After three headline-grabbing deals, there’s talk that more contractors will be swallowed up in a wave of consolidation. Others disagree – but then they’re probably on the menu …

Keith Clarke decided to take his family on a relaxing holiday to Greece in the middle of August. It was also the middle of the “silly season”, when the papers make up for the lack of news by running stories about how many people a year are injured by cotton wool. Unfortunately for the Kvaerner UK chief executive, it also happened to be the week that his Norwegian parent company decided to sell its UK subsidiary to Skanska.

Clarke, who is soon to become the boss of Skanska UK, spent the first week of his break in daily contact with his UK office. He then curtailed the second by flying back on bank holiday Monday and announcing the sale first thing Tuesday. Some silly season.

Apart from preventing Clarke from fully developing his tan, the Skanska takeover was the third large deal to be announced in a week. What would otherwise have been an important event for a single company was beginning to look as though it might be significant for the whole of UK contacting.

The merger of Try and Galliford on 22 August started the ball rolling. This was followed two days later by a real surprise – Morrison’s acquisition by Anglian Water. All three deals were different, but together they led commentators to suspect that the much talked about – but much delayed – consolidation within the construction industry was under way.

I wouldn’t be surprised if Galliford Try hoovers up quite a lot of well-known firms

Sector Analyst

What it certainly has done is increase both the profile and interest in the sector. In the weeks leading up to Skanska’s coup, sector analysts invented a virtual parlour game in which players competed to see just how many UK names could be linked with the giant Scandinavian company; Amec, Balfour Beatty, Carillion, Kvaerner and even Morrison were bandied about.

Now the deal has been done, Clarke is in ebullient form, despite his shortened holiday. He is not just happy about his firm’s prospects now that it is part of one of the world’s largest contractors, but about the standing of UK construction in general. “One of the major reasons they are buying us is our experience in private finance initiative and design-and-build work. That’s a skill that is worth buying,” he says. “It would be nice to talk about how good we are in this country. It’s a skill that the UK is pushing faster than anywhere else in the world.

Clarke’s optimism does have a sting, though. The healthy future he foresees will be confined to the companies that make it to the UK super league. “Three years from now, the performance in the super league of construction will be viewed much more as good on cash and reliable in profits,” he declares.

The optimism is underpinned by the macroeconomic situation. Recent Deutsche Bank figures published in Building go some way bearing this out. The statistics show that, by 2002, the difference between the annual increase in construction output and the annual change in gross domestic product, known as the “building gap”, will be in favour of construction for the first time since 1989. One reason for this is that the extra public spending announced in the Comprehensive Spending Review (particularly the £70bn that has been promised to transport) has made everyone feel better about the future.

Non-industry players buying construction companies will be the exception, not the rule

Kevin Cammack, Merrill Lynch

When analysed in more detail, the deals show the different directions the market is taking. Galliford Try is an indication that medium-sized contractors are waking up to the fact that they need to grow to win City interest.

Kvaerner’s acquisition is not only an example of the increasing interest foreign companies are taking in the UK, but of the underlying divisions in UK construction. Over the past five years or so, two schools of thought have developed: broadly speaking, to contract or not to contract. Kvaerner has defiantly proclaimed its faith in old-fashioned muddy boots construction and is now bullish about its prospects of capitalising on the efficiencies that can be made by implementing the Egan report.

The opposite school of thought is exemplified by Morrison, which ditched “construction” from its name just in time to exit the sector in the arms of utility giant Anglian. The industry reacted to this move with incredulity – comments ranged from “bizarre” to “a joke”.

  Morrison’s chairman, Sir Fraser Morrison, describes the move as a natural progression. He argues that it gives the firm a chance to attack a huge number of new markets, from utilities and transport to property and facilities management. And like Clarke, Sir Fraser maintains that the move is good for construction. “I think it’s positive for the sector,” he says. “Companies need to move away from construction. We have done it and have done it successfully. I think we have been at the leading edge of the sector. More change in the sector is necessary and likely.”

