Executive Corner: Has Rampant Consolidation Been Good for the A/E Industry?
If you’ve noticed a lot of M&A deals announced recently, you’re not alone. Almost every, day we read another press release that touts a new and promising combination between two A/E organizations. Mega deals and ENR 500 recapitalizations as well as small company tuck-ins and local marriages. The articles often incorporate confident leaders exuding the strategic and synergistic merits of the deal as well as the anticipation of collaborative opportunities in joining forces. But with an increasing, almost frenetic, volume of transactions, it’s worth pausing to reflect on the ramifications of all this buying and selling. Can there be too much of a good thing?
During the last five years, the number of U.S. A/E and environmental deals has been running at a torrent pace. It has been, on average, 60-percent higher than the previous five years. What’s driving all this? A range of factors that include: confident CEOs seeking to transform their companies, strong balance sheets, the emergence of private-equity firms as A/E investors, an aggressive mindset of a few dozen serial acquirers, favorable valuations, huge numbers of Baby Boomer owners seeking exit strategies, and geographic diversification into the southern United States. In addition, low barriers to entry in starting professional-service firms generally imply a broad competitive landscape and a continued pipeline of acquisition opportunities as they mature.
Health Check
So what do I mean when asking if the heightened activity has been “good” or not? Well, has M&A as a tool and tactic been wisely utilized by A/E leaders? Have the objectives and capital allocations associated with those been sensible? Are various stakeholders, such as staff, clients, sub-consultants, associations and communities, largely better or worse off? And when we look back at this period, will it be one when these transactions laid the groundwork for enhancing future value or diluting it? Basically, are we a healthier industry for it?
Based on decades of A/E deal-making and soliciting opinions from industry buyers, sellers and those who choose to do neither, let me offer the following comparative arguments.
Overall, rampant consolidation has been good for the industry.
• It has allowed A/E firms to amplify their growth. Scaling design and consulting firms can be challenging. Despite promising initiatives and actions, many organizations simply suffer from negligible to lumpy top-line growth through time. Organic pursuits such as opening new branch offices, hiring outside senior leadership and project managers, and maintaining internal infrastructure and overhead have their opportunity costs. However, when thoughtfully planned with fair commercial terms (not overpaying!), the accretive effects of accelerated M&A can be compelling. And as firms grow, the size premium that comes with a larger revenue and EBITDA base should ultimately enhance shareholder value.
• It has allowed owners to unlock the value in their firms. How to successfully perpetuate their company is a question leaders should continually ask. For many firms, the internal sale option to the next generation isn’t viable. Others may be too small to implement an ESOP. Organizations have great people, but perhaps just not the right one to anoint as a successor. The M&A route, given the current active marketplace, solves this dilemma. It has granted shareholders the ability to transition their business, in most cases at a higher valuation and quicker liquidity than they otherwise could achieve. As such, rather than being an industry comprised of organizations that languish under the overhang of an unknown future with aging owners, selling and being part of a new entity can offer renewed clarity and direction.
• Theoretically, M&A creates broader opportunities for clients and staff. Conversations with successful buyers and sellers years after the close often highlight the sustained advantages that initially brought them together. The buyer now has a location in a key part of the country they wanted to penetrate. Sellers’ rollover equity offers upside incentives. Clients have access to new service lines they used to obtain from competitors. A larger parent was able to bring additional managerial, marketing, financial and recruiting resources to the seller. The seller’s staff has exposure to different career ladders, better benefits or ownership paths they didn’t previously have. That’s not to say these all come seamlessly or immediately, but good buyers with a strong formula understand the discipline and effort to make deals work to their full potential.
Overall, rampant consolidation has not been good for the industry.
• Doing deals for deals’ sake is bad governance and unwise. Without a programmed approach to execution and integration, scooping up targets with an attitude of “on to the next one” can be a recipe for disaster. Onboarding too many firms simultaneously without an overarching vision of bringing them together under one cohesive brand, culture and mission are where critical mistakes are made. We’ve seen it play out in the A/E industry. History shows that periods of overheated M&A activity can result in distracted leadership, sloppy due diligence, legal disputes, talent exodus, misallocation of resources and decreased financial performance.
• Many deals are poorly integrated. Blending two disparate design or consulting organizations of different cultures, sizes, clients, services and people is always fragile. M&A is fundamentally a “change event,” and most people dislike sudden change. Problems can mount without careful planning for every detail. Sellers can bristle in their new roles or in losing control after years of calling the shots. Active communication and direction were evident with the parties early, only to lose momentum. The hard work of uniting IT systems, human resources, marketing, accounting and other business functions is vastly underappreciated. Clients are taken for granted that their positive reaction and buy-in is all but guaranteed. Earnouts, carefully designed to enhance future proceeds, end up being a detriment to working together.
• There’s no margin for error if a recession arrives. Although the A/E industry is broadly in solid financial shape with healthy backlogs and a bright outlook, economists have been debating whether or not the country will slip into a recession later this year. In fact, some of the warning signs we saw play out in 2007-2008 (overheated housing market, rising interest rates, too much leverage) can also be found today. Most financial models and multiples used to justify deals have been made using favorable trends and forecasts. That could change if business conditions suddenly deteriorate. Buyers that binged on deals could be under pressure to reorganize, reassess the value of goodwill paid and could eventually be takeover candidates themselves. As we saw during the last painful downturn, our industry doesn’t benefit with venerable design firms suddenly in distress.
M&A can be used effectively for purposeful growth and ownership transition. But as more combinations transpire, our industry needs to balance the promises and pitfalls that come along with it. I would like to hear your thoughts or observations on this.
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.
