For the first time since emerging from the Great Recession, both the broader economy and the A/E & environmental consulting industry feel poised to break out from a multi-year malaise. And while A/E firms are still prone to headwinds of market sector unevenness and relentless competition, executives are back to looking at the glass as “half full” which is a most welcome sign. Industry revenues and profits are up, pent-up demand in the public and private sectors is fueling growing backlogs, and the war for talent at all levels of experience is back with a vengeance. Maybe not 2005 exactly, but a sense of normalcy is returning. Happy holidays indeed!
So you can’t blame CEOs in this heady climate for their exuberance and feeling, well, pretty darn confident again. And nothing fuels the M&A markets like executive optimism in addition to cash-laden balance sheets and an itch to start building and buying toward multi-year growth objectives.
And while by our tally the overall number of North American A/E & environmental transactions will likely end the year generally even with 2013, there are a number of intriguing observations and subplots we want to highlight as we wrap-up the year.
1. 2014 was the year of the mega-deal – There were a number of dramatic transactions that will truly change the competitive landscape for A/E firms, and frankly will take years to determine if they were sensible or not. AECOM joining forces with URS, WSP buying Parsons Brinckerhoff, and AMEC combining with Foster Wheeler really illustrate the bold and aggressive mindset of the M&A landscape this year. In addition, there were a number of other deals, albeit smaller, that consolidated major players along service specializations such as GHD-Conestoga Rovers (environmental), POWER Engineers-Burns & Roe (energy) and Hughes Associates-Rolf Jensen & Associates (fire protection/life safety). In fact, many of these combinations have ushered in a wave of trickle down discussions at other smaller and mid-size board rooms, wondering if they too should seek out partners as realignment comes to global A/E participants.
However, the reality is that these mega mergers, in addition to several prominent restructurings of other publicly-traded and large privately held firms, will force a necessary breather. Certain acquisitive participants may be out of the market in the short-term as they turn inward, digesting operations and divesting underperforming divisions. As such, heading into next year, we believe the most active and interesting A/E deals will be led by smaller acquirers, generally with $50-$500MM in revenue.
2. Prominent architecture firms got in the mix – Not to be ignored, there were a number of well-known architecture firms across the country that sold, highlighting both the acquirers’ desire for convergence of disciplines under one roof and eager sellers ready to deal after years of rebuilding from 2009 levels. Arcadis buying Callison, Stantec picking up SHW Group and ADD, Inc., ECADI acquiring Wilson Associates, EYP purchasing WHR Associates, and FreemanWhite joining Haskell were just a few examples of interesting strategic and synergistic intent on both sides. We predict more consolidation for architects in 2015.
3. The future for oil & gas deals today looks much murkier – We’ve noted with both awe and interest the impact of the shale oil energy revolution the last 5 years on engineering and environmental firms’ strategies. While some conventional civil engineering firms in well-positioned locations like Pennsylvania, Texas, Ohio, West Virginia, Colorado, and Western Canada completely revamped their business models to serve the booming energy sector, others simply bought their way into these markets. However, as we’ve all witnessed the last month with plunging oil prices, the booms often lead to busts. Many of the valuations and pro-forma assumptions of these M&A deals were based on energy client needs and forecasts predicated on much higher oil levels to justify activity (not $58/barrel!). So just how these firms perform if and when clients pull back their operations will be a major test the next 12-24 months. In the short-run, we feel engineering firms serving both the midstream and upstream client sectors could prove resilient as cheaper pump prices encourage additional consumption and manufacturers witness lower costs on raw materials.
4. Valuation gaps scuttling deals a reality given economic cycle upturn – Unfortunately, there have been a number of promising deals in 2014 that failed to materialize due to larger-than-expected gaps in buyer and seller expectations. This is all too common in deal-making as the economy and A/E industry moves from recession to recovery cycles. For a good number of sellers, the reality is that their financial performance from 2010-2013 was either lackluster or bumpy, but results and/or forecasts in 2014 have been much rosier. As such, sellers are unwillingly to part with their organizations based on valuations at a lower historical trend line, and buyers are reluctant to offer robust valuations on just a couple of quarters (or promises) of better top-and bottom-lines.
We’ve also seen more sellers who have gone out to market, but either did not find eager suitors or experienced lower-than-expected valuations given the aforementioned cyclical timing. As a result, they are now going back to “Plan B” and considering other transition options (internal sale, ESOP, etc).
5. Aging industry demographics is destiny – Looking ahead, 2015 will mark 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 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. As we’ve noted in prior issues, we have begun to see more net sellers of stock at A/E and environmental firms (of all shapes and sizes) than net buyer demand, a phenomenon with wide ramifications for future industry competitiveness, strategic planning, capitalization, and leadership succession.
At Rusk O’Brien Gido + 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.
On a final note, Season’s Greetings and a Happy, Healthy and Prosperous New Year from all of us here at ROG+ Partners!
