We often highlight articles from our customers that would be interesting and relevant to the Firmex community. Enjoy this in-depth report by Mike Rosendahl of PCE Companies, on M&A Trends in the Industrial Services Sector.
The industrial services sector is undergoing a resurgence as merger and acquisition activity continues to grow. As with most sectors, transaction activity decreased substantially after the economic downturn in 2008. The industrial services sector was hit particularly hard due to cutbacks in spending by the private and public sectors. Today, the economy is slowly improving and with this growth strategic and financial acquirers are seeking M&A targets that serve key sectors, such as power, or are based in regions that are experiencing high levels of investment (e.g. Texas, North Dakota, etc.). The outlook for this sector should continue to improve as GDP expands, hiring improves and capital spending increases.
The industrial services sector has benefitted from high levels of investment in the power, petrochemical and manufacturing sectors. According to Joseph LaVorna, Deutsche Bank’s chief U.S. economist, capital expenditures in the U.S. are projected to increase by 10% in 2012 as companies increase manufacturing, open new plants or reopen older facilities. Additionally, in December U.S. businesses increased their investments by 2.9% over November, according to the Commerce Department’s measure of new orders for nondefense capital goods excluding aircraft, a proxy for capital spending. Compared with a year earlier spending is 9% higher.
Industrial services companies that transport, install and maintain equipment as well as build power generation facilities, wind farms, petrochemical facilities, manufacturing, and increasingly at fracking operations throughout the country are benefitting. These highly regulated facilities need to keep up regular maintenance in order to comply with an abundance of laws and regulations at the federal, state and local levels. The work created through shutdowns/turnarounds creates substantial levels of revenue that repeats on a fairly regular cycle, which is highly coveted by acquirers.
The chart below demonstrates recent activity in this sector. In 2007, M&A activity peaked at 298 transactions. Deals started to diminish in the second half of 2008 as acquirers refrained from most investments due to the financial crisis and uncertainty it caused. Beginning in 2010, acquisitions started to increase as the economy started to recover and acquirers sought to make targeted investments. This trend continued in 2011 when the total number of transactions nearly equaled the peak in 2007.
Valuations in the sector have rebounded as well. While the data reported publicly is limited, the direction of value is clear. During 2009, valuations decreased significantly with companies trading for a fraction of the total revenue generated and low multiples of EBITDA. In 2010 and 2011, valuations increased significantly. On average, companies in the industrial services sector traded around 0.8x revenue or 6.5x EBITDA. Factors influencing value include company size, capital expenditure levels, balance sheet strength, contracted revenue, customer concentrations and end markets served. Larger companies with diversified revenue streams that are under contract and serve high investment sectors should expect to receive valuations around this level or potentially above while companies that don’t meet the criteria will be negatively affected.
There is a strong basis to believe M&A activity will be high in 2012, but some issues could force the market to pause, such as:
- Uncertainty surrounding the extension of tax credits that support the wind sector
- Overabundance of natural gas due to an exceptionally warm winter
- Infrastructure spending across the country is underwhelming
Even with these concerns the outlook is positive due to a number of factors, including:
- High Investment levels in the power, petrochemical, manufacturing and infrastructure sectors to help support the expanding economy
- Oil sector continues to exploit new resources using fracking
- Power sector expands as older and dirtier facilities are retired and new plants are built to capitalize low natural gas prices and greener technologies
Leveraging these trends will attract strategic and financial acquirers seeking to benefit from the long-term growth prospects. Companies that are able to provide value added services to these segments will continue to be coveted by acquirers and will be able to extract higher valuations.