This was how one surprised equity analyst greeted last week’s news that construction minister Nick Raynsford is to lead a Movement for Innovation team on a tour of the Square Mile’s financial institutions. Raynsford, movement chief executive Alan Crane and DETR construction mandarin John Hobson are setting up a series of high-level briefings for some of the world’s most powerful fund managers, beginning in May.
They will try to convince them — using new key performance indicator data — that construction is changing its ways. They will argue that, post-Egan, companies can produce good, predictable profits and no longer jump up and bite you with shock losses on giant contracts – as Laing did with last year’s £26m writedown on Cardiff’s Millennium Stadium.
But Raynsford’s team will have a job on its hands. Construction and building materials companies have had 23% wiped off their market value in the past six months, and a large proportion of the sector’s companies are now worth less on the stock market than they are on their balance sheets. Bosses in boardrooms around the country are mopping their brows over the plummet and making crunch decisions about what, if anything, they can do to get their share prices back up.
Why is a low share price such a big deal? How did prices get so low? And what can companies, or for that matter Raynsford, do to get construction off the stock market’s bottom rung?
Directors get paranoid when their company’s share price falls because it makes the business a target for opportunistic, unsolicited bids. Blue Circle recently learned this to its cost and is battling to fend off a £3.4bn hostile bid from French materials rival Lafarge. Contractors are less concerned about hostile bids because the vast amount of due diligence required to buy them means that acquisitions are usually on a friendly basis. Their problem is that they cannot sell shares to raise the funds they need for investment and acquisitions.
Contractors and housebuilders also worry about the damage that a low share price does to their image with clients, investors, disgruntled shareholders and the media – not to mention to morale of their own staff.
Amec has had 25% wiped off its share price since buying Canadian project manager Agra in February. Amec’s corporate communications director Tony Williams says: “If you are a driving an Amec truck through the Yorkshire Dales and you hear that the company’s shares have fallen, you’re going to think, ‘God, the guvnor’s made a big mistake.”’ Employees and directors who put some of their salary into share options are likely to be fearful, too.
So, with so much at stake, how could company chiefs have allowed the situation to come about? It is not all their fault, but there is no denying the long-standing mistrust that exists between contractors and the City. The industry’s history is of businesses taking big lump-sum contracts and making good margins one year, then taking a hit the next. From an investor’s point of view, contractors are also vulnerable to economic swings, and they have tended to try to hide bad results through imaginative accounting.
This is the issue that some contractors are trying to overcome, and that Raynsford & Co will try to address in their presentations. But a number of other factors exist that are out of the government’s and construction’s control.
The past 18 months have seen an explosion of corporate activity between institutional investment firms. The merged institutions have decided that there is little point in spending time and money researching smaller companies because the scale of opportunities is limited compared with the mega firms. The UK’s fragmented construction industry, with its plethora of small quoted firms, has inevitably suffered. The situation is so bad that one institution, Legal & General, no longer has a full-time construction analyst in its fund management arm. And it is not alone.
Every other day a fund manager says, ‘Put everything into e-commerce’
Companies with a market capitalisation below £400m — which tend to be outside the FTSE 350 — are considered small. Most construction companies have a capitalisation below £300m, and so are bound to get less attention. And analysts are predicting that when the new FTSE 250 is announced this month, several high-profile construction firms will no longer be on it, including the likes of Hanson, Balfour Beatty, Persimmon, Redrow and Beazer. They will be hit by a double whammy because “tracker funds” that automatically invest in FTSE 250 companies will stop following them.
There are, of course, some fund managers who reject the “big is beautiful” mantra, but they have no choice but to follow market sentiment because shares in unsexy sectors such as construction inevitably remain depressed in the current environment.
The nightmare has been made even worse for construction because of the wave of mega mergers in other industries. Larger companies have more liquidity in their shares and a large number of buyers and sellers each day. This makes it easier for investors to get large funds in and out quickly. Contractors, by contrast, tend to have very low volumes of shares traded each day.
And if construction was considered unsexy before, it is probably now regarded as near frigid as a result of the high-tech mania of the past six months. Fund managers craving anything with a dot-com suffix have been acting in unison to bleed dry the stocks of what are now disparagingly known as “old economy” companies in sectors such as retailing, banking, manufacturing, engineering and construction. One analyst confides: “It seems like every other day a fund manager tells my broker, ‘Sell everything I have in old economy stocks and put them into Vodafone or e-commerce shares’.”
To add to this, interest rate fears, proposals to raise VAT on new housing and the possible increase of stamp duty have all combined to depress housebuilders’ shares.
