Although merger and acquisition (M&A) activity has been frozen in recent months, as many firms avoid decisive action because of current economic volatility, there is a strong possibility this may change in the second half of 2009.
As a result of the bonding requirements intrinsic to the engineering, procurement, fabrication, and construction industries, many engineering and construction firms are sitting on cash that exceeds what’s needed for bonding relative to current levels of backlog. Backed by strong balance sheets, engineering and construction firms have split into two schools of thought: 1) ride out the storm with current cash and wait for the weaker players to surrender, or 2) use this trough in the cycle as an opportunity to buy smaller players that may open new growth avenues.
When the markets eventually normalize and capital spending returns, the best positioned companies will be those that exhibit strength not because other players have been weakened, but because the companies made strategic moves to enhance their business models. Expansion will most likely come in the form of acquisitions, and we could see transactions as early as the second part of 2009.
Stimulus President Obama made it no secret that his plan to reinvigorate the U.S. economy involves a vast series of infrastructure projects. Enthusiasm about the engineering and construction industry appeared in equity prices of publicly traded companies. In the last six weeks of 2008, infrastructure stocks prices were up 66 percent, according to Stephens Inc. Unfortunately, this rally proved premature and stock prices ceded their gains. On the coattails of strong results from URS Corp in early March 2009, per-share prices of engineering and construction firms shot up again. The sector was also boosted because broad rally on Wall Street after word of a possible Chinese economic stimulus package.
The American Recovery and Reinvestment Act earmarked $27 billion for the nation’s roads and bridges, and another $18 billion for marine-oriented infrastructure. The government’s infrastructure spending could prove a boon to the top engineering and construction companies; yet there is no certainty as to timing or the ultimate beneficiaries. Interest in the sector undoubtedly will draw competition among firms trying to capture more engineering and construction business, or smaller players vying for a bigger piece of the pie.
Acquirers The prospect of future infrastructure projects has already added fuel to the M&A market’s fire. Last year, some of the most significant merger activity in the infrastructure sector included AECOM’s acquisitions of Earth Tech and Boyle Engineering. Other deals included Perini Corp.’s acquisition of Tutor-Saliba Corp., and URS Corp.’s purchase of LopezGarcia Group and Tryck Nyman Hayes Inc. Some of 2008’s acquisitions proved immediately accretive, with a good example being U.K. engineering and construction group Balfour Beatty PLC, which reported a 30-percent increase in full-year net profit.
We expect Balfour and other strategic buyers to continue this trend, including the following: McDermott International, KBR, Shaw Group, Fluor Corporation, Jacobs Engineering, Foster Wheeler, General Cable, and Chicago Bridge & Iron. Already in 2009, McDermott has completed the acquisition of Nuclear Fuel Services; Aecon Group acquired Lockerbie & Hole, Inc.; and Parsons Corp., bought out McMunn Associates.
Smaller deals have also come to the forefront in 2009: In January, heavy industry group Rexnord LLC acquired water engineering company Fontaine-Alliance Inc., based in Quebec, Canada, for $24 million. In June, Terracon, an employee-owned engineering consulting firm, announced the acquisition of AMEC Earth & Environmental Inc.’s Construction Services Group in Redmond, Wash. Also in June, Dessau Inc., one of Canada’s largest engineering-construction firms, announced the acquisition of Naylor Engineering Associates, a Kitchener-based consulting engineering firm.
To capitalize on the strong tailwind, engineering and construction companies needed to start positioning themselves today for what is expected to be a profitable infrastructure build-out in the years ahead. Acquisitions can change the fundamental dynamics of an engineering and construction business by redefining the breadth and scope of the services and markets in which it can compete.
Other than looking to acquire smaller competitors that may be more susceptible to the difficult business environment, strategic buyers seeking to maintain their competitive advantage should study the following action items:
- Consider opportunities that expand the product and services reach. Many engineering and construction firms have traditionally served specific markets, such as oil and gas, civil work, chemical, etc. After the crash in the oil and gas market, some realized the sole market provider model may not be infallible. Market expansion may be achieved by venturing into deals with engineering companies and electrical contractors specializing in environmental retrofitting — especially if government buildings are retrofitted for energy efficiency — or electrical contracting. Still others may want to branch into new specialty areas such as water treatment.
- Build a comprehensive portfolio of services. Proposing a turnkey approach (including the design, engineering, technology, fabrication, construction, and/or follow-up service/maintenance) holds tremendous appeal to government agencies as they begin awarding large contracts. Recognizing the importance of the “value add,” many engineering and construction companies are looking to acquire maintenance, repair, and overhaul specialists to provide a cradle-to-grave solution. For example, KBR bought BE&K for $550 million in May 2008.
- Expand the geographic reach. Some engineering and construction CEOs may want to consider looking to international markets with growth potential, for example the Middle East, and India, to supplement unfilled order books and ensure survival. Developing a strong client base in any new territory (international, national, or regional) will help engineering and construction firms reduce the impact of the downturn in other markets and start building a long-term project stream.
- Identify and invest in new technologies essential to the next stage of industry development. Strategic engineering firms will also be on the lookout for smaller engineering companies that have patented technology or design prototypes and techniques. For example, the new $234 million I-35W Bridge in Minneapolis, designed by Figg Engineering Group Inc., of Tallahassee, Fla., contains hundreds of sensors that will collect data.
- Focus on deals that have the ability to generate meaningful cost and revenue synergies by eliminating redundant expenses and leveraging product and service opportunities into the acquired company.
It stands to reason that potential sellers, seeking attractive sales value, should carefully analyze their business structures before entering M&A discussions. Consider the following questions:
- Is the company being managed and operated efficiently? Identify strengths and weaknesses at a corporate level. Streamline business to optimize free cash flow and profitability. Make better use of excess capital, by investing it or returning it to shareholders.
- Is there a premium for good will? Intangible assets, such as a company’s name, reputation, and management team, also have value. Potential acquirers scrutinize the management team and its demonstrated ability to drive sales and operations. Relationships with customers are also important when considering intangible value.
- What are your value-added services? Shine in this category above all others. Demonstrate the ability to provide valued services, from niche technologies to specialty services. Promote this industry “advantage” in every possible market venue, including earnings calls, press releases,etc.
- Are you a regional/industry leader? Most potential acquirers are looking to expand their operations on both a geographic and market level by picking off those businesses that have already established their brand and reputation. Geographic or market leaders must demonstrate their “first mover knowledge” and have long-standing relationships.
Nicholas V. Beare is a managing director at Stephens Inc., where he specializes in engineering and construction services investment banking. Stephens Inc., is a full-service investment banking firm headquartered in Little Rock, Ark., with offices across the country. For further information, contact Beare in the firm’s Dallas office at email@example.com.