I think it’s positive for the sector. Companies need to move away from construction

Sir Fraser Morrison

Is the Morrison deal a sign that the anti-contracting, pro-diversifying school is prevailing? Not according to Merrill Lynch analyst Kevin Cammack. “I do not see it as a blueprint for how consolidation is going to take shape for the future. Non-industry players buying construction companies will be the exception rather than the rule,” he says. Cammack reckons the Galliford Try merger is more of a model of how the UK market will move.

Another model is provided by Skanska: still focused around construction, but with a global reach. However, the only UK player seen as competing on this scale – Amec – has left nobody in any doubt that it intends to take the Morrison route. Chief executive Peter Mason distanced the firm from Skanska’s swoop at the firm’s interim results last week.

“We would not be interested in a deal like that as there is too much focus on the traditional construction market,” he said.

Whatever route construction firms pick, analysts say the market is on the verge on a major round of consolidation. Leslie Kent, construction analyst at stockbroker Seymour Pierce, believes that it has been on the way for about a year, and that the final push was the UK’s upcoming public spending bonanza. Some analysts foresee a massacre: Merrill’s Cammack thinks that there will be only one to two major players in the market when the feeding frenzy is over. And many are expecting further European purchasers to do some shopping in the UK: the current hot favourite among industry watchers is German contractor Hochtief.

It’s difficult to see where there is any great benefit in merging

John Armitt, Costain

But speak to the contractor at the coalface and there is less unanimity. Clarke is himself sceptical about further consolidation and points to the fact that three deals are hardly a trend. And he has a point. Both Morrison and Kvaerner see their respective acquisitions as platforms for future growth, and Galliford Try says it will not significantly cut staff, planning no more than 12 redundancies. This leaves a market largely unchanged in terms of capacity.

This view is echoed by John Armitt, Costain’s chief executive. His firm, which may lose its joint-venture relationship with Skanska, could be one of the ones on the menu, but Armitt is not convinced that any big shake-up is in the offing. “With the main contractors working for the same clients, it’s difficult to see where there is any great benefit in merging,” he says. “One and one does not really make a significant improvement, so why do it.”

Armitt adds that, with more public sector work coming onstream in the next decade, UK construction is increasingly concerned with its domestic market, and so is less likely to follow the globalising drive of its foreign competitors. “International work is occasionally profitable but it exposes you to a significant risk,” he says. And if he is wrong and there is a round of consolidation, Armitt does not believe that it will be at breakneck speed. “I can’t see it happening that quickly,” he says.

Armitt’s analysis is backed up by the industry’s recent experience, which is that mergers are hugely difficult to negotiate successfully. Those that have failed include Alfred McAlpine and Bryant, Tarmac and Aggregate Industries, and WS Atkins and Mace. There was also speculation surrounding a Taylor Woodrow-Berkeley Group tie-up that came to nothing. And those with longer memories will recall Kvaerner’s failed attempt to buy Amec back in 1996.

Perhaps the consolidation wave will hit the smaller end of the market faster. Analysts are predicting plenty of activity following the Galliford Try merger. One sees the new entity becoming aggressively acquisitive once it has bedded down. “I wouldn’t be surprised if it hoovers up a lot of well known private construction companies,” one analyst predicts.

Yet another factor pushing companies together is the economic peculiarity of their current situation: workload is pretty healthy but margins are wafer thin. “There is concern in the UK that while the market may be approaching the peak of its cycle, there are no decent margins,” JP Morgan analyst Mike Betts says. Long-term margins seem to be on the downward spiral; consolidation, which has the inevitable effect of taking out one member of the opposition, could be the only way around this.

