Sector

IndustrialsManufacturing

Background

Stephen Paice is the Head of European equities at Baillie Gifford. We cover the rich corporate history of Atlas Copco, what makes its culture so noteworthy, and provide an overview of its products that are used in industries all around the world.

Cover

Date

August 24, 2022

Episode Number

71

Atlas Copco Business Breakdown

Background / Overview

Atlas Copco, a Swedish industrial conglomerate founded in 1873, is a global leader in air compressors, vacuum pumps, and industrial tools. With a market capitalization of approximately $50 billion, it has delivered a 40x return to shareholders over the past 20 years. The company’s history is deeply intertwined with the Wallenberg family, a prominent Swedish dynasty that has influenced its strategic direction for nearly 150 years through their investment vehicle, Investor AB. Initially established to manufacture railroad materials, Atlas Copco evolved into a specialist in pneumatic technology and compressors, divesting non-core businesses like diesel engines and mining equipment (spun off as Epiroc in 2018) to focus on high-margin, high-return segments. Headquartered in Stockholm, it operates a decentralized structure with four main divisions—Compressor Technique, Vacuum Technique, Industrial Technique, and Power Technique—employing approximately 43,000 full-time equivalents (FTEs) globally. Its business model emphasizes energy-efficient productivity solutions for industrial applications, serving a wide range of industries from manufacturing to semiconductors.

Ownership / Fundraising / Recent Valuation

The Wallenberg family, through their investment vehicle Investor AB, owns 17% of Atlas Copco’s equity and controls 22% of voting rights, while their foundations hold 22% of equity and 46% of votes due to Sweden’s dual-class share structure. This long-term ownership has fostered a conservative balance sheet and disciplined capital allocation, enabling resilience through economic cycles. The company’s market cap is around $50 billion, reflecting its strong market position and consistent financial performance. No recent fundraising or private equity transactions were mentioned, as Atlas Copco is a publicly listed entity with a stable ownership structure. Its valuation is supported by high returns on capital (80-100% in Compressor Technique) and a track record of organic and acquisitive growth.

Key Products / Services / Value Proposition

Atlas Copco’s products are mission-critical productivity solutions, emphasizing energy efficiency and reliability. The key offerings include:

Value Proposition: Atlas Copco’s products are a small fraction of customers’ capital outlay (e.g., 10% of compressor total cost of ownership, 5% of semiconductor fab cost) but critical for operational efficiency. Energy efficiency is the primary differentiator, as 80% of a compressor’s lifetime cost is energy consumption. The service business enhances customer loyalty through digital monitoring, uptime guarantees, and air quality management, creating sticky, high-margin revenue streams.

Segments and Revenue Model

Atlas Copco operates four segments:

1. Compressor Technique (50% of revenue): Air compressors and related services, with 40-45% service revenue. Generates 80-100% returns on capital employed (ROCE) and low-20s EBITDA margins.
2. Vacuum Technique (25% of revenue): Vacuum pumps, primarily for semiconductors (60% of segment). Service is ~20% of revenue, with 25% ROCE and low-20s margins.
3. Industrial Technique (12.5% of revenue): Industrial tools for manufacturing, with solid margins but less service potential.
4. Power Technique (12.5% of revenue): Portable compressors and generators, often rented, with lower service revenue.

Revenue Model: The company generates revenue through equipment sales (67% of total revenue) and services (33%), including repairs, spare parts, and long-term contracts. The service model leverages an installed base, with digitalization enabling real-time monitoring and predictive maintenance. Revenue is driven by:

• Equipment Sales: Premium pricing for energy-efficient products, with a multi-brand strategy (high-end Atlas Copco brand and entry-level brands for emerging markets).
• Service Contracts: High-margin aftermarket services, including “total care” packages guaranteeing uptime and air quality, especially in Compressor Technique.
• Acquisitions: Bolt-on deals for distribution, service, or adjacent technologies, contributing 2-3% to annual revenue growth.

Splits and Mix

• Channel Mix: Most sales are direct for large customers, with distributors used for smaller clients. Atlas Copco has acquired distributors to increase its brand share (from 30% to 100% in acquired distributors), enhancing control and margins.
• Geo Mix: 80% of revenue comes from international markets, with significant exposure to Asia-Pacific (especially for Vacuum Technique) and emerging markets driving volume growth.
• Customer Mix: Diverse, spanning manufacturing, food and beverage, oil and gas, semiconductors, and agriculture. No single customer dominates, reducing concentration risk.
• Product/Segment Mix: Compressor Technique dominates (50%), followed by Vacuum Technique (25%), with Industrial and Power Techniques each at ~12.5%. Service revenue is highest in Compressor Technique (40-45%) and growing in Vacuum Technique (20%).
• End-Market Mix: Broad exposure to industrial production, with Vacuum Technique heavily tied to semiconductors (60%) and Compressor Technique ubiquitous across industries.
• EBITDA Split: Compressor Technique contributes the most due to high ROCE and service margins, followed by Vacuum Technique. Industrial and Power Techniques are profitable but less margin-accretive.

