Gambling on the future of the market?
As government spending cuts bite, mergers, takeovers and joint working will become the hallmark of contracting. Dean Stiles considers the impact on the construction industry.
Consolidation among service providers comes as the UK government seeks to rapidly reduce the deficit by trimming spending: a move that threatens to curtail the number of contracts and tighten margins. Recovery will be slow with the risk of a return to recession still high, according to some economists concerned about the unexpected half point dip in gross domestic product in the last quarter of 2010 compared with predictions of a half percent gain.
Recovery for companies in the construction sector could be at least five years away, says Rick Willmott, chief executive of Willmott Dixon, one of the UK's largest privately-owned construction companies. He warns that main contractors have still to face the worst: "There is no question any of the large contractors have been in a recession yet. But it's coming. The reality that most of us are contemplating, is how to make it through the next five years as the price squeeze stays on at main contractor level."
Further stress will come from contractors pricing below cost, effectively gambling on the future direction of the market as well as making it harder for other firms to win tenders without competing aggressively on price, he says. This is likely to mean more consolidation and failed businesses, as some firms are unable to deliver schemes at the price they have quoted clients, once prices rise.
Takeovers are less likely for struggling contractors operating in a market where building activity is set to contract further as a result of government spending cuts and with little recovery in the private sector.
Michael Magnay, director in corporate finance reorganisation services at Deloitte in Manchester, says: "The confidence of CFOs [chief financial officers] in companies to make any moves in terms of mergers or acquisitions with the risk of a double-dip looming has been severely eroded."
The priority for his clients in construction remains firmly on cost control, not contemplating buying rivals, Magnay says. Limited availability of funding for mergers and acquisitions will also check any growth in such activity. Shareholders are also wary of debt-laden deals in the face of a shrinking economy.
Philip Fellowes-Prynne, May Gurney Integrated Services' chief executive, says: "A lot of investors are very nervous of mega deals at the moment because of the debt that may imply."
May Gurney purchased UK maintenance company Turriff Group for an initial £8.6M in cash, plus the assumption of £9.4M debt. "It's sensible not to get heavily indebted," Fellowes-Prynne says, and only those acquisition targets that can be readily absorbed into the company for cash will be considered.
Fellowes-Prynne's strategy contrasts with Costain Group's attempted takeover of larger services company Mouchel Group, which has £180M debt due next year. Mouchel has reached agreement on new banking arrangements, but failed to ward off the bidders surrounding the group. Costain sees the takeover of Mouchel as an opportunity to expand from construction into new business areas.
May Gurney's debt-free position places it in a better position, providing more protection from the economic headwinds that hurt Mouchel. May Gurney, which forecast full-year profit at the top end of the range analysts' estimates, is not looking to be acquired, Fellowes-Prynne says.
"We have been around since 1926 so it's not
something that I'm unduly worried about. We are a strong company."
The pattern is for more long-term working relationships, something that is already evident in the water sector. "The emerging model for construction is all about maintenance contracts," says Magnay. He predicts more joint ventures as the UK comes out of the recession, driven by the greater security they offer both sides. "A joint venture can be the start of a future takeover, with parties getting access to the join-venture partners' assets and effectively using the collaboration as a prolonged period of due diligence," he says.
A stalled economy suggests that casualties rather than takeovers may be the more likely option. Matt Dunham, construction partner at Grant Thornton in Manchester, says: "The biggest problem is often among the small- and medium-sized sector where they are reluctant to see what is good for the
business. Owner-managers find it harder psychologically to take advice."
The most recent water sector acquisition is MWH Global's purchase of Biwater Services, the holding company for UK-based Biwater Treatment, Farrer Consulting and BiProduct Recovery. Together, the companies will be able to provide programme and asset-management-led frameworks, enabling MWH to benefit from expected market changes and to be responsive to future challenges.
Joseph Adams, president of MWH Constructors, says of the purchase: "We planned our expansion and growth through acquisition. When Biwater Services became available, it was just the
type of company we were looking for."
The acquisition is about expanding the service offering, he says. "Prior to acquiring Biwater Services, MWH had a strong engineering programme as well as programme management and management consulting services. We did not have the same scale of business in construction services in the UK.
"Biwater Services quickly brought us the scale we were looking for. We are able now to provide services through any or all stages in the full asset life cycle for our clients," Adams says.
The water industry is changing rapidly as it faces ageing assets and the need to provide low-carbon and low-energy solutions, he says.
"We wanted to be prepared to meet our clients' needs by expanding our range of service offerings, so that we are ready to support the optimisation of existing assets through their whole life cycle considering the ever-increasing challenges," Adams says.
The acquisition meets the challenge the sector faces for greater innovation in delivering and operating built assets. "With our combined expertise, we now have the ability to support the full asset life cycle of our clients from asset planning through commissioning and into operation. While wet infrastructure remains our focus, the new capabilities offered by the combination of our companies adds increased momentum in our growth in other market sectors, like energy and waste," Adams says.
His views resonate with those in a report produced last December by accountants PwC and law firm Pinsent Masons.
The report, New Realities for Construction -The Comprehensive Spending Review, says: "Innovation is vital to achieve greater efficiency in many aspects of delivering and operating built assets. And innovation should go beyond design and technical issues. For many, the way that projects are commissioned and procured needs to change - and newer modern methods and approaches will be required to achieve this."
Chris Temple, construction strategy partner at PwC says innovation is essential for construction companies if they are to survive. "The Spending Review focuses urgent attention on a number of long-running themes and trends that have created barriers to greater efficiency in the UK construction sector. Only those businesses that are able to drive innovation and change are likely to survive and prosper."
The report also highlighted the extremely fragmented supply chain within the industry, which is a major barrier to achieving greater efficiency. "Compared to other major industries, construction has remained inefficient whilst overcapacity is also both a cause and a function of construction's highly fragmented supply chains," the report says.
Pinsent Masons and PwC believe that greater supply chain integration and more efficient procurement will inevitably lead to consolidation as smaller and less-efficient businesses find it increasingly tough to compete and remain independent. Consolidation will be particularly acute for SMEs in construction and acquisitions by the majors of both healthy and distressed businesses are likely they say.
Pinsent Masons and PwC say that while cuts in capital spending by government will inevitably lead to consolidation in the construction sector, reduced spending also offers the opportunity to make the industry less wasteful, more cost effective and more productive.
However, they warn that only those businesses that are willing and able to drive innovation are likely to prosper.
Collaboration is the key to delivering higher levels of
efficiency and to meet the challenges ahead with streamlined procurement models fundamental to driving efficiency.