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2012 A/E M&A Outlook – Is the Glass Half-Full or Half-Empty?

“Never make predictions, especially about the future.” – Casey Stengel

As we settle into 2012, there are many reasons to be upbeat about the prospects for A/E and environmental consulting firms. First and foremost, many presidents and principals we talk to across various geographies and capabilities just sound more optimistic and confident, which in many cases is more than half the battle. After “hunkering down” and slashing costs for most of the last three years, many firms are soundly growing again, profits are up, and morale has improved. Backlogs are firmer, utilization rates have improved, and while many organizations continue to do “more with less,” incremental hiring is starting to take root. The private sector, slumped at the wheel since 2008, is reviving from its slumber and the early embers of sensible construction lending activity appear to be picking up.

For the half-full crowd, there are many A/E firms of all shapes and sizes that continue to stand out. These organizations have clearly benefitted from core market capabilities in thriving sectors, skillful penetration of new markets, stronger business development initiatives, and/or seasoned management teams who knew how to steer the ship when the storm clouds emerged. And while many of these firms are well-positioned in “hot” sectors like energy and power infrastructure, industrial and manufacturing, mining/extraction, and water, there are just as many firms in general architecture and renovation, transportation, environmental science and compliance, and (gasp!) land development who can also tout their improved performance and outlook.

However, we’ve all been around the block long enough to know that it’s way too early for the end zone dance. The recovery (are we allowed to say that word now?) has come in frustrating fits and starts and many A/E firms that have grown are simply bouncing back from huge drops in historical performance. A good number of firms are, in fact, still struggling along. Leaders that predict sunnier days ahead are also quick to acknowledge a laundry list of factors that could spoil the party, from yet another economic recession, Congress (everyone’s favorite piñata), looming election uncertainties, potentially higher taxes, and dramatically slower government spending. Add to that hand-wringing over internal leadership and ownership succession issues, elevated fee and billing pressures, and rising costs for healthcare and other benefits, and the half-empty crowd starts to roar. And don’t forget that no sustained economic recovery has ever occurred without major contributions from housing. Hey, no one said this would be easy!

These divergences have played their way out in the A/E M&A market, typically a barometer of overall industry confidence, capital allocation, and risk-tolerance. By our figures, after an impressive 2011 performance, M&A activity is down roughly 30% to start the year and is mirroring a general slump in global M&A across all industries. Today’s A/E and environmental deals that are getting done are increasingly dedicated to international combinations or targets in well-fortified niches. And yes, while we certainly feel strongly regarding the long-term rationale that M&A activity will ramp up (i.e., – it’s a consolidating industry, aging demographics amid glum internal transition prospects, firms should evaluate M&A to accelerate growth in a 2% GDP world, etc.), the short-term headwinds still have to be considered (i.e., – many serial A/E buyers remain gun shy about jumping back in, potential sellers are holding off to showcase better future financial results, etc.).

Buyers – Beggars Can Be Choosers
A/E leaders and M&A development teams continue to express heightened interest in speaking with firms that match their well-defined target criteria, and we here at ROG + Partners remain quite busy with numerous buyside engagements. Many of the factors that we outlined in last year’s M&A outlook remain in force, including publicly traded and large privately-held A/E firms seeking international franchises in emerging economies or access to natural resource development, while international players continue to shop for platform companies here in the U.S.

However, in this stop and start economic environment, buyers of all shapes and sizes are also becoming a bit more “patient” and “picky” about the targets they are evaluating and the time and energy they are putting forth. Not acquiring simply for acquiring’s sake, they are thus seeking targets that will either enhance their market/service presence or allow them to penetrate into new markets or geographies. They are not spinning their wheels with targets with unrealistic valuations and demands or dire turnaround situations. However, buyers will negotiate on terms and show more structure flexibility and overall willingness for those firms that readily add synergistic and strategic value and fit their “square peg in the square hole” needs.

Another interesting development from our viewpoint is the growing number of leaders who share that they would be readily open to a “game changing” deal for their organization. By this metaphor they mean potentially acquiring a firm much larger than their preferred comfort zone, or even an outright merger of equals and talents, if it helped diversify the organization geographically and added complementary clients and services, while creating long-term shareholder value. As we lamented recently regarding the plight of many mid-size A/E firms, these organizations are most ripe for this type of transformational combination.

Sellers – Timing is Everything
There have been a number of sizable, well known U.S. firms that have sold in the last year. Two firms in particular, MACTEC (sold to U.K.-based AMEC) and ATC Associates (sold to Australian-based Cardno) were motivated, in part, due to private equity-related sponsors wishing to finally part with their portfolio companies. Both international buyers were motivated by further expansion of their environmental engineering and consulting capabilities in the U.S. Right place at the right time!

Ultimately, timing plays a huge role for sellers. Many owners who are considering selling realize that their last 3-4 years of financial performance isn’t exactly inspiring and are rightly worried about valuation expectations and selling on the “down slope.” Some may just hold out for a few more years or attempt to convince buyers of the (real or imaginary) “hockey stick” performance just ready to emerge in 2012 and beyond. But sitting on the sidelines doesn’t change the fact that these ownership teams aren’t getting any younger, and don’t have feasible internal transition plans in place. Add to the mix that tax rates will be a huge wild card coming out of the election this year (alas, 2010 all over again), with the possibility of capital gains and qualified dividend rates either remaining at existing levels or perhaps rising dramatically.

Unfortunately, complacency sets in and owners can become paralyzed to simply do nothing at all, exacerbating an untenable position and putting the organization’s overall future and sustainability at risk. Given that ownership stakes in A/E firms likely constitute a sizable portion of future retirement assets, we encourage many owners to start planning for a coordinated internal or external planning process sooner rather than later!

At ROG+ Partners, we possess strong relationships and years of experience navigating A/E and environmental buyers and sellers through the M&A process and towards winning combinations. Whether you are seeking to grow through acquisitions or by evaluating your firm’s strategic and ownership alternatives, please contact us as to how we can help your organization.