Construction Services M&A at Historic Levels, Sellers Capitalizing on Strong Valuations
M&A professionals are racing to complete as many transactions as possible before year-end to take advantage of the low-tax environment which will likely result in a record setting year for everyone.
Supply chain disruptions, labor shortages, and elevated input prices have served as substantial headwinds to the post-COVID recovery of the Construction Services industry. While leading contractors and professional services providers have managed to capture strong revenue gains, delays in construction projects have begun to manifest in depressed backlog levels. Notably, the Associated Builders and Contractors’ (ABC) construction backlog indicator fell to 7.7 months in August, a significant decline from 8.5 months in July.1 In addition, surging input prices, which have increased 20.8% year-over-year (Bureau of Labor Statistics)2, have stressed margins and negatively impacted the feasibility of undertaking certain projects, disproportionally affecting smaller market participants. However, current backlogs remain above levels experienced during the height of the pandemic, when backlogs fell to a low of 7.2 months in November 2020. Despite lingering labor challenges and rising construction service costs, the sector remains optimistic with contractors expecting growth in sales, profit margins, and staffing over the next six months, according to ABC.
Massive government-led liquidity injections and stimulus measures have supported the acceleration of the U.S. economy, strengthening the balance sheets of state and local governments. Notably, leading design, engineering, construction, and management provider AECOM (NYSE:ACM) recorded a 7% increase in revenue in fiscal Q3, noting that its public sector clients have benefited from strong budgets and investments in infrastructure, according to its most recent earnings call.3 In addition, the Senate-passed Bipartisan Infrastructure bill stands to provide a significant boost to the Construction Services industry, with $550 billion in new federal investment towards U.S. infrastructure. Of this $550 billion, $65 billion has been allocated to investment in broadband infrastructure, providing significant revenue opportunities to industry participants serving Telecommunications and Utilities Construction markets among others.
M&A Activity Reaches Record Levels as Buyers Scale and Add Headcount
Merger and acquisition (M&A) activity has surged through year-to-date (YTD) 2021, with 366 transactions announced or completed, marking a 70% year-over-year (YOY) increase. Strategic buyers (61%) have comprised the majority of M&A volume, with many acquisitions fueled by the need to rapidly expand capacity and headcount to complete large scale construction projects. In addition, prospective tax increases encouraged a wave of sellers to expedite their exit timeline to potentially lock in favorable tax rates and maximize take-home proceeds, a dynamic explored in Capstone’s recent white paper, Biden Taxes: Implications to Business Owners. However, business owners may be breathing a sigh of relief, with the recent House Democrats proposal calling for a top 25% federal tax rate on capital gains, far lower than the initial rate of 39.6%.
Public companies in the sector, leveraging improved balance sheets and healthy backlogs, have actively reengaged in M&A after slowing inorganic growth initiatives through much of 2020. Notably, the number of acquisitions by public buyers through mid-September has already met full year 2020 levels at 34 transactions.
Private equity firms have continued to increase their exposure to the Construction Services industry, accounting for 39% of total transactions - the highest financial buyer composition over the past six years. For many sponsors, 2020 represented a lost year in terms of capital deployment, and firms are eager to generate returns for their investor base now that economic conditions have improved. Private equity add-on transactions (30.1% of total transactions) have proliferated through YTD as sponsors have actively scaled platform investments. In addition, high quality construction services providers have attracted significant buyer competition in deal processes from the sponsor community, driving elevated pricing upon close. The intense level of financial buyer appetite in the market can be evidenced in the closing of New Mountain Capital's take private acquisition of Aegion Technologies (May 2021 close date) for an enterprise value of $1.2 billion, equivalent to 8.6x EBITDA. The final purchase price represented a premium from New Mountain's initial offer as an unsolicited bidder, rumored to be Apollo Global Management (Bloomberg)4, made a competing offer which drove the final transaction price higher.
M&A Purchase Multiples Elevated, Favor Professional Services Providers
Valuations in the Construction Services industry have reached historic highs, with the average transaction purchase multiple amounting to 11.2x EBITDA in 2021, a sharp increase from an average of 9.6x in 2020. A significantly improved debt environment has also provided a healthy backdrop for private equity, armed with record levels of dry powder and benefiting from historically low interest rates. Notably, middle market debt multiples have improved substantially, rising to 3.7x Total Debt/EBITDA in Q2 2021 compared to 3.3x in Q2 2020, according to GF Data®.5
Professional services providers, including industry participants offering consulting, testing, inspection, engineering, and design, have commanded healthy buyer interest often at premium multiples compared to contractor services. Transaction valuations for professional services target companies have historically averaged 15.2x EBITDA, significantly outpacing purchase multiples for contractor services which have averaged 7.8x EBITDA. Scale certainly impacts valuations as many of the larger M&A transactions have accounted for the higher EBITDA multiple ranges. Notably, the average historic enterprise value for transactions with disclosed multiples has amounted to over $485 million. Robust demand for outsourced construction services has driven a flurry of deal activity and strong pricing as state departments of transportation and cities & municipalities continue to outsource for project and quality assurance services, according to Atlas Technical Consultants.6 This market growth is expected to manifest in a $10.7 billion global Building Inspection Services industry in 2021, expanding at a compound annual growth rate of 15.1% from 2020, according to Research and Markets.7
Professional Services Buyers Pursue Accretive Consolidation Opportunities
Leading professional service buyers have targeted acquisitions to bolster margins, capitalize on cross selling opportunities, and enhance scale. White Wolf Capital-backed DCCM, a national provider of design, consulting, and program & construction management services, has emerged as an active buyer through YTD 2021, targeting civil engineering and infrastructure services companies of $10- $150 million in gross revenue. DCCM has announced several recent transactions outlined below. Terms of the transactions were undisclosed.
