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Cobham – Managing Expectations Well By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

Six months have now passed since Cobham made the last of what were, spread over a period of seventeen months, to be a total of five profit warnings. There was no profit warning with the interim results published this morning – just confirmation of the considerable effort that is going in to return Cobham to growth. Small though they may be as yet, signs of progress are now visible. H1 improvements in underlying operating profits and earnings along with free cash flow and cash conversion have not surprisingly gone down well with shareholders in early morning trade. From my perspective, it is the improved messaging of actions and intentions that is writ large throughout the Cobham H1 statement that from a confidence perspective, provide more than enough in the way of positive indicators of performance improvement that will inevitably follow over the next couple of years.

In his interim report statement this morning, CEO, David Lockwood tells shareholders that “We have been working hard to build the foundations for our future success but we are in the early stages of implementing a challenging turnaround in the Group’s performance. We are making progress across a number of areas but full implementation of all the required steps will be time consuming and may encounter some turbulence along the way. Against this backdrop, it is pleasing to report that the first half results, including Group underlying operating profit of £89.9m (2016 £102.2 million) are in line with the Board’s expectations. Cobham has a number of high quality businesses with differentiated technologies and know-how and leading positions in a number of attractive markets – this gives us confidence in Cobham’s future.”

In respect of forward strategy, the new management team has concluded that “Cobham is best placed to generate value when it focuses on its defence and commercial aerospace markets, in which it designs and delivers services, systems and products.  We have therefore decided to commence a strategic review of the Group’s Wireless and AvComm business units, both part of the Communications and Connectivity Sector, comprising circa 10% of the Group’s revenue. These businesses have strong technology and/or market positions and we will investigate how to optimise shareholder value”.

The above remarks will undoubtedly be welcomed by shareholders just as they will also be seen as confirmation of the enormous effort now going on to turn the fortunes of Cobham around. Progress rally is now being made.

In the process of getting to grips with what needs to be done Lockwood and his strengthened management team have been leading interaction at senior level with major customers, put much effort into better aligning internal measures with customer commitments, focussed a lot of effort on improving internal processes and training and resolved a number of issues in individual businesses that have led Cobham to previously fall short of customer expectations.

Better control and execution are major elements of the turnaround strategy and the new team has been quick to recognise that better oversight and scrutiny of key projects by senior management was required. All this is being done and the appointment of a Chief Operating Officer responsible for consolidating supply chain, quality, information technology and engineering functions bodes well.

The statement confirms that significant investment has commenced to remediate quality management, product quality, supply chain and infrastructure failings in certain larger sites and that a supply chain plan has been launched in order to better control functions that relate to spend on common categories of items and procurement changes in order to drive cost reductions and improve on-time delivery and quality. Cobham is also at how best it can better optimise a manufacturing strategy across the Group.

Internal engagement and communication together with increased site visits by the senior management team in order to better instil a common sense of purpose and direction and to encourage collaboration are seemingly all elements now being used to push the company forward into a new direction. Importantly, the statement confirms that a major overhaul is underway aimed at strengthening the board of Advanced Electronics Solutions which has been one of the main problem areas for Cobham

Turning Cobham around following a period that one newspaper recently described as being a combination of bad luck, poor trading and ill-timed acquisitions, was never going to be easy or quick but it didn’t take David Lockwood long to realise that despite the raft of obvious problems that needed to be sorted out, the company was brimming with talent, skills and people ready to get right behind him in sorting the many issues out.

The point about the interim results today is not the figures but confirmation that the significant amount of work needed to put Cobham back on course is well under way. With the new CEO in post for just six months, to get to the point of understanding what needs to be done is remarkable enough but what Lockwood has told us today is confirmation that ‘real’ work is underway and that progress is hard on the heels of that,.

I take the view that after a period of high distress in which Cobham customers and shareholders have suffered what Lockwood has managed to do so far is to bring everyone back on side working for the self-same ends. No excuses but we need to remember that issues that needed to be resolved were not universally spread across the company. There are many elements of Cobham activity that are just as strong as they ever were. Problems there are a plenty, but throughout all of this dreadful past period, Cobham has remained a profitable group all the problems and issues the company has suffered, it remained profitable throughout.

