With the recession over, rising turnover and damaged valuations have left construction firms in a climate perfect for acquisition deals. Are you in a position to grow your business or is it time to sell up?
In three weeks’ time Carillion will officially - according to stock market rules - be free to renew its interest in acquiring the UK’s biggest contractor Balfour Beatty.
Carillion’s opportunistic £2.1bn approach for the firm was one of last year’s biggest stories and, while unsuccessful at that time, still has potential to create a construction giant of a scale the UK market has never seen before, uniting the two largest firms in domestic construction. Speculation is mounting as to whether it will use the ending of the six-month prohibition on bidding on 21 February to fire the starting gun on a fresh takeover approach.
And it’s not the only potential major acquisition on the cards: Kier in December announced it was in preliminary discussions with engineering business Mouchel about mounting a takeover, and just this week engineer WYG announced it was potentially looking for a buyer. This activity comes on the back of a number of major deals in 2014 of both listed and unlisted companies, with WSP buying Parsons Brinckerhoff from Balfour Beatty, Dutch engineer Arcadis buying Hyder, and Galliford Try purchasing the troubled construction arm of Miller Group.
It’s little surprise that with turnover of construction firms back on the rise after years of recession, but with valuations still low as years of difficulty continue to take their toll on profits, some companies are spying the opportunity to make a good deal. A survey of construction finance directors, conducted by analyst house Liberium, found that 85% expect an increase in M&A activity this year - and importantly nine out of 10 of the sector’s investors (small-to-midsize fund managers) agree. So what are the prospects for more mergers and acquisitions this year, and who is out hunting for targets?
M&A activity during the recession has been characterised by two principal themes: consolidation in the consultancy sector, where a number of major business have been acquired, mostly by large foreign-owned consultants looking for prestigious UK expertise and manpower; and opportunistic purchases of businesses made vulnerable by the long economic slowdown. Aecom’s purchase of Davis Langdon and Arcadis’ buy-up of Hyder are two examples of the former, while Morgan Sindall’s purchase of parts of Connaught and Galliford Try’s Miller Construction acquisition are examples of the latter.
Few experts see any reason for the pressure for consultant consolidation to ease, with Liberum marking all consultants as potential acquisition targets in 2014, making WYG merely the most open example. UK engineer Atkins, for example, was widely reported to have mulled buying Parsons Brinckerhoff last year before WSP stepped in, and has made no secret of its desire to bolt on further acquisitions to boost growth, primarily into new markets overseas. However, for other analysts, the 17,000-strong firm could itself be a target for one of the international consultancy giants.
The second dynamic - of opportunistic purchases of troubled contractors - has seen some major deals pulled off, but, with the major exception of Balfour Beatty, is becoming less plausible as the market recovers. These deals are in stark contrast to those undertaken before the recession took hold, where housebuilders and contractors were agreeing to merge with other strongly-placed rivals in order to grow turnover and market share. Chris Temple, construction leader at PwC, says: “Activity has been limited during the long recession as there have actually been very few really good businesses to buy. The deals that we’ve seen have very rarely been the coming together of two businesses both from a position of strength.”
With the strengthening market comes the opportunity - potentially - for a return to this kind of approach. But there are a number of factors mitigating against it. Tony Williams, chairman of analyst Building Value, says: “With contractor acquisitions you have this perennial question of what are you actually buying? It’s generally a set of mobile assets and plant and a bunch of works in progress. All these things are notoriously difficult to value - it’s very easy to buy a big can of worms.”
Kevin Cammack, analyst at Cenkos, agrees: “It’s still quite early in the recovery and there is still quite a tail of poor margins and profit recovery at contractors. Companies are not too sure whether if they buy someone with a rising order book it will deliver a commensurate rise in cash flow and profits. It may make them cautious about taking on a business.”
Factors such as the general election, which is expected to lead to a hiatus in government spending decisions and local authority planning approvals, may also lead firms to defer business decisions until later in the year.
Nevertheless, PwC’s Temple says he is seeing strong interest in sales and acquisitions in a number of areas: firstly, where firms are looking to dispose of non-core assets; secondly, where they are looking to acquire businesses operating in spaces they are not currently exposed to; and thirdly, where there is an opportunity to fill in particular gaps in their service provision in a specific market through a targeted small purchase. “There’s a reasonable amount of interest in deals where you can identify a business with a cross section of the right competencies in the right sector, enabling you to in-fill certain specific skills sets,” he says.
Another area which analysts suggest may prove fruitful in 2015 is that of private equity-owned housebuilders such as Miller and Countryside, who have previously been angling toward a stock market flotation, but may now be seeing a trade sale as a potentially more lucrative exit. Miller Group’s owners Blackstone pulled its flotation in October last year, just 10 days after launching it.
Building Value’s Williams says: “Miller may think, ‘if we’re not going to float now, we could put this business up for sale’. If you’re Galliford [Try] or Kier you may be interested in picking up one of these firms that has been groomed for flotation.”
