Executive Corner: Five Takeaways on 2015 A/E M&A Activity
Fueled by cheap debt, a restless and activist investor climate, and a desire to accelerate growth through economies of scale and efficiencies, global mergers and acquisitions (M&A) across all industries hit an all-time high in 2015. In fact, this year will break the dollar volume M&A record achieved back in 2007. Every few days saw one massive transformational combination announced after another: Dow Chemical/DuPont, Pfizer/Allergan, Dell/EMC, AB InBev/SABMiller, Kraft/Heinz, Walgreens/Rite Aid, Anthem/Cigna and Intel/Alera to name a few.
The A/E industry is concluding a solid year in terms of the number of deals as well as intriguing partnerships that came together. And although 2015 lacked true mega combinations, that can be chalked up to global participants still digesting and integrating sizable targets during the last 24 months as well as a number of prominent A/E organizations undertaking high-profile restructurings and leadership successions. Still, deals such as WSP’s $425 million purchase of MMM Group, Intertek’s $330 million acquisition of PSI, and Tetra Tech’s $96 million purchase of Coffey International indicate that cross-border M&A is indeed active, and strategic buyers are on the hunt for blue-chip consultancies in the United States and beyond.
By our analysis, the total number of North American A/E deals will be up a few percentage points over 2014 levels. Despite the persistent unevenness of the industry recovery and entering 2016 with a few large unknowns (e.g., interest rates, elections, energy prices, tight A/E labor market, etc.), CEOs continue to feel relatively confident on the near-term outlook. As a result, many are looking to make calculated deals to enhance market-sector or service capabilities or expand their reach into new geographies.
Notable A/E M&A takeaways include the following:
1. 2015 was the year of the small deal. The median size for an A/E seller in 2015 was 18 employees, which equates to a firm generating net revenue between $2-$3 million—the smallest level during the last six years. The vast number of transactions in 2015 were undertaken by mid-size firms (50-500 employees) and, in some cases, new or infrequent buyers, who absorbed “tuck-in” and easily digestible targets. It also indicates that multi-discipline or multi-studio buyers were seeking highly specialized or localized targets, which by their nature tend to be niche/smaller.
2. Increase in certified and set-aside firms adding to deal complications. One of the ramifications of the recession was an increase in the number of A/E firms that started (or changed their ownership profiles) to explicitly participate in a range of federal- and state-certified programs (e.g., WBE, MBE, DBE, SDB, HUB, Veteran-Owned, 8(a), etc.). In addition, 2012 saw the federal government dramatically amend its definition of “small business” for A/E firms by ramping up the amount of revenue a firm can generate and still be considered a small business. Although this change offered firms new opportunities to pursue federal small-business set-aside contracts as well as team on large federal contracts that have small-business requirements, it also complicates M&A pursuits for buyers and sellers.
Buyers seeking smaller non-certified targets focusing on federal and state infrastructure, building, environmental or transportation projects, particularly those in heavily regulated states, are increasingly finding limited options available. Buyers are naturally skeptical of certified firms’ (even targets with only small amounts of revenue generated by these programs) ability to assign contracts over and then win future work without the benefit of set-aside programs and vehicles. And firms who rushed into these certifications and classifications for near-term economic benefits, but who may want to sell down the road, will likely face longer-term exit-strategy challenges, potential valuation haircuts, and limits on staff size and revenue growth.
3. It was an active year for private-equity investors. Private-equity teams have had a limited, but steadily growing appetite for investing in large and mid-size A/E and environmental-consulting firms. However, 2015 was perhaps the most active year for these financial buyers in recent memory, highlighted by Apollo Global Management’s $300 million preferred equity stake in CH2M as well as Crescent Capital’s 41 percent unsolicited takeover position in Cardno. Numerous other financial sponsors came into the mix to recapitalize or make new investments in prominent A/E and environmental firms, including Jensen Hughes, EN Engineering, Trinity Consultants, ERM, ENTACT, Vidaris, MorrisSwitzer and Cardno ATC. We expect all of these A/E platforms to actively seek “add-on” deals in 2016 and beyond.
4. The need for skillful integration remains critical. Although agreeing to terms and negotiating the closing documents is certainly a crucial part of the M&A process, the integration of people and capabilities to truly become one organization is the “secret sauce” in professional-service transactions. With more than 1,000 A/E deals completed during the last five years, obviously not all work out as planned.
Each year, we hear the rumors and see the fallout of deals that failed to live up to expectations despite a favorable design and operating environment. These setbacks can emanate from poor operational execution, key staff departing, unfulfilled synergies, leaders uncomfortable in new roles, bad timing/luck and even questionable buyer intent from the beginning. As such, with millions at stake, we’re seeing renewed emphasis on thoughtful and deliberate multi-year integration and communication activities for risk minimization and enhancing overall shareholder value.
5. Sellers need to be mindful of their options. Today’s sellers need to be increasingly aware of their organization’s marketability, valuation potential and synergistic prospects. We’ve seen a number of otherwise exemplary A/E firms engage with a buyer or test the broader market only to find tepid interest, underwhelming offers or disparate cultures and business practices in joining forces. For owners who have “hung their hats” on an external sale route, we’re encouraging them to take a more-reflective look at other internal transition options or deferred compensation arrangements for unlocking value and overall firm sustainability.
On a final note, Happy New Year from all of us here at ROG + Partners!