Buying Spree - M&A in FM sector doubles

12 February 2008

Against a backdrop of retail profit warnings, subprime mortgage issues, falling business confidence and credit market turmoil, the FM sector is at present something of a beacon in the dark, as Mat Bhagrath explains, The year ahead should be a busy one if the industry 'feeding frenzy' in 2007 continues.

The year that was saw many private equity firms enter the industry through significant acquisitions and embark on often ambitious 'buy and build' strategies, while many of the industry's largest firms also accelerated their quest for both geographic and sub-sector dominance.

The total number of mergers and acquisitions almost doubled the previous year's total; from 42 in 2006 to a total of 81 in 2007. Total deal values also jumped substantially in just one year, from £1.35bn in 2006 to £3.83bn in 2007. So who were the big players in 2007 that drove M&A activity in the sector, and who will be buying in what may be a difficult year?

Consolidation within the industry is being driven in part by an evolution in procurement practices in the FM industry, in which a rationalisation of the supplier base is being sought, with fewer suppliers providing multiple services in multiple locations, offering more efficient procurement to FM buyers. This trend is evident among both public bodies and the private sector client base.

These changes in procurement practice - the demand for ‘bundled’ services - is driving both horizontal consolidation and, to slightly lesser degree, vertical integration. Increasingly, the fragmented smaller players in the market are being scooped up by the larger organisations, while vertical integration is shortening the supply chain in certain sub-sectors of the industry, as the larger FM companies seek greater control over cost and quality.

Changes in the areas where the public and private sectors meet is also having an impact on the direction of the FM industry. Currently there seems to be a slowdown in traditional PFI and PPP schemes, while the Building Schools for the Future (BSF) and social housing developments are featuring highly on the Government's agenda at present, with many schemes reaching financial close and beginning construction. New BSF projects and social housing developments both offer extensive opportunities for FM companies, and the more forward thinking in the industry are developing strategies, including growth by acquisition, to meet the needs of these areas in the decade to come.

In terms of specific FM markets, the highest number of transactions have taken place in the ‘hard’ FM space, with a jump in the volume of deals from eight in 2006 to 30 in 2007. Within this group the most active segment has been the M&E and building services market, with notable deals including the £117m acquisition of AMEC's M&E business by SPIE Batignolles SA, and the Hermes Private Equity tertiary buyout of industrial support services provider, Beck & Pollitzer.

‘Soft’ FM has also seen high volume in small and medium transactions as consolidation of thecatering, cleaning and manned guarding markets continued, driven in part by serial acquirers such as MITIE plc and ISS.

It was in multi-service and integrated facilities management that businesses with the greatest value changed hands, reflecting the drive to greater scale, and the ongoing rise of the 'one stop FM shop'. Deals involving market leaders Enterprise, Alfred McAlpine, GSL and Accord were all announced during 2007.

There have been a number of examples of structural change involving the larger corporates in the FM industry, emphasising the perceived benefits of scale and a diverse service offering. Carillion plc, who acquired Mowlem in 2006, is to acquire Alfred McAlpine plc in a deal valued at £574m. The deal creates a combined group with the scale and balance sheet strength to attract larger clients, and is particularly attractive to Carillion due to McAlpine's higher margin support services business, providing outsourced property services to a blue-chip corporate client base.

Diversification of the client base, as well as entry to soft FM sector, were key drivers behind another large transaction when Interserve acquired MacLellan in 2006. The deal provided an extension of the acquirer's public sector business, with this segment increasing from approximately 30 per cent to approximately 40 per cent by revenue post merger.

Private equity
The long-term contracted revenues that large parts of the FM industry offer have proved attractive to investors, with private equity in particular focusing on the visibility of earnings of FM players, along with a relatively clear exit route, underpinned by the longer term prospects for the sector. The security this offers in a time of economic uncertainty has also kept the industry in the spotlight, as it remains more defensive than many sectors of the UK economy.

Also adding to the sector's general attractiveness is the well-established trend of businesses and public organisations to outsource non-core services, which is set to continue as the next generation of FM companies prove their cost effectiveness over keeping the work in-house.

Private equity funders have been highly active in FM, funding 19 transactions in 2007 with a total deal value of close to £1.5bn.

Among those targeting the larger, platform investments, 3i Group plc increased its exposure to the FM sector with the acquisition of Enterprise PLC for £486m, one of a handful of high profile public-to-private deals completed in 2007 in what was a very active period for private equity generally. Further funding was provided later in 2007 when Enterprise made a significant advance in scale with the acquisition of Accord. These transactions followed 3i's participation in the consortium funded acquisition of AWG plc in 2006, in which FM and utility services provider Morrison was acquired as part of the deal. AWG is now seeking to divest the Morrison business, with private equity groups once again among the likely bidders.

