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Over the past decade, there has been a steady long-term increase in mergers and acquisitions (M&A) activity in the engineering and construction (E&C) industry, climbing 40% year over year in 2018 and 2019 from the pace of 2013-2017, slowing in 2020 (primarily as a result of COVID-19) and surging in 2021 as delayed deals from 2020 came back to market.
Increased deal volume in 2021, specifically the outsized level of activity in the second half of 2021, was also driven by sellers who brought forward opportunities that might have taken place over the next few years but were worried about the risk of changes to capital gains laws and were inspired by frothy valuations. As a result, 2021 represented a record year of global M&A activity.
The E&C industry also saw a record number of M&A transactions announced. While 2022 will likely not meet the level of activity in 2021, there is sustained M&A activity in the E&C industry. Activity in 2022 is forecasted to return to pre-pandemic levels, driven by seller demographics, macrotrends in the marketplace and sustained buyer demand, despite softening conditions in the broader economic environment.
In the 2022 FMI M&A Survey, whose participants included E&C industry firms (representative strategic buyers), two-thirds of respondents said they are more likely to make an acquisition in 2022 than in 2021. On the other side of the equation, only 55% of participants indicated that acquisitions were a current part of their strategy. While this is still more than half of all respondents, it represents the lowest level recorded since we began the survey, as buyers are watching rising inflation and high valuations and remain wary of broader economic conditions. Supply chain issues are also beginning to hurt valuations as projects are delayed, impacting near-term earnings for seller and keeping some buyers focused on their operational challenges.
Despite these economic headwinds, macrotrends, such as aging infrastructure, increased environmental concerns and regulations, the ongoing energy transition and gains in construction productivity from increased use of technology, suggest that M&A activity will continue to accelerate in the E&C industry, even if 2022 represents a decline from 2021 record levels.
Trends Worth Watching
Increased Talent Shortage Leading to Strategic Acquisitions
Once a rare occurrence, job openings are now exceeding hires and limited supply of skilled and craftworkers ranked as the top risk E&C firms face in the 2022 FMI/AGC Risk Survey.
Acquisitions are increasingly seen as an avenue to acquire labor resources and bridge leadership voids as firms expand into new regional operations or new capabilities. In FMI’s survey, “acquiring additional personnel (management or labor) resources” ranked second among respondents. Nearly 20% of respondents ranked it highest.
Need for Environmental Services and Disaster Recovery
As a result of increased environmental concerns, firms addressing the need for increased resiliency of infrastructure and firms that are addressing the disasters of today are seeing high market demand, which in turn is driving M&A activity in the E&C industry.
As noted in Figure 1, there was an uptick in M&A activity in 2021 around environmental services, both by private equity and strategic players in the E&C space.
The Infrastructure Investment and Jobs Act (IIJA), prioritizes projects that help the U.S. address this growing issue, with $65 billion set aside for clean energy transmission, $15 billion set aside for road and bridge projects promoting low-carbon mobility and over $50 billion earmarked for projects that make infrastructure resilient to climate change. Federal funding will help drive this effort, and we see evidence that both strategic buyers and private equity are looking to capitalize on this expected spend, creating a unique opportunity for technical specialists in the E&C industry.
Significant Demand for Alternative Energy
The push toward renewable energy and decarbonization goals is also driving major interest from both private equity firms and strategic buyers looking to diversify their existing services around power generation and energy use.
Utility-scale solar, wind, hydro and other renewables now account for 21% of all electricity generation, while solar and wind were projected by the Environmental Protection Agency to account for 70% of new capacity in 2021. Renewables-focused engineering, procurement and construction (EPC) companies have thus been popular targets for buyers, with sales of Blattner Holding Group ($2.7 billion), Solv, (the Renewables Services division of Swinerton Builders) and CS Energy in 2021.
Increased generating capacity from renewable sources has also created demand for the continued services of these assets, resulting in transactions like Mortenson Energy Services, LLC, which was acquired by Pearce Renewables to grow its renewables services capabilities to the installed asset base across the U.S.
As you follow the electron further down the value chain, we see energy efficiency service providers and mechanical, engineering and plumbing (MEP) services firms continuing to combine across many end markets as the ability to vertically integrate and serve the holistic needs of a client from planning a project all the way through ongoing service gains popularity. The sale of CMTA, a national consulting engineering firm and energy service company (ESCO) focused on energy-efficient and net-zero buildings, by Legence (Therma Holdings, at the time of acquisition), a specialty MEP services company, is a prime example of the vertical integration of energy efficiency solutions and adjacent services with traditional MEP construction and maintenance services.
Aging Infrastructure and the Deployment of Funds
One-third of respondents in the FMI M&A Survey identified civil infrastructure as the market that will see the most activity in the next 12 months. The IIJA funds will be a catalyst to addressing aging infrastructure and will fuel an increase in E&C M&A activity, judging by deal activity following previous large federal infrastructure programs.
While traditionally we have seen an uptick in M&A activity for firms addressing traditional civil infrastructure, such as roads and bridges (which are apportioned $110 billion of the IIJA), we expect to see increased M&A across other civil infrastructure sectors as well, including:
- Water, which has a $55 billion allocation for clean water projects.
- Dredging, under the $16 billion allotment for improvement of ports and waterways.
- Rail, with $78 billion allocated over the next five years to support infrastructure and multimodal and freight transportation.
- Utility and telecom, with $65 billion set aside for clean energy transmission and electric grid infrastructure.
We also see increased M&A activity and funding toward emerging growth sectors, such as intelligent transportation and electrical vehicle (EV) charging infrastructure, with $7.5 billion earmarked under IIJA for building out EV charging infrastructure and developing alternative fuel corridors across the U.S.
Additional M&A Drivers
Consolidation of Select Building Services
Long-term consolidation of heating, ventilation, air conditioning and refrigeration (HVACR) services means several large buyers are now competing for a decreasing number of quality assets, especially in the commercial and institutional markets. Firms of scale with a significant percent of revenue tied to preventive maintenance and retrofit of existing assets still demand a high premium. The residential services segment remains ripe for consolidation with higher fragmentation characteristics today, along with other segments like fire protection/life safety, roofing/building envelope and select building controls/systems providers.
M&A activity also remains high for traditional E&C firms serving the building sector, specifically for design and construction management/project management firms as well as specialty trades.
Continued Presence of Private Equity
Recognizing many of the emerging trends impacting the E&C market, such as increased need for environmental and building services, the energy transition and aging infrastructure, private equity firms have continued to increase activity in the E&C sector over the past decade, and the momentum continues to grow (see Figure 2).
Geography Remains a Key Driver
While technology is increasingly moving construction delivery away from the project site, E&C services are still largely delivered locally, and geographic expansions continue to be a catalyst for M&A activity. Among buyers, gaining the ability to enter a new geographic market was the top driver for M&A deals, ranked first by nearly 37% of respondents to FMI’s survey.
Demographics and Ownership Transfer Needs
The E&C industry remains highly fragmented and is predominantly populated with small to midsized and family-owned businesses. Many of these owners are nearing or have passed the traditional retirement age and need an avenue to transfer their ownership. In 2020, FMI and the Construction Financial Management Association (CFMA) completed a national survey, which found that 49% of owners intending to retire in less than five years had no plan for transferring their ownership.
In the short term, we expect solid activity through the rest of 2022 and sustained M&A activity for the next several years, with some buyers increasing due diligence and scrutiny of assets in the near term, given the mixed signals in the wider economy and operational issues caused by supply chain challenges.
*This article is a condensed version of the FMI’s 2022 M&A Trends for Engineering and Construction report.