Executive Corner: A/E Industry Consolidation, Let the Good Times Roll
It seems like almost every day, another merger or acquisition is announced between two architecture, engineering (A/E) or environmental-consulting firms. And although the global mega combinations such as URS-AECOM and Parsons Brinckerhoff-WSP draw the most attention and scrutiny, each year there are more than 200 U.S. transactions involving organizations of every shape and size. We’re clearly in a consolidating industry that shows no sign of relenting.
What’s going on here? Why are so many transactions occurring? Having done A/E merger and acquisition (M&A) deals for more than a decade, I thought I would offer my thoughts on five key forces driving merger activity today and for the long-run:
1. Buyers want to accelerate growth. In this plodding economic and design climate, where we can’t rely on a consistent, broad-based recovery to lift the tide once again, many A/E leaders realize that growth is coming from taking market share away from others and/or penetrating new markets and clients. And more often than not, acquisitions are a faster way to accomplish that goal.
With organic growth elusive or uneven, many organizations are ramping up acquisition programs, search efforts and courtship discussions to maintain a viable pipeline of target firms to acquire and integrate. In addition, many A/E firms are laden with cash and are barely earning 1-2 percent on their deposits. Compared to other pursuits, smart transactions can offer a way to enhance returns and boost shareholder value.
2. Ownership transition challenges. 2015 marks the year those individuals born in the 1950s will be hitting 55 to 65, the prime years for ownership transition and monetization of equity stakes heading into retirement. For A/E owners and leaders who survived the last few years of recessionary headaches and drama, many feel now is the time to step aside and pass the baton either internally or externally.
However, a large percentage of A/E firms have ownership profiles that defy logic. Many are “top heavy” with principals in their 50s and 60s who own a large majority of the stock. There aren’t enough 30- to 45-year-olds ready, willing or able to buy these senior owners out in a coordinated process that won’t result in a decade-long (or more) sell down.
With profitability levels uneven, using the firm as a conduit to fund buyouts via cash bonuses for equity or other transfer mechanisms is increasingly difficult. More ominously, in a low-growth environment, the cash used to pay down redemption liabilities means there’s less available for firm reinvestment, incentive compensation and growth capital. Thus, rather than “sell down” to their employees, many owners are “selling out” to other larger competitors.
3. Higher valuations for external sales. It’s common to see A/E firms sell stock internally at book value or other deeply discounted levels as a means of affordability and simplicity. Larger buyers have the resources to offer much higher valuations and, in many cases, from 5-8 times operating earnings and 2-4 times book value. For baby-boomer principals whose ownership stake often is the largest asset in their retirement portfolio, better to cash out sooner than later!
That said, in a fragmented A/E and environmental-consulting market, today’s prices are more dependent than ever on a breadth of target-specific attributes. Those include market sector/client base, firm size, growth rates, synergistic qualities, geographic locations, revenue diversity, depth of management team, and, of course, profitability. More owners considering a sale today can point to three years of improved growth and profitability as well as a growing backlog, thus offering a better “story” and enhanced valuation prospects to potential suitors.
4. Leadership succession failures. During the last few years, the lack of bench strength for up-and-coming leaders has become a growing refrain from presidents and principals seeking a firm merger or sale. Traditionally, it’s the aforementioned ownership transition dilemma: the difficulty in effectively moving blocks of stock from one generation to the next that forces owners into the arms of a larger suitor. And this isn’t just a small-firm problem.
You’d be surprised at the scarcity of future leadership talent at some large, nationally renowned firms, many of which are reliant (to the point of paralysis) on the decisions of one or two senior people for making the organization function. Unfortunately, aging A/E leaders haven’t done nearly enough to prepare and groom their next generation. Many presidents and principals look around and readily admit they don’t have faith that the next tier of managers will have the capacity and acumen to guide them into the 21st century.
5. Increasing client demands. The trend in A/E client-delivery models has been toward more “one-stop shopping” and offering end-to-end solutions from multi-discipline planning and design through construction and monitoring. Buyers today are seeking to add diverse, broader service offerings through acquisitions, while sellers realize that they and their clients can benefit from the added marketing, managerial, financial and recruiting resources as well as the scale and scope that a larger parent firm often can provide.
The A/E landscape will continue to change and evolve as large-scale combinations and niche deals accelerate. Industry leaders should be encouraged that when properly planned and communicated, and when cultures and design philosophies are aligned, M&A can be a powerful method for strategic growth and ownership transition.
About Steve Gido
Steve Gido specializes in corporate financial advisory services, including mergers and acquisitions, business valuations, ownership transition plans, and strategic planning for engineering, architecture, environmental consulting and construction firms. He leads ROG+ Partners’ merger and acquisition practice, and has advised on a wide number of A/E/C transactions, representing buyers and sellers of all sizes and disciplines.