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Financial Challenges

24 March 2009

With the financial crisis as daily headline news how is the FM sector faring in these challenging times for access to securing working capital and acquisition funding? Keely A Woodley explains the problems and opportunities

THE CORPORATE BANKING ENVIRONMENT has clearly changed dramatically in recent months, with lenders cutting back significantly on funding available for corporate loans. Banks are now in a position where rather than competing for business, and hence offering competitive terms as they have been for the last two to three years, they now have customers competing for their capital, so they are cherry picking the safest and most stable of clients.

What we have seen at Grant Thornton is that many companies in the FM sector have characteristics that make them well positioned when it comes to securing credit lines, even at a time when global economies are experiencing the most restrictive lending environment in decades. In our experience, banks tend to be particularly supportive of businesses providing essential services to their clients, and boasting relatively non cyclical revenues secured by long term contracts. Many FM companies fit that profile.

Services provided in the FM arena, from cleaning and security to M&E maintenance, tend to be regarded as essential services. Whereas an organisation facing difficult market conditions can quickly reduce costs by freezing recruitment and cutting marketing spend, cutting back on cleaning, security, maintenance and other property support services is a less straightforward option.

Clearly there can be an impact on the FM provider through erosion of the client base due to insolvency, but they are less subject to discretionary curtailment of their services. Consequently, banks are reassured by FMs stronger financial forecasts, and have confidence that cash flows will be there for the borrower to honour its obligations. Many FM companies have the additional advantage that they operate under long-term contracts and are, therefore, able to demonstrate long term visibility of earnings to potential funders.

Long term contracts
Lenders increasingly base their decisions on the creditworthiness of the customers of the firms applying for loans. The likes of Experian and Equifax are increasingly being asked to provide credit information on businesses as the incidence of default and administration is significantly higher than 18 months ago.

FMs with long term government contracts can be hopeful of finding supportive lenders, as the government is viewed as a reliable customer. Therefore, those with service agreements with a public sector client base are more likely to obtain a funding package on more favourable terms than those businesses that are reliant on more volatile parts of the economy, such as retail. Good examples of this in the current climate are the likes of Carillion, MITIE and Mears who have significant forward order books, together with the relative certainty of a robust public sector client base.

Margin pressure
One of the key risk areas for banks looking at this sector is the margin pressure that the industry is increasingly becoming subject to - a feature of the leaner economic environment that we all find ourselves in. Typically, additional scrutiny will be applied by diligence providers when looking at margin trends on specific contracts over a three or five year period to understand how contracts have been priced and whether this is sustainable given other economic factors.

In practice many banks will factor in margin pressure as a consideration when reviewing a lending proposal. Whereas previously lenders may have considered a 20 percent reduction to the operating case in order to model the downside risk to their covenants, it is now not uncommon to see scenarios where 30 or 40 percent downside scenarios are tested. In a worse case scenario, the impact of this is that it reduces the level of lend that the lender is prepared to commit.

Planning ahead
As credit in the form of both working capital and acquisition funding has become increasingly scarce, the rationale for securing such funds well in advance is significantly stronger than in previous times. At Grant Thornton, we are helping companies secure funds by presenting businesses in the best possible light and securing the most favourable terms through our knowledge of the current funding climate.

The key questions that finance directors and managing directors are asking in the current climate tend to be:

● Who is providing funding at the moment?
● What information do I need to provide to successfully apply for loans?
● What do 'favourable terms' look like in the current environment in terms of arrangement fees, LIBOR vs base rate and margins?
● What multiple of EBITDA can I expect to borrow?
● Do certain lenders prefer certain niches?

Given the low LIBOR rates at the moment and the sophisticated interest rate hedging products available, higher margins don't necessarily convert in to more expensive debt. Furthermore, given that sentiment is beginning to suggest an inflation issue may be on the horizon in future years, the possibility of hedging interest rates for a five or ten year period may be a good idea.

M&A activity
With access to funding now greatly reduced, the ability for corporates and financial institutions to engage in M&A activity is now constrained. This was reflected in a reduced volume and value of deals in the FM industry during 2008, compared to a peak in 2007, although the more resilient characteristics of the industry have continued to drive mid-market transactions.

Grant Thornton research has identified 55 corporate transactions involving UK based FM companies during 2008, with total disclosed deal value of almost £800m, a significant fall compared to 2007 when 81 transactions worth a total of £3.83bn were announced. Although this is a significant year on year fall, the figures nevertheless represent an active M&A market compared to other industries, and in the context of longer term trends the 2008 volume of deals is 23 percent higher than figures for 2006, which saw 42, although the average size of transaction was smaller.

In the UK, the largest transaction in this sector completed in February 2008, when Carillion's tender offer for the UK-listed construction company Alfred McAlpine was approved, paving the way for the cash and share offer valuing Alfred McAlpine at £572m. Another major transaction saw private equity firms Englefield Capital and Cognetas exiting their investment in the sector, when quoted security services contractor G4S plc completed with the £355m cash takeover of GSL.

Aside from a small number of major deals, the key characteristic of M&A in FM, and in other support services industries, is the volume of small and mid-market transactions. Here at Grant Thornton we have been working with corporates and financial buyers seeking to consolidate fragmented sectors, or to enter new sectors through acquisition of specialist niche players.

The private equity community remains interested in the sector, and we saw a number of deals during 2008, though here again reduced from the peak in 2007. Investors included midmarket buy-and-build specialist Sovereign Capital Partners LLP who continued to consolidate the social housing marketplace both via existing platform Kinetics Group, and through a new investment in Renovo Services. HIG Capital also entered the FM sector, funding the £25m acquisition of United Utilities Facilities Management by Europa Facilities Management.

In 2008 we also saw continuing activity in the quoted corporate sector, with well-funded and/or highly rated groups such as MITIE and Spice both making several acquisitions during the year, and Mears and Connaught acquiring complementary service lines. (It is helpful that quoted corporates in the FM space are highly rated compared to other sectors. With an average price earnings ratio (PE) of 13.7 at the year-end, compared with FTSE All Share, which had an average PE of 9.1).

So what does the deal market look like going into 2009? There are certainly buyers seeking deal opportunities. However, given the challenges corporates currently face in raising funds on the quoted equity markets, and the reduced availability of debt financing for both corporate and private equity deals, we anticipate that buyer price expectations may not be aligned with those of the would-be vendor. As a result we may need to look beyond this year before we see a significant increase in transaction volumes.

Clearly these are challenging times across all industry sectors. However, carefully managed, well-advised companies in the FM sector, who address funding requirements early, ought to be able to weather the storm. Additionally, this difficult marketplace may present more aggressive operators to capitalise on opportunities along the way.

● Keely A Woodley is Associate Director, Lead Advisory at Grant Thornton UK LLP, a leading provider of lead advisory, transaction services, capital markets and operations and post-deal services. (keely.a.woodley@gtuk.com)


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