Historical Mix Shifts: Service revenue has grown from ~25% to 33% over 20 years, driven by Compressor Technique’s focus on aftermarket contracts. Vacuum Technique’s share has increased through acquisitions since 2014, while the Epiroc spin-off in 2018 streamlined the portfolio. Forecasts suggest continued service growth, particularly in Vacuum Technique, improving overall margins.

KPIs

• Revenue Growth: 6-7% organic CAGR, plus 2-3% from acquisitions, outpacing GDP due to emerging market exposure and service expansion.
• EBITDA Margin: Improved from 12% in the early 2000s to 21-22% today, driven by service revenue and operating leverage.
• ROCE: Compressor Technique at 80-100%, Vacuum Technique at 25%, group-level high due to asset-light model.
• FCF Conversion: Near 100% of net profit converts to free cash flow, reflecting low capital intensity.
• Acquisition Pace: 30-40% of FCF allocated annually, primarily for bolt-on deals.
• Service Revenue Growth: Accelerating in Compressor Technique (40-45%) and Vacuum Technique (20%), indicating strong customer retention and digitalization benefits.

Acceleration/Deceleration: Revenue growth is stable, with no signs of deceleration due to fragmented markets and acquisition opportunities. Margin expansion continues as service revenue grows, though cyclical risks (e.g., semiconductor capex or industrial production slowdowns) could temporarily impact volumes.

Headline Financials

Long-Term Trends:

• Revenue: Compounded at 8-10% (6-7% organic + 2-3% acquisitions), driven by volume (3-4%), price (2%), and service growth.
• EBITDA: Margin doubled from 12% to 21-22% over 20 years, reflecting service revenue and operating leverage.
• FCF: Consistently high due to low capex and efficient working capital management.

Value Chain Position

Atlas Copco operates midstream in the industrial equipment value chain, assembling compressors, vacuum pumps, and tools from purchased components (75% of inputs). Its primary activities include:

• Inbound Logistics: Sourcing components from global suppliers, leveraging partner expertise for flexibility.
• Operations: Asset-light assembly, with decentralized production across 23 business units and 400 autonomous P&Ls.
• Outbound Logistics: Direct sales to large customers and distributors for smaller clients, supported by 300 global service centers.
• Service: High-margin aftermarket services, including repairs, spare parts, and digital monitoring, ensuring uptime and efficiency.

GTM Strategy: Direct sales dominate for large industrial clients, with distributors used for smaller customers. Acquired distributors are converted to sell primarily Atlas Copco brands, enhancing margins. The multi-brand strategy (premium Atlas Copco and entry-level brands) protects against low-cost competition in emerging markets.

Competitive Advantage: Atlas Copco’s value-add lies in energy-efficient products and a sticky service model. Its decentralized structure enables rapid customer response, while digitalization (connected compressors) enhances service offerings. The company’s position as a critical supplier (e.g., compressors as the “fourth utility”) ensures high switching costs and customer retention.

Customers and Suppliers

• Customers: Diverse, including manufacturers, semiconductor fabs, food and beverage, oil and gas, and agriculture. Semiconductor clients (60% of Vacuum Technique) are concentrated in Asia-Pacific, while Compressor Technique serves a broad industrial base.
• Suppliers: 75% of components are sourced externally, with Atlas Copco maintaining strong supplier partnerships rather than an outsourcing model. This flexibility reduces working capital volatility and supports high ROCE.

Pricing

• Contract Structure: Equipment sales are one-time, with service contracts ranging from short-term repairs to long-term “total care” packages guaranteeing uptime and air quality. Contracts are often sold post-warranty, with increasing adoption of upfront service agreements.
• Pricing Drivers:
• Energy Efficiency: Primary differentiator, as 80% of compressor costs are energy-related. A 5% efficiency gain significantly reduces total cost of ownership.
• Branding: Atlas Copco’s premium brand commands higher prices, with entry-level brands protecting margins in emerging markets.
• Mission-Criticality: Compressors and vacuum pumps are essential for operations, reducing price sensitivity.
• Service Value-Add: Digital monitoring and uptime guarantees justify premium service pricing.
• Visibility: Service contracts provide predictable revenue, with 33% of revenue recurring. Digitalization enhances forecasting accuracy.