This doesn’t mean, however, that we should expect a return to the frothy market that saw Barratt buy Wilson Bowden and George Wimpey merge with Taylor Woodrow in multi-billion pound deals in 2007 - two transactions driven by an acute shortage of land with planning permission in a booming market. Stephen Rawlinson, analyst at Whitman Howard, says: “The publication of the NPPF (National Planning Policy Framework) means there is much more land available for housebuilders. Land is not the issue that it was in 2007, the top 20 [housebuilders] have plenty of land so they don’t need to acquire each other just to expand.”
Despite this, an increase in M&A activity looks to be upon us. It will be interesting to see which firms exist in the same state as they are now, by the end of this year.
Market cap: £1.47bn
Cash position: £215m net debt
Business briefing: The £4.1bn turnover firm is split three ways between UK contracting, support services work such as FM at home and abroad, and overseas construction and PPP interests, principally in the Middle East and Canada.
Likelihood to make a bid: Fifty-fifty. Like many contractors currently, Carillion is constrained by its debt position, albeit it expects this to improve quickly. Therefore any bid for Balfour Beatty would involve a rights issue or be paid for in shares, meaning shareholder approval will need to be sought, and making a hostile bid very unlikely. The rally in Balfour’s share price since new chief executive Leo Quinn joined will make reaching a deal harder but, while analysts are divided over the likelihood of a Carillion bid, the logic for creating a FTSE 100-scale international contractor remains. Whitman Howard analyst Stephen Rawlinson says “it would be a good thing for both companies in my view.”
Market cap: £890m
Cash position: £123m net debt
Business briefing: From being renowned as the safest and most corporately conservative of contractors over almost two decades, Kier is, under two chief executives since the departure of longtime boss John Dodds in 2010, almost gaining a reputation for adverturism with the 2013 purchase of May Gurney for £221m and discussions to buy Mouchel.
Likelihood to make a bid: Medium. Kier has provided no update on talks with Mouchel since its December 1 statement that it was holding “preliminary discussions” with the privately-owned engineering and support services group. However, sources close to the situation suggest talks are ongoing. Mouchel, which was taken private in 2012 following significant accounting errors, is now seen as a reformed business and analysts back the logic of Kier’s move. Combining the firms would cement Kier’s market strength in services to public sector and local authority clients. However, Kier is also constrained by its debt position, and shareholders would have the power to veto any move if the price wasn’t right.
Market cap: £1.29bn
Cash position: £188m net cash
Business briefing: With the return of both home and overseas markets, the UK architect and engineer is making profit margins that its contractor peers can only cast envious glances at, while retaining significant cash to make acquisitions or other corporate investments.
Likelihood to make a bid: High. While Atkins has made clear it will consider acquisitions to bolster its position in what it considers to be high growth markets, it has never formally confirmed widespread reports it attempted to buy Parsons Brinckerhoff from Balfour last year, despite admitting in its accounts it spent £4.5m pursuing a “significant acquisition opportunity.” WYG is seen as an unlikely target, as it adds little extra capability beyond what Atkins already has. Peel Hunt analyst Chris Bamberry says: “I’d expect Atkins to continue to do bolt-on acquisitions over the next few years, but will they actively go and look for something major? I’d expect them to be opportunistic.”
Market cap: £1.56bn
Pre-tax profit margin: 0.32%
Business briefing: After a disastrous few years, new chief executive Leo Quinn has steadied the nerves of investors, appointed a new finance director, and attempted to buy himself a little time in which to sort out the £10bn-turnover largest UK contractor. The upward revaluation of the firm’s PPP portfolio, and his promise to find £175m of cost savings within the business make it harder for a prospective buyer to persuade shareholders it can squeeze additional value out with a purchase.
Likelihood to sell: Fifty-fifty. So far, Quinn’s actions have been consistent with maintaining the business in broadly its current form. However, he has made it clear to analysts that no options are as yet off the table, leaving room for continued speculation as to whether the business will be broken up or sold. Building Value’s Tony Williams says: “The number one question is whether Balfour will end this year as an independent company. I’d say the odds are three or four to one it won’t.” Aside from Carillion, possible buyers could include large overseas contractors from Europe or Asia.
Likely valuation: £250-300m
Pre-tax profit margin: 3.3%
Business briefing: Chief executive Grant Rumbles is widely credited by putting this one-time basket case back on the rails, following its 2012 £87m debt for equity swap that left it in the hands of its creditors. It has already completed bank re-financing in 2015, and now boasts a record order book of £3.bn, up 82% on the position last year.
Likelihood to sell: High. The owners of the engineering and support services group, which is dominant in the highways sector, are its former bankers and are unlikely to want to keep the business forever. As well as Kier, the business has been linked with a possible sale to private equity businesses or a re-flotation on the stock exchange.
Market cap: £78m
Pre-tax profit margin: 1.4%
Business briefing: WYG is another turnaround business with a potentially strong outlook after some torrid years. Chief executive Paul Hamer has led the firm through a series of operational and financial restructurings since making a £140m writedown after the recession hit in 2009. It made pre-tax profit of £1.7m in 2014 on turnover of £127m.
Likelihood to sell: Very high. The engineering firm this week put itself in a formal offer period while it conducts a strategic review to determine the business’s future. It made clear in this week’s statement that it envisages the review could result in either a strategic partnership, a merger or a sale of the company.