Aside from these larger, high profile deals, much of the activity has centred on mid-market transactions, with notable investments including the Lloyds Development Capital £52m MBO of Emprise Holdings and Bank of Scotland Integrated Finance funding the £40m secondary buyout of textile services specialist, Fishers
Services.

Private equity funding often supports a buyand-build strategy, where a ‘platform’ business is acquired, to be supplemented by further acquisitions to create scale and/or complementary services. Sovereign Capital has implemented this strategy in the social housing and property maintenance sector with portfolio company Kinetics Group. The initial acquisition of DC Group in December 2006 has been followed by ‘bolt-on’ acquisitions including Walmotts and TA Horn Holdings creating a group with revenues of £90m.

For many social housing service providers the market has supported a high level of growth in recent years. Ongoing public funding for affordable homes, the imperative to deploy funds efficiently, and structural and policy change affecting the client base all point to continuing opportunities for service providers, and will no doubt also present new challenges. This environment has been a driver of M&A activity among corporates in the sector, and has attracted keen interest from the private equity community and other financial buyers.

During 2007 there were 14 acquisitions of social housing specialists, with a combined disclosed deal value of close to £500m, up from eight deals with disclosed values of £245m in 2006. Although the high level of refurbishment business driven and funded in large part by the Decent Homes initiative will diminish as this programme concludes, maintenance expenditure will be sustained by ongoing need, and it is in this sector where significant FM deal activity has taken place.

A number of sector specialists among UK listed groups have been particularly active consolidators of the market, utilising a supportive stock market rating through much of the period. Connaught plc, in addition to diversifying into new support services offerings, has acquired social housing maintenance specialists Botes, in 2006, and AE Williams in 2007. Spice plc has continued to implement a buyand- build strategy, with particular focus on creating scale in the highly fragmented gas and heating maintenance sector, with acquisitions including Pargas, Apollo Heating, Homerton Heating, GMT and Gas Heating UK.

Private equity investors have also invested in the social housing sector, with a number of deals completed during 2006 and 2007.

Among the larger players, highlights (as previously mentioned) include 3i's investment in Morrison, via AWG plc, and Enterprise plc, a broadly based FM group but with significant exposure to the social housing market. The midmarket has also been extremely active: Sovereign Capital are supporting Kinetics Group's buy-and-build strategy in this market, and both Lloyds Development Capital (Herbert T Forrest) and Lyceum Capital (Octopus Electrical) have recently entered the market.

The sector also provides an example of the returns achievable by PE investors who identify market leading players in growth markets. In July 2006, Lloyds Development Capital (LDC) invested in Apollo Group, the largest privately owned provider of social housing refurbishment and planned maintenance service in the UK. A little over a year later the business was sold in a secondary MBO funded by Bank of Scotland Integrated Finance, in a deal valued at £410m. LDC achieved an internal rate of return on their investment of more than 200 per cent - representing a gain of more than £100m in little over a year. (Source: Unquote magazine)

During the final quarter of 2007, the total UK value of domestic M&A activity fell to its lowest quarterly level in more than five years, the second lowest values in a decade (£6.9 bn). Credit issues mean M&A pricing in the UK - including the private equity market - is set for a general correction as competition for deals and the availability of debt funding diminishes.

So what does this mean for the FM M&A market? We may see a reduction in deal volumes through 2008 (almost certainly the case in the first half of this year) and perhaps also an impact on pricing. Corporates may be more selective in the assets they acquire, and strong valuations achieved by only the highest quality FM assets, who offer genuine differentiation from their peer group and are capable of making a real and immediate difference to the buyer. Financial buyers' requirement to leverage transactions will make them similarly selective.

However, as we have outlined above, many of the key deal drivers in FM are underpinned by the fundamental structural characteristics of the industry, by positive longer term market trends, and by the relatively predictable nature of the FM business model. With these features in mind, despite the wider market malaise, transactional activity in the FM sector appears set to continue for some time to come.

● Mat Bhagrath is a Corporate Finance Partner with Grant Thornton, a leading provider of lead advisory, transaction services, capital markets and operations and post-deal services. For more information on Facilities Management M&A, contact Mat on mat.bhagrath@gtuk.com Tel:0207 728 2525. www.grantthornton.co.uk