Bottoms-Up Drivers

Revenue Model & Drivers

• Revenue Model:
• Equipment (67%): Sales of compressors, vacuum pumps, and tools, with premium pricing for energy efficiency. Multi-brand strategy mitigates low-cost competition.
• Service (33%): High-margin aftermarket, including repairs, spare parts, and contracts. Compressor Technique leads (40-45% service), followed by Vacuum Technique (20%).
• Acquisitions: Bolt-on deals for distribution, service, or adjacent technologies add 2-3% to revenue annually.
• Pricing: Driven by energy efficiency, brand reputation, and mission-criticality. Blended pricing benefits from service growth and premium product mix.
• Volume:
• Industry Growth: Tied to industrial production and semiconductor capex, with emerging markets driving 3-4% volume growth.
• Switching Costs: High due to installed base and service contracts, ensuring repeat purchases.
• Acquisitions: Expand distribution and service networks, boosting volumes.
• Mix:
• Product/Segment: Compressor Technique (50%) and Vacuum Technique (25%) dominate, with service revenue growing across both.
• Geo: 80% international, with Asia-Pacific and emerging markets increasing share.
• Customer: Diverse, with semiconductors concentrated in Vacuum Technique.
• Distribution: Shift toward direct sales via acquired distributors.
• Organic vs. Inorganic: 6-7% organic growth from volume and price, 2-3% from acquisitions.

Cost Structure & Drivers

• Variable Costs:
• 75% of components are sourced, tying costs to supplier pricing and raw material inflation.
• Assembly is labor-intensive but flexible, minimizing variable cost volatility.
• Contribution margin is high due to premium pricing and low direct production costs.
• Fixed Costs:
• R&D, sales, marketing, and administrative overheads are spread across 400 autonomous units, creating operating leverage.
• Facilities and equipment are minimal due to asset-light assembly, enhancing scalability.
• Gross Margin: High, driven by premium pricing and service revenue. Compressor Technique’s service focus boosts blended margins.
• EBITDA Margin: 21-22%, up from 12% in the early 2000s, reflecting service growth and fixed-cost leverage. Incremental margins are ~35%, indicating strong operating leverage.
• Cost Trends:
• Service revenue reduces reliance on variable costs, improving margins.
• Decentralized structure sacrifices some economies of scale but enhances customer proximity and flexibility.

FCF Drivers

• Net Income: High EBITDA margins flow to net profit, with minimal interest expense due to a conservative balance sheet.
• Capex: Low, as manufacturing is asset-light. Maintenance capex is minimal, with growth capex tied to acquisitions.
• NWC: Efficient due to supplier partnerships and decentralized operations. Cash conversion cycle is short, supporting high FCF.
• FCF Conversion: Near 100% of net profit, with 50% paid as dividends, 30-40% allocated to acquisitions, and the rest retained for flexibility.

Capital Deployment

• M&A: 30-40% of FCF funds bolt-on acquisitions (distribution, service, or adjacent technologies), with occasional larger deals (e.g., Vacuum Technique expansion in 2014). Acquisitions target fragmented markets, enhancing market share and service revenue.
• Dividends: ~50% payout ratio, balancing shareholder returns with growth investments.
• Organic Growth: R&D and digitalization drive service revenue and energy efficiency, supporting 6-7% organic growth.
• Divestitures: Strategic spin-offs (e.g., Epiroc in 2018) prevent bureaucracy and maintain focus, creating value without short-term shareholder pressure.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Compressor Market: Fragmented, with Atlas Copco holding ~30% global share (2x larger than Ingersoll Rand). Estimated market size is ~$50 billion, growing at 4-5% annually (3-4% volume, 1-2% price), driven by industrial production and emerging markets.
• Vacuum Pump Market: Smaller, ~$10 billion, with Atlas Copco as the leader (ahead of Pfeiffer Vacuum). Growth is 6-8%, tied to semiconductor capex and electronics demand.
• Total Market: ~$60 billion, with Atlas Copco’s ~$15 billion revenue implying ~25% overall share. Growth is above GDP due to industrialization and technology adoption.

Market Structure

• Fragmented: Both compressor and vacuum markets have many small competitors, enabling consolidation. Minimum efficient scale (MES) is moderate, allowing Atlas Copco to dominate through scale and service networks.
• Competitors: Ingersoll Rand (compressors), Pfeiffer Vacuum (vacuum pumps), and numerous regional players. No oligopoly, but Atlas Copco’s scale and brand create barriers.
• Cyclicality: Tied to industrial production and semiconductor capex, with downturns impacting volumes but service revenue providing stability.

Competitive Positioning

• Matrix Position: Premium pricing, high-quality products, and extensive service networks position Atlas Copco as a market leader. Entry-level brands protect against low-cost competitors.
• Risk of Disintermediation: Low, as compressors and vacuum pumps are mission-critical with high switching costs.
• Market Share Trends: Growing through organic sales and acquisitions, outpacing market growth (8-10% vs. 4-8%).

