Building an M&A boom

National construction firms are acquiring local companies to tap into Seattles building boom. As they do so, theyre setting off a wave of consolidation in the states $30 billion construction industry, encompassing associated businesses in architecture, engineering, development and building supplies.

People want to be in Seattle because its a hot market with legs to it, says John Fa, head of the Project and Development Services Team for the Pacific Northwest at Jones Lang LaSalle, a publicly traded real estate services firm based in Chicago. Because of the high cost and the knowledge of local conditions required to play in this market, says Fa, its a difficult market to enter unless you do it through acquisition.

With many owners of midsize contractors and suppliers close to retirement and looking for opportunities to sell, and with private equity firms holding $328 billion in cash, the environment is ripe for deals. Cascadia Capital Managing Director Christian Schiller expects a jump in sales of commercial construction companies, with the strongest interest focused on firms with annual revenues of $100 million and above.

As an industry that employs close to 200,000 workers in Washington and accounts for roughly 15 percent of all sales in the state, consolidation is bound to have an enormous impact on the Washington economy. It could result in a more efficient, lower cost construction industry with larger, better-financed players. But consolidation and new building techniques could also result in fewer well-paid jobs.

The Seattle area market has been strong for several years and is now red hot. In downtown alone, more than 100 projects valued at more than $2.8 billion have recently been completed or are underway, driven by job expansion of 3 percent a year, which is 40 percent higher than the national average.

In recent years, large construction firms have sought to tap that market by acquiring local companies. In the housing market, Toll Brothers, a national luxury homebuilder from Pennsylvania, expanded its local presence in 2011 by acquiring CamWest Development, while Southern California-based William Lyon Homes acquired Polygon Northwest last June. In the commercial market, national giant Balfour Beatty Construction picked up Howard S. Wright, also in 2011. Now a second wave of consolidations is happening.

One factor driving scale is the growing risk of real estate projects as land becomes scarce while building projects get bigger and more expensive. When Seattles Joshua Green Corporation, which owns the Urban Renaissance Group, acquired Touchstone Corporation last fall, it invested $1 billion in six Touchstone projects, including a hotel, a 40-story apartment tower and an 11-story office building, and instantly acquired significant development expertise it was looking for to expand its property operations. Touchstone, in turn, won access to Joshua Greens substantial financial resources.

We are doing a lot of projects that are capital intensive, says A-P Hurd, president and chief development officer at Touchstone. And since lenders want to see developers have more skin in the game, she says, You need to be financially stronger as a developer.

Another compelling aspect of consolidation is the tendency for large companies to want to work with other large companies. When you get consolidation in one part of a market, it tends to drive consolidation across the supply chain, says Stan McCammon, president and CEO of Joshua Green Corporation.

After merging its operations with Philadelphia-based Nelson last November, for example, Seattle-based EHS Design emerged as a national leader in office design with the resources to serve a global market.

Former Callison CEO John Jastrem says the Seattle architecture companys sale in November to the Dutch firm Arcadis for an estimated $150 to $175 million vastly expanded its global reach and the range of services it could provide. Callison is partnering with an Arcadis subsidiary experienced in designing neurosurgery and interventional radiology facilities for a project at Swedish Medical Centers Cherry Hill Campus.

The engineering sector is going through consolidation, too. By merging last May with Mazzetti, a San Francisco firm with nine national offices, CDi Engineers, a Seattle firm that once focused on mechanical engineering, will now be able to offer services in electrical, plumbing and other arenas. Similarly, by acquiring the assets of Honolulu-based Moss Engineering, Seattle-based Coffman Engineers added valuable talent in electrical engineering and lighting.

Not all are turning to acquisition to build scale. Dexter & Chaney, a developer of software for software contractors, recently received a huge equity investment it says it will use to strengthen its product line and improve customer service.
Consolidation is not just happening in Seattle. Its a national phenomenon. From January 2013 to mid-November 2014, Seattle-based investment banking firm Exvere Inc. tracked 66 acquisitions of U.S.-based construction companies valued at $10 million or more. The most active sector was specialty contractors, with 22 sales valued at $3.36 billion. The largest sector by dollar volume was energy-related construction, with 12 deals worth $5.1 billion.

