M&A Market for Architecture, Engineering and Contractors: A Q&A with Industry Experts

Experts in the architecture, engineering, and contractor (A/E/C) advisory community were asked by LP to weigh in on the current state of the M&A market for A/E/C firms. Their insights are valuable to any owner of an A/E/C firm looking to sell their firm or consolidate their firm’s operations with a strategic partner during and after the COVID-19 pandemic. Below are the questions posed to these experts and a summary of their answers, edited for clarity.

 

Question #1:

What are the biggest challenges to completing the purchase and sale of an A/E/C firm in the current environment?

 

Christopher M. Staloch, Managing Director, Chartwell Financial Advisors: 

One of the most significant challenges in today’s environment is overcoming uncertainty.  The considerations determine how long the coronavirus will continue to disrupt society and the economy, whether there will be future shutdowns after reopening and what will be the impact to local, state, and federal budgets and how this will affect the future spending.

 

Greg Hogan, Managing Director, SC&H Group:

The global pandemic has made M&A challenging in nearly all industries, including the A/E/C industry.  A/E/C firms are primarily valued based on a multiple of EBITDA, subject to their contract backlog and projected levels of future earnings.

During the COVID situation, the level of uncertainty about the future earnings of many A/E/C firms has risen substantially as projects (primarily private and municipal) have been delayed or canceled due to budgetary constraints and clients’ administrative challenges. Uncertainty around the short to medium-term outlook for the economy has also created uncertainty around future funding for projects. Both private and public budgets are likely to experience downward pressure in the short term.

 

Steve Gido, ROG Partners:

The biggest bottleneck is simply the human element of connecting face to face during the entire purchase/sale process. You need to be able to meet people in person during courtship and diligence activities, and until workforces are remobilized back to the offices, that will be a setback.

Many of the A/E/C transactions that have been recently announced are ones where talks started back 6-12 months ago in pre-virus settings. The other challenge is the valuation context. Many A/E/C firms were coming off record years in 2019 and having a strong start in the first quarter before the pandemic struck. Trying to now assess what projects are advancing, which ones are on hold, and what are either commercial/institutional capital expenditure or state/local infrastructure needs from clients is still somewhat fluid, and that impacts the current and future financial performance.

 

Question #2:

If you were talking to a potential A/E/C firm, what would you say are the reasons why now is actually a good time to transact?

 

Christopher M. Staloch, Managing Director, Chartwell Financial Advisors:

With the speculation around stimulus spending – especially in the form of infrastructure projects – there may be significant opportunities for A/E/C companies to pursue.  Growth-oriented companies will continue to look to expand their geographic footprint, areas of expertise, markets, services, etc., through acquisition.

Those companies will be actively pursuing quality companies, and if your company performed well over the past several months, now could be a good time to test the market.

 

Greg Hogan, Managing Director, SC&H Group:

For buyers, now may be a good time to transact if the target company has a contract backlog and pipeline of diverse projects (various clients, services, and geographies).  The economy may be in flux for a period of time, but diverse companies will likely be able to withstand the economic downturn.  With few M&A deals moving forward, buyers face less competition and may be able to make acquisitions at a lower purchase price given current uncertainties.  For a potential seller, it all depends on whether the current market aligns with your goals for a transaction.  Although valuations across the industry may be under some short-term pressure, firms that have not experienced any negative impact, or can substantiate continued future earnings and growth via strong contract backlogs, may still be able to transact at valuations attractive to sellers.

 

Steve Gido, ROG Partners:

2018 and 2019 were the two biggest years of M&A activity for our industry this decade, so it’s natural and healthy to have a bit of a pause in overall activity for sensible integration to occur. For A/E/C buyers, their long-term growth plans haven’t been significantly impacted by this setback. Many were struggling to hire talent just three months ago and still have the cash and capital to deploy to make synergistic deals.

For sellers confronting ownership transition and leadership succession issues, and were planning to address those in 2020, it’s more of a delayed scenario. Timing plays a huge role in every transaction, so owners have to be mentally ready to initiate a sale process and feel comfortable about their financial performance and outlook. The challenge is getting their staff and operations back to normal first and foremost before committing to M&A, which is ultimately a big change event.

 

 

Question #3:

What are the key attributes of a target A/E/C firm that make it most attractive to a buyer in the current environment?

 

Christopher M. Staloch, Managing Director, Chartwell Financial Advisors:

Companies who have demonstrated an ability to maintain or thrive through a “hundred-year event” will be viewed attractively by buyers, whether it stems from strong niches, defensible positions, or assembled expertise.  Strong management teams are also important in the current environment, not only to navigate through these tumultuous times but given the difficulty with travel, to operate independently while integrating into the acquiring company.  

 

Greg Hogan, Managing Director, SC&H Group:

In the current environment, diversification is key.  While some projects are bound to be canceled or delayed, A/E/C firms with exposure to various client types, industries, and locations are desirable targets because the demand for some of their services may unexpectedly increase.  Lack of customer concentration is also a key factor. Firms with material customer concentration are at a higher level of risk to future earnings volatility than firms with a broader base of customers.   Additionally, firms with strong expertise in core service lines (structural engineering, mechanical/electrical/plumbing, highway resurfacing, bridge inspection, etc.) are attractive.  Demand for these services is not as impacted by economic downturns, and these services can be applied to new builds or renovation/repair projects.

 

Steve Gido, ROG Partners:

Targets in resilient client sectors have strong backlogs, and positive 2020-21 forecasts will continue to be sought after. Of course, in professional service transactions, it’s all about people and culture alignment, so targets with strong leadership teams, a good second tier of future talent, a track record of successful growth and profitability, and the right motivations will be attractive. 

 

Question #4:

What are the key considerations in integrating an A/E/C firm post-acquisition in the current environment?

 

Christopher M. Staloch, Managing Director, Chartwell Financial Advisors:

There are two elements to this – technical and cultural – both of which are complicated in the current environment due to travel restrictions, lack of people in the office, etc.  For both pieces, you need to have a well thought out plan going in.  The primary reason companies struggle with integrations is because the planning is left until after the transaction closes.

Companies who do acquisitions frequently have a well thought out plan and often have a team dedicated to executing the integration on a particular timeline, which is particularly critical today.  However, traditional plans may need to be adapted to allow for a “virtual welcome” to the new employees in the short-term and a longer timeline to fully execute technical and cultural integration. 

 

Greg Hogan, Managing Director, SC&H Group:

Integrating a firm in the current environment will be challenging, as employees are working remotely and have already undergone significant changes in their lifestyles.  A few key considerations to make the transition as smooth as possible are (i) developing a short term communication plan for employees and key customers of the acquired firm in advance of the closing (value in A/E/C firm acquisitions is derived from people and customers, so a good integration plan needs to address both), (ii) try to minimize short term disruption and change for acquired employees by observing the day to day of how the acquired business operates for at least one quarter before making substantive changes and (iii) be as transparent as possible with the reasons for the transaction and the long-term benefits for employees and customers.

 

Steve Gido, ROG Partners:

This is the wildcard right now. Successfully integrating A/E/C companies means people consistently working together on combining disparate systems, clients, benefits, processes, and brands. Often that means traveling to offices and sitting alongside new team members. That is very hard to do in the “virtual” world environment we have now.

I think these issues will gradually recede in the second half of 2020. Still, we will either see delayed closings or slower integration processes until we’re back to a normal work environment.