Hamilton’s 7 Powers Analysis

1. Economies of Scale: Moderate, with decentralized operations sacrificing some scale for flexibility. Service networks and acquired distributors create local scale advantages.
2. Network Effects: Limited, but service contracts and digital monitoring create a flywheel of customer retention and data-driven insights.
3. Branding: Strong Atlas Copco brand commands premium pricing, reinforced by energy efficiency and reliability. Entry-level brands protect margins.
4. Counter-Positioning: Asset-light assembly and decentralized structure allow rapid market response, challenging centralized competitors.
5. Cornered Resource: Proprietary technology in energy-efficient compressors and vacuum pumps provides a performance edge.
6. Process Power: Decentralized operations, digitalization, and robust benchmarking enable superior execution and customer proximity.
7. Switching Costs: High, due to installed base, service contracts, and mission-critical applications, ensuring sticky revenue.

Strategic Logic

• Capex Cycle Bets: Defensive, with low maintenance capex and selective growth capex for acquisitions. Digitalization investments enhance service offerings.
• Vertical Integration: Limited, with 75% of components sourced externally to maintain flexibility and low capital intensity.
• Horizontal Integration: Aggressive via bolt-on acquisitions, consolidating fragmented markets and expanding service networks.
• New Geos: Focus on emerging markets (80% of revenue international), leveraging entry-level brands for volume growth.
• M&A: Disciplined, targeting high-ROCE businesses. The Epiroc spin-off avoided diseconomies of scale, maintaining agility.

Valuation

Atlas Copco’s $50 billion market cap implies an enterprise value (EV) of ~$52 billion (assuming minimal net debt). Using EV/FCF as a valuation metric:

• FCF Estimate: Assuming $15 billion revenue, 21% EBITDA margin ($3.15 billion), and 100% FCF conversion, FCF is ~$3 billion.
• EV/FCF Multiple: ~17x, reasonable for a high-ROCE, growing industrial with 8-10% revenue CAGR and margin expansion potential.
• Implied Expectations: Market assumes 6-8% revenue growth and stable 21-22% margins, conservative given 35% incremental margins and acquisition optionality.

Bull Case: Continued service revenue growth (to 40%+ of total), Vacuum Technique margin expansion, and disciplined acquisitions could drive 10-12% annual returns over 10 years, with upside from new adjacencies or technologies.

Risks: Cyclical downturns (semiconductor capex, industrial production) or a disruptive shift to free energy could challenge the energy-efficiency value proposition, though transmission costs would likely preserve demand.

Key Takeaways and Unique Dynamics

1. Energy Efficiency as Core Differentiator: Atlas Copco’s focus on energy-efficient products addresses the largest cost component (80% of compressor total cost of ownership), creating a compelling value proposition. This aligns with customer priorities, ensuring premium pricing and high switching costs.
2. Service Revenue Flywheel: The 33% service revenue (40-45% in Compressor Technique) is a high-margin, sticky revenue stream, enhanced by digitalization (real-time monitoring, predictive maintenance). This drives margin expansion (12% to 21-22% over 20 years) and customer loyalty, with potential to grow to 50% in key segments.
3. Decentralized Structure: The 23 business units and 400 autonomous P&Ls sacrifice some economies of scale but enable rapid customer response, local innovation, and acquisition integration. Robust benchmarking ensures accountability, making this a unique governance model.
4. Asset-Light Model: Sourcing 75% of components and minimal capex result in high ROCE (80-100% in Compressor Technique) and near-100% FCF conversion, supporting acquisitions and dividends.
5. Acquisition Discipline: Allocating 30-40% of FCF to bolt-on deals in fragmented markets has driven 2-3% revenue growth without overpaying. Strategic divestitures (e.g., Epiroc) prevent bureaucracy, preserving long-term value.
6. Wallenberg Influence: The family’s 150-year stewardship fosters a conservative balance sheet, long-term focus, and cultural continuity (codified in the Atlas Copco Blue Book), enabling resilience through crises and disciplined capital allocation.
7. Fragmented Market Opportunity: With ~30% compressor market share and leadership in vacuum pumps, Atlas Copco benefits from consolidating fragmented markets, outpacing competitors through scale and service networks.

Critical Insights:

• The interplay of energy efficiency and service revenue creates a virtuous cycle: efficient products attract customers, and service contracts lock them in, driving margins and ROCE.
• Decentralization, while counterintuitive to scale-driven industrials, is a competitive moat, enabling agility and customer proximity that centralized competitors struggle to replicate.
• The Wallenberg family’s influence is a double-edged sword: it ensures stability but could limit aggressive pivots if market dynamics shift (e.g., disruptive energy innovations).
• The business’s cyclicality is mitigated by service revenue and emerging market growth, but semiconductor capex volatility (Vacuum Technique) remains a risk.

Atlas Copco’s model exemplifies how niche industrial dominance, disciplined acquisitions, and a customer-centric culture can deliver outsized returns in fragmented markets, with significant runway for growth in service and vacuum segments.

Transcript