- Rochester & Associates (September) - Rochester & Associates is a leading civil engineering, land surveying, project management, and infrastructure services provider with robust client relationships in the Southeast U.S. The acquisition expands DCCM's geographic footprint and adds complementary capabilities to its services offerings.
- Binkley & Barfield (August) - Binkley & Barfield offers complex consulting services for county and municipal clients, region and state surface transportation, public infrastructure, gas pipeline, electrical distribution, and telecommunications. With the addition of Binkley & Barfield DCCM deepens its consulting solutions and continues its geographic expansion efforts.
- G. Miller Engineers (July) - Houston-based R.G. Miller is a civil engineering firm providing infrastructure services to public and private sector clients. The transaction marked the first add-on investment following White Wolf's formation of DCCM as a platform company in December 2020.
Atlas Technical Consultants (Nasdaq:ATCX), a specialized provider of testing, inspection, environmental, and engineering services to critical infrastructure, has followed a similar consolidation playbook, acquiring smaller companies at lower EBITDA multiples and realizing synergies to drive robust earnings growth. Atlas' recent acquisitions include the addition of O'Neill Services Group (July, $26.7 million) and Atlantic Engineering Laboratories (March, $7.8 million). Atlas has identified over 20 companies in advanced stages of its M&A pipeline, according to its investor presentation.
Public Companies Capture Healthy Growth Despite Supply Chain Headwinds
Leading public companies in both the Contractor Services and Professional Services markets have captured strong revenue growth through Q2 2021 despite combating supply chain disruptions and labor shortages. In the Contractor Services segment, leading insulation installer to the Residential market, Installed Building Products (NYSE:IBP) experienced a 23.9% increase in sales fueled by a higher volume of completed customer jobs and revenue from recent acquisitions, according to its most recent earnings call.8 Healthy backlogs and robust project pipelines have also contributed to elevated operating performance for leading professional services providers. WSP Global (TSX:WSP), a premier engineering and design firm, experienced a 19.3% YOY revenue increase in Q2, according to its earnings release.9
Similar to M&A pricing, professional services providers typically command higher EBITDA trading multiples in the public market compared to Contractor Services. Valuations in Capstone's Professional Services Index have averaged 19.0x last twelve-month (LTM) EBITDA, exceeding the average valuation of 12.0x in the Contractor Services Index. In addition, operating efficiency has historically favored professional service players who often provide differentiated and complex services catering to a variety of construction end markets. This can be evidenced by the strong gross margin profiles of public professional service providers, averaging 28.5% compared to 18.8% for contractor services. Industry participants with healthy backlogs and expansive client relationships are poised to continue to achieve strong revenue growth through year end and into 2022.
Associated Builders and Contractors, " ABC’s Construction Backlog Indicator Plummets in August; Contractor Confidence Down," https://www.abc.org/News-Media/News-Releases/entryid/18967/abc-s-construction-backlog-indicator-plummets-in-august-contractor-confidence-down, accessed September 16, 2021.
Bureau of Labor Statistics, "PPI Commodity Data," https://data.bls.gov/timeseries/WPUIP2300001, accessed September 16, 2021.
AECOM, " Q3 2021 AECOM Earnings Call," https://investors.aecom.com/static-files/883eee99-81d2-4d3f-b9e5-bfb32c5c35d7, accessed September 14, 2021.
Bloomberg, " Apollo Bids for Aegion After New Mountain Buyout Deal," https://www.bloomberg.com/news/articles/2021-03-12/apollo-is-said-to-bid-for-aegion-after-new-mountain-buyout-deal, accessed September 14, 2021.
GF Data®, "Leverage Report," https://gfdata.com/, accessed September 14, 2021.
Atlas Technical Consultants, "Investor Presentation," https://s1.q4cdn.com/951448701/files/doc_presentations/2021/09/ATCX-Investor-Presentation-September-2021-FINAL-UPDATED-09-09-21-v2.pdf, accessed September 16, 2021.
Research and Markets, "Global Building Inspection Services Market Report 2021: Market is Expected to Reach $14.33 Billion in 2025 at a CAGR of 7.6% - Forecast to 2030," https://www.globenewswire.com/en/news-release/2021/06/08/2243379/28124/en/Global-Building-Inspection-Services-Market-Report-2021-Market-is-Expected-to-Reach-14-33-Billion-in-2025-at-a-CAGR-of-7-6-Forecast-to-2030.html, accessed September 16, 2021.
Seeking Alpha, " Installed Building Products Inc. (IBP) CEO Jeff Edwards on Q2 2021 Results - Earnings Call Transcript," https://seekingalpha.com/article/4446551-installed-building-products-inc-ibp-ceo-jeff-edwards-on-q2-2021-results-earnings-call, accessed September 16, 2021.
WSP Global, " WSP Reports Robust Q2 2021 Results and Increases Financial Guidance," https://www.wsp.com/en-GL/investors/press-releases/details/WSP-Reports-Robust-Q2-2021-Results-and-Increases-Financial-Guidance/2278407/2021, accessed September 16, 2021.
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