The Current State of Mergers and Acquisitions from FMI

Chris Daum is president and senior managing director of FMI Capital Advisors, the investment banking subsidiary of FMI Corporation. In addition to leading FMI’s investment banking business he is responsible for the firm’s utility infrastructure sector and advises clients on mergers & acquisitions and other strategic issues. CBO sat down with Daum to discuss the current state of mergers and acquisitions in the construction industry. See his answers to our most pressing questions below.

According to Daum, acquisition activity is optimistic across the board, especially for 2015. “We anticipate that the broader industry will have 2 to 3 more good years before we may be looking at another industry downturn,” Daum said. CBO: Based on the trends discussed in the FMI Non-Residential Construction Index Report, what trend do you think will have the strongest long-term effect on the construction industry? CD: The continued bifurcation of the industry between very large and smaller niche firms is the trend that will have the strongest effect on the industry over time. The largest companies in many sectors control over half of the construction volume put in place annually and they continue to make acquisitions. Correlated to that is the continued move toward integration of engineering and construction. Companies with design and construction capabilities often have a competitive advantage in the markets and geographic locations they serve, as well as intellectual property around processes and systems. CBO: How will a continued lack in public spending and surge in private sector construction change the industry? How would a long-term funding bill affect these trends? CD: I don’t believe it has changed dramatically. Public sector spending is cyclical in nature. For infrastructure that is typically funded by public spending, a lot critical infrastructure that needs to be updated is being deferred. It’s a growing problem that needs to be solved soon. It will probably accelerate a private funding response such as, more public/private partnerships and private ownership of certain types of public infrastructure. A long term funding bill would mainly benefit companies involved in road and highway infrastructure. One thing it would do to affect mergers and acquisitions would be to start another wave of consolidation by construction materials producers. There are a large number of these private firms waiting for the right time to sell their businesses and there will be a number of large consolidators looking to acquire them. While a long-term funding bill have a positive impact on the construction economy broadly, it will mostly benefit firms involved in civil infrastructure construction and some social infrastructure projects. CBO: Will international purchasing influence, strengthen or dilute the U.S. market? CD: International participation is influencing the market already. We are currently working with at least 13 international companies to strengthen their presence in the U.S. and Canada. International companies are positioning themselves to move in on civil building and infrastructure. Their ability to compete effectively in the U.S. market helps these international companies compete in their home markets as well. At the same time, it forces U.S.-based firms to grow. U.S. firms are becoming more international and moving abroad at the same time. CBO: How can smaller firms with at-risk construction projects find opportunities for M&A? CD: One thing to keep in mind—for every large M&A transaction in the industry, there are 10+ smaller companies being acquired. There is a pretty robust market for local and regional firms across the industry that are well-run, have strong management in place and are a strong player in their local market. Construction is still a locally delivered business. We believe there will continue to be opportunities for smaller firms of quality and size to participate in M&A. Local firms with special capabilities are attractive to acquirers because of their project resume and their local contacts. We also see regional firms that have grown in size and capability making their own acquisitions in order to compete more successfully and protect their home markets. CBO: What potential downsides can megadeals have on construction business owners, and how can they prevent such downsides? CD: A conclusion seems to have been drawn that large transactions in our industry fail in some shape or form to live up to expectations. Either they are significantly over budget or over the time schedule. There is strong, growing evidence that two-thirds of these projects fail to live up to their original expectations. So, one of the biggest challenges is that these large projects can turn out to have huge financial downsides. Both the general contractors and the trade subcontractors feel this impact—it can even cause smaller or less well capitalized firms to go out of business.

One way companies are mitigating this risk is to team up—spread the risk out. Forming joint or tri-ventures and applying appropriate risk management tools in selecting which of these projects they get involved in are good routes to take. We see fewer and fewer participants at the upper end of the market, simply because the risk is too great. One of the challenges to local and regional contractors with respect to mega projects is they often turn into subcontractors to large owners they have little or no experience with. They become further away from the owner contractually, which puts more financial risk on them when projects get into trouble. There is some talk in the industry about the need for owners of these mega projects to rethink how the project itself is designed and managed.

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