith. Several analysts point out that the slowdown in analytical purchases in the early 1990s has led to the sale of numerous businesses, several of which Smith acquired at bargain prices. However, some people now wonder whether Thermo Instrument's glory days might be over. "Thermo Instrument despite its impressive record of growth is in many mature markets and is finding fewer bargains to buy and fix up " according to Forbes (2) Nevertheless, Smith may be ready to confound the experts again. He has set his sights on the estimated $25 billion a year process-control market. Currently, only around 11% of Thermo Instrument's revenue derives from this market; 60% comes from the analytical instrument market. But last year, Thermo Instrument acquired several businesses from Baker Hughes Incorporated to strengthen its position in process control. In response, NatWest Securities issued a bullish buy signal for Thermo Instrument stock. Yet another vote of confidence for the Thermo philosophy. "We," says Smith, "are trying to climb higher mountains than the others." Alan Newman
References (1) Autry, R. Fortune March 11,1991,123,96. (2) Alster, N. Forbes Oct. 9,1995,156,49. (3) The Thermo Handbook; NatWest Securities Corporation: New York, 1995.
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Analytical Chemistry News & Features, March 1, 1996 189 A