That said, there still remains the body of large firm such as Balfour Beatty, Carillion, Mowlem and Laing that seem reluctant to embrace consolidation. But for how much longer? If you fancy a quick round of the analysts’ parlour game, how about Mowlem buying Carillion? The former still has some of the money it got for its stake in scaffolding firm SGB, and is thought to be keen to re-establish itself as a large contracting group. Carillion, on the other hand, was recently forced to make 900 redundancies following troubles at M&E subsidiary Crown House Engineering. Speculation that chairman Sir Neville Simms will be retiring sooner rather than later is fuelling predictions that the firm could well attract suitors before long.

The next course?

Carillion The City was abuzz with talk that Carillion was a major target for Skanska just after its first anniversary last month. That may die down following the Kvaerner deal, but not for long. Despite job losses at subsidiary Crown House Engineering, the firm has a strong core operation that analysts believe will continue to attract suitors. Mowlem The firm is keen to dispel the impression that it has been slow to change. Having sold its stake in scaffolding firm SGB for £95.6m in May, it almost immediately bought M&E firm Bower for £7.5m. Analysts are tipping it to expand its contracting business as well. Hochtief The German contractor could well be eyeing up targets in the UK again. In recent years, speculation has linked the fast-expanding group with Carillion, Balfour Beatty and Birse. Now could be the time for it to follow Skanska’s lead. WS Atkins The multidisciplinary giant has a modest ambition – to be “the world’s first choice supplier of technical services and integrated solutions for the built environment”. Rumoured to have been after Morrison, its talks with Mace collapsed in January. More activity is surely imminent.

Is Skanska still hungry?

Skanska’s acquisition of Kvaerner Construction may have been overshadowed by Swedish firm OM Group’s crack at buying the London stock exchange, but its move into Britain is very significant for construction. First, because the company dwarfs its UK rivals: Skanska has a turnover of £5.76bn, almost twice as much as Amec, the UK’s largest contractor. Second, because it seems to have an insatiable appetite, having gobbled up the largest contractors in four countries in the past year, leading to speculation that Kvaerner may not be its last UK buy. As well as the five major contractor purchases – Kvaerner in the UK, Selmer in Noway, Exbud in Poland, IPS in the Czech Republic and EMV in Estonia – it has bought construction manager Barclay White in the USA and two Finnish IT companies. It also still owns a 7.6% stake in UK contractor Costain. The overall strategy is largely the work of chief executive Claes Björk. Within weeks of taking his post in 1997, he cut the firm’s workforce by 1500, closed 160 local offices and replaced the company’s seven divisions with four. And in the past year, he has considerably stepped up the pace of the firm’s global expansion. The Swedish giant also has a track-record for being successful in those countries it enters. It has, for example, become the fourth-biggest contractor in the USA. It now operates in 50 countries. One secret of Skanska’s success is its policy of allowing its acquisitions to run autonomously with independent balance sheets. Hence the retention of Kvaerner’s management was a key part of the deal.

Kvaerner Construction dumped for oil …

December 1995 Kvaerner launches a £375m hostile bid for Amec. It fails March 1996 Buys Trafalgar House for £904m. Trafalgar man Keith Clarke becomes chief executive of Kvaerner Construction April 1999 Kvaerner exits from shipbuilding to focus on its three main divisions – construction, process engineering and oil and gas July 2000 Oil and gas rival Aker Maritime buys 26% stake in company August 2000Kvaerner counter attacks, launching a £334m takeover bid for its rival. Weeks later,it sells construction arm to Skanska for £358m

… Morrison swallowed up by water

1948Firm set up by Alex Morrison in Tain, in the Scottish Highlands. First year’s turnover is £2500. Alex’s son Fraser is born. 1974Alex sells 80% of his stake to conglomerate Charter Consolidated, a move backed by Fraser, by now managing director. 1976Group moves into civil engineering with the acquisition of Highland-based Alexander Sutherland. 1989Fraser and brother Gordon, also a director, buy back the firm Also buy English contractor Shand and Biggs Wall 1995Morrison floats, with the brothers retaining a 44% stake 1998Alex dies, just after the firm’s 50th anniversary. Fraser, now executive chairman, is knighted 2000Morrison drops construction from its name and sells to Anglian Water