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Interview: Cobham CFO Simon Nicholls

AS the son of a Royal Navy helicopter pilot, it was perhaps inevitable that Simon Nicholls would end up in a similar field to his father. Despite – if you will – a maths, statistics and economics degree from Warwick, and nine years at Big Four accountancy giant PwC, he did end up thriving in that world, as he clearly does in his current role as CFO of Cobham, one of the UK’s biggest aero, defence and technology companies.

Cobham’s products have something of the Boys’ Own about them, from cutting-edge in-flight re-fuelling capabilites, to liquid-cooled suits for helicopter pilots and tank drivers, anti-IED and digital warfare, radar and aerial technologies to name just a few of its market-leading offerings.

Notwithstanding his own paternal military connection and the company’s long and illustrious defence pedigree, which stretches back to the early 1930s, the 51-year-old is helping to drive a challenging strategy set to take the FTSE 250 company away from its historical reliance on military markets and into new commercial waters.

Which is both a canny move and one firmly grounded in hard-edged political realism as British defence spending by successive Con-Dem and Conservative governments has continued to cut deep into the soul of the army, navy and air force. This has occurred with such an apparent disregard for the country’s military capabilities that many in the armed services regard it as taking a massive risk with the forces.

Indeed, a recent report by the hugely respected Royal United Services Institute (Rusi) intimates that defence budgets may be hacked by a further 10% in the course of the next parliament, decimating armed forces personnel by more than 40,000. Hardware and ancillary services also face drastic cuts.

As the government’s relentless austerity drive continues apace, Britain’s £36bn defence budget has never been under such pressure – in spite of the ongoing threats from IS in the Middle East and Putin’s sabre rattling in Crimea, Ukraine and Russia’s entry into the Syrian conflict.

So worrying is the Conservative fixation on cuts to the British military that US defence secretary Ashton Carter expressed his fears that the UK could become “disengaged” if it makes any further cuts to defence spending.

From defence to commercial aerospace

Cobham’s nascent plans to steer away from relying too heavily on government defence budgets is clearly a bold move given that about 60% of its current income stream is derived from defence – a third of which comes from the US military – and the remainder is commercial.

And it was during his five-year stint at fellow FTSE 250 outfit Senior – which designs, manufactures and markets high-technology components and systems for equipment producers in the aerospace, defence, land vehicle and energy markets – that he further honed his financial skill. Prior to his years at Senior, he worked at Hanson, both in North America and at its UK-based plc cousin.

Nicholls says Senior was “what you’d call a build-to-print manufacturer – taking somebody else’s design and manufacturing it very efficiently”, whereas “Cobham has much more technical development where we do a lot of our own design work and own the IP in virtually everything that we do, which brings with it a slightly different set of challenges”.

Cobham’s journey to move away from defence began in 2009/10 when the board started looking to build a more commercial aerospace side to its business, which chimed well with Nicholls’s experience at Senior.

“The day after I joined in May 2013, the chief executive Bob Murphy brought in a new head of strategy and over the next few months we went through a redesign of the whole strategic planning process,” explains Nicholls.

“I’m part of the team that works through that and commercial aerospace is a very logical place for Cobham to go. But at that time, the multiples being paid for these businesses were scary and it was very difficult for a strategic owner to be able to see how you can drive value at those prices. So we took a step back and said, ‘What are our core capabilities?’ Sending and receiving signals is one of them, and we are one of the world leaders in certain niches that can be applied in a whole bunch of other areas.”

He is excited by the huge and varied market for wireless communications, both from man to machine and machine to machine, whether in the fields of energy, mining, or even the Ryder Cup or 20/20 cricket – for which Cobham designed a camera that sits on the batsman’s helmet, enabling viewers to so see the batsman’s view of ball hurtling down the wicket.

“Rather than thinking about Cobham as an aerospace company and about what we can do with aerospace,” enthuses Nicholls, “we thought about it more as technology-based communications company, and if you widen that a little further, you actually get to something called connectivity – which is a $22bn-a-year (£14.4bn) market.”

That connectivity market – which essentially consists of sending and receiving signals – is a communications element where Cobham is “really strong”.
“Another element is the actual connections themselves,” continues Nicholls, citing the example of a surgeon being able to operate a device inside a body remotely. This “has to be very precisely controlled with very reliable signals and that’s not easy to do and applications like that, as well as the next generation of CT scanners, are examples of where Cobham’s technology can come to the fore”.

Diminishing budgets

Part of that determined strategic play away from diminishing defence budgets – a commercial downside of the relative peace dividend in Afghanistan and Iraq – is its $1.5bn acquisition of US company Aeroflex in May 2014, the biggest in its history.
The deal immediately strengthened Cobham’s longed-for positioning as about 70% of Aeroflex’s income is derived from the commercial market – a lucrative sector which eagerly hoovers up its components for the aerospace, manufacturing, mobile and broadband communications and defence markets. This was a key piece of the connectivity jigsaw for Cobham as Aeroflex – formerly a competitor – is also big in the high-end sensing, testing and measurement space.

“Until we acquired Aeroflex,” says Nicholls, “we had no presence at all in the medical sector – so when we started to look at where the next generation of communications technology is coming from and what we would need to put in with our existing technology to ensure we can meet those needs such that the whole is greater than the sum of its parts, that’s where the Aeroflex deal came from.”

Nicholls took charge of funding the deal through both a $1.3bn short-term bank bridging facility and a small 5.5% equity placing of £180m to help give “plenty of headroom to be able to continue to fund the existing business and it investment requirements”.