Putting a monetary value on an architecture, engineering or environmental consulting firm can be a tricky business. And yet, as business owners and managers, many situations arise that require us to do just that. Whether it’s establishing your own firm’s value for ownership transition purposes, or valuing a firm you are considering acquiring, at some point money will be changing hands and the question of what the firm is worth must be answered. Below are some frequently asked questions (FAQs) regarding the valuation of A/E firms – and our answers.
What is the difference between book value and fair market value?
Book value, sometimes referred to as shareholders equity, is an accounting term. It refers to that section of the balance sheet that reflects the sum of the capital invested in the company by its shareholders and earnings retained and reinvested in the company over time. It should be equal to the total assets of the company, less its liabilities. Don’t confuse book value with the fair market value of a business. The fair market value can be higher or lower (usually it’s higher). This is because the real value of a business enterprise is not the net value of all the “stuff” it owns, but its ability to generate earnings (or more precisely, cash flow), which it in turn can pay out to its shareholders. The present value of this cash flow stream is often higher (particularly in growing firms with strong profit margins) than the net value of the firm’s assets.
What is goodwill?
In the finance and accounting world, goodwill has a very specific definition. It is defined as the difference between a firm’s fair market value, and its book value (assuming the former is higher than the latter). You typically will not see goodwill on a firm’s balance sheet unless it has made an acquisition of another firm. In that case the buyer would record the difference between what it paid for the firm and the net value of the firm’s assets on its balance sheet as goodwill.
Goodwill is an “intangible” asset. You can think of it as representing the value of all the things beyond tangible assets (computers, software, furniture, accounts receivable, etc) that contribute to a firm’s ability to generate cash flow. Those things include the firm’s workforce, their experience and expertise, the firm’s reputation, its client lists and relationships, etc.
How do you value goodwill?
The simple answer to this question is, “you don’t.” That is, rather than trying to place a value on a firm’s workforce, reputation, client lists, etc., an appraiser will determine the fair market value of the business as a whole (inclusive of all its assets, both tangible and intangible). Since all the components of goodwill, together with the firm’s tangible assets contribute to its fair market value, the goodwill is already “baked in” to the firm’s fair market value. Simply deduct the book value of the company from its fair market value, and the result is the value of its goodwill. Allocating that goodwill value between its various components is another challenge altogether—one we won’t tackle here.
What are valuation multiples?
Valuation multiples are used by appraisers in market-based approaches to valuation. Market-based approaches to valuation attempt to establish a firm’s fair market value by looking at transactions of similar firms. These can be transactions of shares of publicly traded companies, or mergers and acquisitions of whole companies (publicly traded or privately held). This approach is analogous to the comparable sales approach used by real estate appraisers. To apply data from these transactions, the appraiser develops ratios of the price paid for the comparable company, and various aspects of the company (such as its revenue, earnings, book value, etc). Since no two firms are exactly alike, the appraiser will usually develop valuation multiples using a group of comparable firms, rather than a single one.
Below is a sample of valuation multiples from our own 2014 A/E Business Valuation and M&A Transactions Study. The 2014 study includes data from over 200 transactions of stock in the A/E and environmental consulting industries. These include internal ownership transition sales, ESOP transactions, and mergers & acquisitions. The study also examines pricing data from publicly traded firms. Valuation multiples are presented for a variety of firm types, and distinguished between minority interest transactions, controlling interest transactions, and ESOP transactions. It also examines how M&A transactions are structured.
Why do appraisers use marketability and minority interest discounts?
A lot of confusion could be avoided if the appraisal community simply substituted the word “adjustment” for “discount.” The term discount suggests there is a “full” price, the appraiser is arbitrarily reducing. In fact, adjustments are necessary to present an estimate of value on the appropriate basis (e.g. minority interest or controlling interest) when using market pricing data from a variety of sources. For example, using valuation multiples derived from mergers & acquisitions of whole companies, if left unadjusted, will produce a valuation that also reflects a controlling interest. Therefore, if the goal is to determine the value of a minority interest (e.g. a 3% ownership stake), the appraiser must apply a minority interest discount. Similarly, when valuing a privately held company, if an appraiser uses data from publicly traded firms, the results must be adjusted to reflect the much lower level of liquidity of privately held stock. To quantify these adjustments, appraisers look to a variety of studies conducted by practitioners and academics. As an example, a number of studies have been conducted to quantify the value of marketability/liquidity using data from initial public offerings (IPOs) and restricted stock.
Where can I get reliable valuation data for firms in the A/E and environmental consulting industries?
OK, I admit that this question is a self-served softball. But if you are looking for a source of reliable business valuation data compiled, analyzed and interpreted by accredited business appraisers with decades of experience within the A/E industry, we invite you to check out the aforementioned A/E Business Valuation and M&A Transactions Study. Better yet, if you participate in the confidential on-line survey, you’ll receive a $200 discount on the 2015 edition of this publication (to be released in January of 2015). To participate in the survey, simply follow this link www.rog-partners.com/aestudy.