Pitt Means, a director at Exvere, expects a lot more deal making, particularly among midsize companies with annual sales of more than $50 million. Thats because investors are willing to pay a premium for size. Companies with earnings above $50 million have been selling at three times the median multiple of earnings as companies with revenues under $10 million, according to an Exvere report. Smaller firms are less attractive because they are more likely to depend on a single rainmaker to bring in business. Additionally, private equity firms typically are on a timeline to invest in, profit from and exit a business. A larger business allows investors to put more capital to work.

So whats driving the sell side? One explanation is that aging business owners who may have wanted to sell several years ago were forced to wait out the recession. Demographically, theres a little bit of a surge in people reaching that age, Means says.
In 2014, Exvere represented the sellers of two construction-related businesses. The sellers of one company were second-generation shareholders seeking to diversify their holdings. The buyer was a company based in the southeastern United States who was able to enter the Northwest market through the deal. The owners of the acquired company were nearing retirement and wanted to partner with a firm that could grow the business.

The buyer is in a related business and felt their unique services could be sold into many of their existing clients, explains Means.

Smaller companies under $10 million in annual sales are often sold to employees, while larger firms in the $50 million to $100 million range that can provide more scale and competitive advantage are the ones selling to investors.

Aggressive bidding to win work during the recession is squeezing profits among some subcontractors and general contractors. As a result, cautious buyers may favor earnout pricing structures, in which the final purchase price depends on the sellers achieving certain earnings targets. Meanwhile, the low level of government spending on infrastructure is hobbling merger and acquisition activity among heavy civil contractors. Public-private partnerships to develop infrastructure could spark more interest in acquisitions.

A shift to a more streamlined design/build model, with one firm designing and building an entire project, is also driving acquisitions. Being able to control all aspects of a project can increase efficiency and reduce costs. Getting the architect, engineer, contractor and owner together early on is a much more efficient way to deliver a project.

This model is especially appealing to building owners with large, complex projects. Its a trend Jastrem, recently named CEO of Arcadis North America, says he sees particularly among clients who operate in several countries around the world.

Still, the fit between merging companies is important. Blending two weak players may simply create a bigger weak player.

Clients are focused on working with fewer partners, notes Jastrem. Quality, service levels and global capabilities to achieve consistency throughout the world are critical requirements they expect. Simply said, we need to keep getting better.

Denver-based FMI Capital Advisors, a consulting and investment banking firm, predicts strong interest in acquiring specialty trade contractors will continue, especially as commercial buildings become more complex and energy efficient. Prospective suitors include both strategic buyers who are in the same business as their target and want to expand through acquisition as well as opportunistic buyers, such as hedge funds, which see the target company as an opportunity to buy an investment that will grow.

Typically, strategic buyers will pay more because the benefits of the acquisition make the target company worth more to them. This approach has led to competitive bidding as buyers have the ability to stretch their dollars because of continued low interest rates, strong stock prices and a ready supply of cash.

While its uncertain how long the M&A market will remain favorable, Exvere notes that since roughly World War II, the average economic expansion has lasted 58.4 months. That statistic would put the U.S. economy on track for another contraction as early as the end of this year.

But there are those who think the slow pace of the current economic recovery means it will last longer than the average expansion. We are in a sellers market here, says Means. Im seeing what I consider strong valuations because the sellers businesses are performing well and there is confidence in their continued performance.

Jastrem also expects consolidation in the construction industry to continue at a fast pace as the economy continues to improve. It may make the construction industry more competitive, he says, and could mean a more efficient construction sector employing fewer workers.

The number of competitors to consider is less, but the competition among those few competitors is closer than ever, Jastrem notes. The players are getting better.