With the situation as bad as it is, what can companies do to hoist their share prices back up? One option, tried by Henry Boot and Alfred McAlpine in the past six months, is a share buy-back. The main advantage is that with fewer shares in issue, the earnings per share are greater, and in theory the share price should rise as a result.
“The market may boost your price further because you are seen to be using your cash well,” says Alastair Stewart, analyst at Flemings Securities. “Unless it has an acquisition target that is screamingly cheap, a contractor with a decent cash pile earning very little interest in the current environment should seriously consider buying back some of its shares.”
However, one contractor says that his company has increased its earnings per share — that is, its profit after tax per share — by nearly 80% over the past five years, but that this has had no impact on the share price; in fact, it has fallen 45%. “It is hard to see why a further increase in EPS — especially one achieved by financial engineering — would be effective,” he says.
Another downside to the strategy is that the net assets of the company will fall because of the cash eaten up in the buy-back. The company becomes smaller, making it even less attractive to institutional investors.
A more radical option, which a number of construction companies are considering, is a management buyout. Cala, Wainhomes and Banner Homes followed this route last year, and analysts predict another high-profile MBO within the next two months. Private equity groups have been sniffing around sectors like construction in recent months because they think there are rich pickings to be had.
A contractor with a cash pile earning little interest should think of buying back shares
Alastair Stewart, Flemings Securities
Buyouts offer managers looking to raise finance an alternative to the capital markets. Delisted firms also save huge amounts of money on the administrative expenses of being publicly quoted. And they do not have to deal with the “teenage scribblers”, as one chief executive calls equity analysts.
The problem it tends to create for companies, however, is that the venture capitalists who help fund the MBO inevitably want an exit route after three or four years. This is likely to mean a refloat – which lands the company with the same problems it had before – or a trade sale to another company. The latter is undesirable because most bosses are very protective of their businesses.
A different strategy being pursued by a growing number of companies that used to put up buildings for a living is a sector shift to support services. Jarvis and Amey have already done this, and Peterhouse and Tilbury Douglas are set to follow suit. Support services companies tend to get better stock market ratings. But reclassification is hardly a realistic option for many contractors because most of their turnover still comes from physical construction. Elsewhere, the likes of Laing, Balfour Beatty and Kvaerner are increasing their dot-com factor with a proposed e-commerce venture.
But the best way for contractors to go, it seems, is to follow rivals in other industries and get big. Many companies, including Laing, Carillion and Morgan Sindall, have all said they want to take part in consolidation. The City is crying out for it, too, because European analysts have seen the success of mergers of big firms on the Continent.
Consolidation has been talked about for years, but bosses say there is more pressure from the City than ever for this to happen. With major acquisitions difficult in the current climate, merging is an option the likes of Alfred McAlpine, Morgan Sindall and others are actively pursuing. Taylor Woodrow and Berkeley are also understood to have had talks.
One chief executive says: “There are lots of talks going on, especially in housebuilding, but not much action, and I can’t work out why.” But he points out that the urge to merge could well become irresistible if one big link-up is pulled off.
But if none of the above options are for your firm, what can you do to get your share price to perform? “Not a lot,” says one chief executive, who did not want to be named. “The best thing to do is attend to the fundamentals of the business. Investors are behaving extremely irrationally at the moment.”
So, it is back to basics, then. Raynsford is not about to rescue the industry from its share-price hell. Snide remarks have been made by some that he has dreamed up the initiative because he is looking for non-executive directorships in his retirement. Other more sober observers see the City tour as an attempt to soften the blow of the proposed rises in stamp duty and the introduction of VAT on new housing that are expected in next month’s budget. But whatever the motives, the Movement for Innovation initiative has been warmly received in most quarters of the industry.
Similarly, most people are reasonably confident that loss-making Internet start-ups will not be in vogue forever. And there is some good news: UK interest rates are on hold and may be close to peaking; the results season is under way and companies appear to be showing good sustainable results; column inches devoted to a return to so-called “value investments” are increasing, and in 10 of the past 11 years, the sector has risen relative to the market in the first quarter.
Amec’s Williams has definite ideas about what Raynsford should tell the City: “The last thing we are going to do is moan about our share price,” he says. “The thing to do is to educate the market and our employees and rebuild. In six months, with any luck, we’ll be back on top again. The market is pretty much always right, and when it’s not, it corrects itself.”
And the good news is …
- Interest rates appear to be on hold and may be reaching their peak.
- The results season is under way and companies are reporting good sustainable results.
- Column inches devoted to so-called “value investments” are on the rise.
- In 10 of the past 11 years, construction has risen relative to the market in the first quarter of the year.
- Many of the Internet companies will be losers in the long run. The news that search engine AltaVista is undercutting rival Freeserve is putting more pressure on the Internet shares boom.
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