He describes the timing as “great” as he was able to convert short-term facilities into long-term, fixed-term lending of between five to ten years at historically low rates. This was then refinanced on a long-term basis through the US private placement market where Cobham financed $930m in October 2014. Then, in April 2015, “we financed the remaining $370m – half through a term loan with one of our major relationships banks and the other half through the European Schuldschiene market”, explains Nicholls.

“Operational excellence and value creation are areas where we have been working very hard. This is something I first touched at Hanson – a building materials company which was an EVA (economic value add) company. I learned a huge amount about value drivers at Hanson. I was responsible for rolling out EVA training across the group and driving asset efficiency and the return on capital, as well as optimising margins across the footprint. We did the same thing at Senior – which was very strong on operational excellence and lean manufacturing principles, so I was able to learn a bit more there and harness that with asset utilisation.”

Stripping down

Another key focus for Nicholls is Cobham’s operational efficiency/continuous improvement programme. Started by his predecessor, Nicholls has eagerly taken up the mantle to “drive the cost base down” and “make us as efficient as possible”, “with the best technology” so that “we can win the maximum market share and be lowest cost provider to add the maximum value to shareholders”.

As recent governance failures have landed damaging corporate and reputational body blows on technology giant Toshiba and retailing behemoth Tesco, this is an issue whose importance is not lost on Nicholls.

“I went through Sarbanes Oxley at Hanson in 2004 – and all the pain that went with that,” he says, recalling the testing of controls that weren’t actually key controls in the business, which he describes as “just wasting a lot of time”.

“I learned then that effective governance – controlling the things that really matter and not wasting resources on things that don’t – can add huge value to a business,” he explains.

In 2004 to 2006 he and his US team set about “stripping it all back”, asking: “What are the key things we need to control in this business and how can we devise a governance structure that adds value for the business and ourselves?”
He posits that at Cobham, like many plcs, “the governance structure has been put together incrementally as various different sets of regulations have come out” – from the Cadbury requirements in 1998 to Turnbull to the combined code and then the UK governance code – so “the regulatory requirements get a bit bigger each time” and plcs have to add “another ten policies, adding to the 25 or 30 already in the business”.

What’s needed, says the lifelong rugby fan and father of two daughters, is to take a look at what the governance code is asking companies to do and ask “how we can best apply that in our the most efficient way and then allocate the resources to control what really are the risks in the business”.

“A lot of businesses spend too much time on risks and associated policies and controls that are never going to be mission-critical. They waste money and management time on things that don’t really matter, and then miss the big things. I could see areas of Cobham in that bucket when I arrived, and we’re working our way out of it, re-organising the business and moving towards a very different culture and governance framework – one which is much more based on an integrated and joined-up way of thinking through the business and we need a governance structure that is fit for purpose,” he explains.

Absolute profit

When it comes to the cash conversion cycle, Nicholls learned a lot from the work he did at Hanson, namely that the “best proxy for value creation in the business is a combination of superior levels of absolute profit, absolute cash and return on capital employed and the need for all three of those on a sustainable basis to drive long-term value in any business”.

He’s quick to point out “we’re actually tying up a fair amount of cash in development programmes and we need to manage that very carefully” and is acutely aware that a drive for short-term cash conversion can come at the long-term detriment of the business, which in Cobham’s case is less of an issue, as the majority of investors are in it for the longer term.

“This can mean making a bit of investment upfront and understanding when that investment should start to pay off. Our cash conversion is slightly challenged in Cobham at the moment due to the amount of development work we are doing and capital expenditure requirements in some areas. But we know why and we can explain that to the market, and investors understand where we are trying to get to in order to drive long-term value creation.”

Diversified and integrated

With Nicholls’ proverbial ducks now nicely aligned, what are his most pressing challenges?

“It’s a much more complex business with a much more complex set of challenges than I had originally thought. It was historically run as a defence business with a holding company mentality. We’re trying to move to an integrated operating company mentality and diversify the portfolio into commercial markets so that we have a more balanced set of market exposures to allow us to grow consistently over the cycles,” he says.

But he’s adamant he’s effectively tamed and harnessed the competing demands of  issues such as the external market, capital structure, strategy, internal efficiency, culture and people. Experience has taught him that as you move into “businesses of more scale, roles take longer to get to grips with – so I only feel now, after a couple of years, that I have truly got to grips with all the things we need to do. And it will take another three of four years to start to see the full benefits of that coming through into the business.”

And now, after some two and a half years in his current role, he wants to help “develop our finance people” to engage in “more business partnering within the finance function, less pure reporting and more insightful analysis”. From a governance perspective, he sees the “need to get rid of some of this unnecessary bureaucratic admin that we have in the business”,  while still controlling “all of the key risks that matter”.

And because current debt levels are “too high” Nicholls has set his sight on the need to “tighten up delivery on development programmes and start to reduce our inventory and engineering work in progress” while driving more efficiency through the supply chain, production and manufacturing. This will “help reduce net debt and create capacity to participate more fully in the connectivity market” where he sees major growth opportunities.

Nicholls is quietly confident that finance is now more involved in the strategic trajectory of Cobham than it was a few years ago. And given his record to date, the keen golfer and Queen fan is clearly, to steal a track from his favourite band’s eponymous 1973 album, ‘Doing Alright’. ?

Simon NichollsIN BLACK AND WHITE

May 2013 – present Chief financial officer, Cobham
April 2008 – April 2013 Group finance director, Senior
June 2003 – December 2007 Chief financial officer, Hanson North America
March 2000 – May 2003 Group financial controller, Hanson

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