For those that may not know the company as well as others, Cobham is a leading UK based technology and services innovator engaged in the space, air, land and maritime domains and one that is highly respected by its customers for providing solutions to the most challenging of problems. With activities spread internationally including the USA, Cobham’s principle activities are based around sectors of advanced electronics solutions, mission systems, aviation services, communications and connectivity.

Respected by government and other customers for its engineering technology and service based excellence, it is good to see that after two years of turmoil and change Cobham is now making progress. During the course of the past six month Lockwood has brought in various people to assist in the process of turning the fortunes of the company around. Naturally, the main emphasis of the turnaround process is achieving greater productivity and efficiency rather than rewriting strategy but over time I suspect that Cobham will make some adjustments.

By that time that Lockwood arrived Cobham was close to breaching its banking covenants and what followed was of necessity a second difficult rights issue that raised an additional £500m of funding. Lockwood has needed to work hard and fast not only to assist in the process of turning the company around but to restore confidence of shareholders. Most would agree that he has done a very good job so far.

An amiable man and one with a sense of humour to match, Lockwood is not necessarily how one imagines a typical CEO to be. Energetic, clever, respected and enthusiastic about the future, he remains a realist and knows full well that there are hostages to fortune yet to be overcome.

In the space of six months since he arrived Lockwood has wasted no time in pursuing his objectives. Never doubting the huge potential that was within the Cobham portfolio and within grasp if he succeeded in his mission, he also knew that despite the well exposed failings of previous management in respect of certain acquisitions, that the majority of the company’s market and technology positions were still very strong and that nothing had altered the excellent reputation that Cobham enjoyed with its customer base.

While there can be little doubt that Cobham seriously lost its way due to a combination of factors, not least of which was over paying for acquisitions and failing to integrate them into the group, that bit is now history. The work that David Lockwood and his team are doing today in turning the company round both strategically and operationally will be the measure of his success. So far, so good.

So what did really go wrong and what are the principle issues to resolve? Arguably, top of the list was ‘diversification’ into commercial connectivity and communications markets through the debt and equity funded $1.5bn purchase of US rival Aeroflex in 2014. Strategically right or wrong, this proved to be an ill-timed, over-priced, and badly structured acquisition that proved difficult to integrate with the rest of the group. Timing is everything and shortly after the Aeroflex acquisition Cobham began to suffer a downturn in some of its core markets such as aviation services and satellite communications. This was made all the worse as one of its largest contracts in the original Flight Refuelling business, providing in-flight refuelling systems for the US Air Force’s fleet of KC-46 aerial tankers, ran into severe delay due to a variety of problems, some of which were outside of its own making. In February this year following a decision by Cobham and its Boeing customer to incorporate a wide range of changes into the KC-46 schedule in order to provide a solid baseline for completion of the development programme and which resolved long standing technical and conformance issues   the group announced a £150m charge for the KC-46. Wisely, at the same time Cobham took a further £574m impairment charge against some of the businesses previous management had acquired.

While the charges mentioned above left Cobham to produce a £847.9m pre-tax loss for FY16, the £1bn that from two separate rights issues Cobham raised from shareholders did at least provide breathing space that would allow David Lockwood and his team to take a long hard look at the assets Cobham possesses and decide what they intended to do in terms of future strategy.

When I met with David Lockwood during a visit to the company’s Wimborne, Dorset headquarters during April there was no doubting the determination to get things right and rebuild lost shareholder trust. Whether or not there will be changes to Cobham’s wide range of activities and its diverseness across in-flight air-to-air refuelling, wireless testing, satellite communications, internet connectivity, electronic warfare, aviation services and a range of military life support systems and wider support services within the defence arena is hard to say but I do not believe that change in this respect is a priority. Improving efficiency of operation and rebuilding margins certainly is.

Moreover, with realisation that after several years of reduced spending by governments that defence market recovering, is also important. Doubts about whether Cobham has the skills or resources necessary to rebuild its fortunes should be dispelled. I may know nothing about the highly competitive commercial connectivity and communications sector and which now accounts for close to a third of Cobham’s annual revenue but I am more than content to believe that Lockwood is the right person to decide all aspects of Cobham’s future. Today we will I suspect get some idea of what his wider intentions for the future shape of the group are.

CHW (London 3rd August 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon





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