Globalisation of FM: Mergers and acquisitions, and the fourth wave
What the increased focus on new markets means for mergers and acquisitions in the global FM market is explained by RICHARD HOLDEN, director of Catalyst Corporate Finance.
Worldwide facilities management (FM) deal volumes for the first half of 2012 were 40 percent ahead of the same period in 2011. Western economies have stalled and boards are redirecting their strategies towards emerging markets as organic growth becomes harder to achieve and multinational customers seek integrated cross-border FM services. What does this increased focus on new markets mean for mergers and acquisitions (M&A) in the global FM market?
- Cross-border deals have accounted for 20 percent of FM deals over the past three years, with the balance being mainly domestic infill of additional services or localities. This proportion grew to 30 percent in H1 2012, marking the start of what Catalyst Corporate Finance predicts will be a run of ‘Fourth Wave’ deals by large strategic acquirers.
- Technical services continue to be the most talked about target segment of the FM market. There has been strong competition for good quality businesses as buyers seek to increase the number of value-added services to clients.
- Private equity continues to invest in the sector attracted by the buy and build opportunities.
- The economic downturn has delayed or thwarted the exit plans of several large private equity backed FM companies.
- The large, listed FM companies have performed well compared to global stock markets over the past three years, with the exception of those with a high exposure to the construction market. Typical trading multiples have remained at 6x-10x EBITDA.
Sustained economic pressure is forcing FM providers to cut prices or risk losing customers. Competition has increased and FM companies need to work harder and become more efficient just to stand still.
FM providers continue to bundle services in response to pressure from customers wanting cost savings by procuring from fewer suppliers. Customers perceive self-delivered services to be better value for money and increasingly expect FM providers to self-deliver core services rather than using subcontractors.
The total FM (TFM) model of delivery continues to grow its share of the larger contracts market, putting pressure on growing FM companies to invest in high calibre people and systems to be able to manage a single source contract across large or multi-site customers.
FM companies continue to look to move up the value chain of services, seeking to add technical or niche services to their offering. Customers perceive these services as adding value rather than just a necessary cost.
In order to protect margins, some FM companies are targeting more resilient end markets, such as the defence and pharmaceutical sectors. Customers in these sectors are less focused on short-term cost reduction initiatives and more on avoiding business disruption. This is achieved through building trusted relationships with their suppliers.
The fourth wave of M&A in the FM market sees the larger players becoming increasingly global, turning to the immature, high growth markets of South America, the Middle East, North Africa and Asia to compensate for their competitive and low growth domestic markets. This development is an investment in the long-term as emerging market entry strategies are risky and growth can be elusive due to the lack of sophistication of local customers.
The drivers of this activity are twofold: pressure to grow shareholder value and demand from an increasingly multinational customer base for cross-border provision of FM services. Customers want reliability, quality and administrative ease, as well as the cost savings that come from using a single global FM supplier.
Corporate social responsibility continues to be a priority for customers’ agendas and working with trusted suppliers mitigates the potential negatives of encountering corruption or poor working practices that are common in emerging economies.
Market entry strategies differ. Some FM providers have followed their multinational customers and then seeded domestic customers around these larger contracts. Others have acquired local delivery capability, established joint ventures or taken the low risk approach of operating a white collar managed service offering.
FM MARKET DEVELOPMENT
Regional FM markets around the world are at different stages of development. The UK is generally accepted to be the most mature market, with Western Europe and the US following close behind.
We believe there are four distinct phases or ‘waves’ of development as a market moves from the early stage use of dedicated single service providers, up to the global cross-border use of a single TFM provider.
M&A plays a key role in enabling a FM provider to move through each wave, initially acquiring customers, national coverage and then new services – becoming more sophisticated over time.
Most FM companies are heavily influenced by the heritage of their business model, typically evolving from construction/engineering companies, support services companies or property services businesses. There is a clear difference in valuation between the different models:
- Construction/engineering-led FM providers are currently trading on a 5x-7x EBITDA (earnings before interest, taxes, depreciation and amortisation) multiple due to their use of a blue collar workforce and the lack of visibility of earnings from project-based revenues. These predominantly maintenance-focused businesses have a project completion culture that drives their approach to customer service.
- Support services FM providers are trading in the range of 7x-9x EBITDA driven by the increasing trend of outsourced facilities services, the visibility of earnings from long-term contracts and the increasing provision of technical services. The support services culture is focused on delivering against service level targets.
- Property services FM providers are valued higher at 9x-11x EBITDA due to the provision of higher margin white collar consultancy services, transactional property services and a diverse range of services across the life cycle of a property. Excellence in systems and the provision of a wide range of bundled services keeps margins high.
Support services FM providers remained most resilient over the three years reviewed. Property services and construction/engineering-led business valuations are more cyclical as a result of the greater proportion of transactional revenues in their businesses. FM companies or the FM divisions tend to be stable in a recessionary market as increased outsourcing and a desire to save costs balance increasing downwards margin pressure from customers.
FM deal volumes have been rising since the low of 2009. Second and third wave domestic consolidation accounts for most deal activity, but cross-border M&A is increasing in importance, particularly in emerging markets. Cross-border activity for H1 2012 has been almost double the average of the past three years.
Concerning regional consolidation, much of the rising activity can be attributed to FM players consolidating their maturing domestic markets, moving towards the next wave of development. This is evident in the US market, which remains surprisingly regional in outlook below the largest players. The market share of the top 10 FM companies in the US has only increased from 12 to 14 percent during the past three years and the potential for further consolidation is huge.
The maturity of the UK and West European FM markets has driven large players to look to emerging markets for growth opportunities. This is aligned with the globalisation of the large FM companies’ client base, which is pushing for the cross-border provision of FM services.
Private equity investment in the sector has been responsible for 10 percent of all multi-service global FM deals since 2008. Private equity firms have been attracted to the sector because of the high level of recurring revenues and the fact that it remains a fragmented sector offering the potential to pursue a buy and build strategy. There have been few exits in recent years, but there have been several high profile failed exits.
PROSPECTS FOR M&A AND THE INDUSTRY
Although the trend to outsource facilities services continues, the uncertain economic environment and the desire to cut costs in non-core areas will mean organic growth rates will remain low in the medium-term. FM companies consider M&A a fundamental part of any growth strategy and so we predict that:
- deal volumes will continue to increase as trade buyers use their strengthened balance sheets to drive growth
- the second and third wave markets will continue to consolidate regionally through infill acquisitions of new services and gaining fuller geographic coverage
- as basic services such as cleaning are now commoditised and there is strong downward pressure on margins, large businesses reliant on these activities will have to acquire to maintain growth and sellers of these businesses should not expect high valuations as most large players are content to use third-party providers, and
- fourth wave deals will increase in volume and valuations in emerging markets will continue to rise as good quality assets become scarce.
In addition, private equity investors are under pressure to exit their FM businesses and we believe this will come quickly as M&A markets become more positive in the short-term.