Deal-making by MEP Giants takes a breather

After a very active 2016, fewer mechanical, electrical, plumbing, and fire protection (MEP/FP) engineering firms made acquisitions in 2017, matching the downward trend seen in the broader engineering industry. However, 2018 is on track to becoming a record-setting year.

By Nick Belitz, Morrissey Goodale, Denver August 9, 2018

In terms of corporate marriages in the overall architecture, engineering, construction (AEC) industry, 2017 turned out to be an extension of a trend we began to observe in 2016. That year, the number of transactions in the sector declined modestly after back-to-back record years in 2014 and 2015. Also in 2016, the MEP Giants stepped up their deal-making, with 23% of the largest mechanical, electrical, plumbing, and fire protection (MEP/FP) engineering firms reporting a transaction. In 2017, the engineering industry at large slowed the pace of what had been a feverish tempo of consolidation.

Morrissey Goodale tracked 309 AEC deals globally in 2017, which was down noticeably from the 349 deals logged in 2016. Last year also posted the lowest overall deal count in 4 years; fewer than 300 transactions were consummated in 2013 (see Figure 1). Consulting-Specifying Engineer‘s 2018 MEP Giants followed the trend and reduced their own deal involvement, with 16% of the industry-leading group reporting a transaction to either acquire another firm or an agreement to sell itself to a larger buyer. Again, we must look 4 years back in time before we see a similar level of activity; in 2013, 16% of the MEP Giants made an acquisition.

Domestic M&A more steady

As global mergers and acquisitions (M&A) activity in the global AEC industry fell, M&A in the U.S. held its own, decreasing slightly from the 216 transactions tracked in 2016 to 211 deals in 2017, but noticeably down from the high-water mark of 240 deals observed in 2015 (see Figure 2).

While our firm would expect the market to take something of a pause following multiple years of record activity, it is interesting to note deal-making in the domestic U.S. remained largely at the same level of activity as the year before, while the global market showed a more pronounced slowdown. We believe this is due to the greater expectations for economic growth in the U.S. relative to the rest of the world.

Increased building translates to more spending in the horizontal and vertical building sectors across the country, which in turn will result in greater opportunities for engineering firms large and small. These expectations for more projects and the growth in revenue and profits they represent drove sustained interest in U.S. engineering firms in 2017 and, we believe, will continue to do so in the current economic expansion.

Private equity arrives-and decides to stay

Perhaps the most notable change in industry deal-making, recently, is the emergence of private equity firms as active players in the AEC M&A market. These firms typically expect to hold acquired companies in a portfolio for approximately 5 years, although the timeline can vary based on the goals of the firm and general market conditions.

This is in contrast to strategic buyers, such as MEP Giants Stantec and NV5, which buy firms with the intent of gaining staff and access to geographies and clients on an indefinite basis. This means that private equity firms, as financial buyers, acquire firms with the goal of building revenue and profits-generally to at least double the point at which the acquired firm stood at the time of acquisition-such that the sale of the engineering company nets the firm a healthy profit on the deal.

Private equity firm involvement peaked in 2015-the industry high point of deal-making-both in terms of the number of transactions (41) and as a percentage of the overall number of deals struck (17%; see Figure 3). However, these firms have continued buying companies in the industry since. While the number of private equity deals varies from year to year, the multiyear trend includes an upswing in 2017, which points to private equity decision-makers’ sustained interest in the engineering sector.

We firmly expect the trend of private equity interest in engineering to continue for the following reasons:

Engineering is a mature industry. While the industry will never see the growth possible in the technology or other cutting-edge sectors, there are more than 100,000 engineering firms in the U.S. In the eyes of a private equity professional, this is an industry ripe for consolidation and the efficiencies in operation business combinations will bring.

The economy is going gangbusters. While we may not be in the irrationally exuberant days of 2006, projects in nearly every sector are moving forward and there is money to be made. Further, public-sector projects, especially infrastructure projects, are traditionally seen as a bulwark against an economic downturn; firms that serve the public sector are in demand as a hedge against the next recession, whenever it may arrive.

Capital is cheap. Interest rates have risen in the last year and expectations are for further hikes in 2018, but debt providers are still lending money for single-digit percentage points. That cost of capital is still attractive for investors looking for yield, and private equity firms see acquisitions of engineering firms as a way of efficiently capitalizing on investing in America’s growth.

Repeat buyers joined by less acquisitive firms

Though the MEP Giants acquired at a lesser rate than years past, 2017 still brought acquisitions by such notable Giants as Stantec, Jensen Hughes, and NV5. Based in Hollywood, Fla., NV5 made multiple acquisitions in the MEP space and climbed from the No. 44 spot on Consulting-Specifying Engineer’s Giants list to No. 36.

The past year also saw less frequent acquirers join the ranks of MEP buyers, including No. 79 Ross & Baruzzini (St. Louis), No. 84 Pond (Peachtree Corners, Ga.), and No. 91 LaBella Associates (Rochester, N.Y.).

The road ahead, to retirement and beyond

Apart from the drivers faced by acquiring organizations, whether they are backed by private equity or traditional strategic buyers, a number of factors at work right now are pushing sellers into the market. We at Morrissey Goodale believe that these factors will continue to drive an escalating number of transactions in 2018 and later years.

First, leadership and ownership challenges abound. We are in the middle of the transition of the baby boomer generation to retirement and-particularly given the effects of the Great Recession, in which firms stopped hiring young talent and lost more senior staff due to lack of work-many firms are struggling with simply not having any capable leaders to assume ownership and management.

Second, after enjoying a series of robust years (and potentially wishing they’d sold in 2006 or 2007), these same baby boomer principals want to monetize their equity positions in their firms while facing a millennial generation that is perhaps ambivalent or even unable to buy their way into an equity position in their firms. This naturally leads principals to consider selling.

Third, firms that wish to grow must do so in an environment where the MEP Giants are competing on smaller projects. This, too, is a legacy from the Great Recession when even the industry giants were forced to compete for work. Growth is facilitated by accessing the greater marketing and administrative resources of a larger organization, and that too may lead to a sale.

Finally, we must always consider the effect of valuations. A robust and growing market for engineering services-just like the one in which we lived during 2018-makes MEP firms more profitable and, therefore, more valuable in an acquisition. As of this writing, data for 2018 indicates we are in the midst of another record-breaking year for M&A activity, with the number of deals through the first 5 months of the year on pace for 260 transactions in the U.S. alone. For the right price, after all, most engineering firms are for sale!

Nick Belitz is a principal with Morrissey Goodale LLC, a management consulting and research firm that exclusively serves the AEC industry. Based in the firm’s Denver office, Belitz works with AEC firms to deliver M&A, consulting, and financial advisory solutions. Morrissey Goodale is a CFE Media content partner.