Environmental services M&A defies crunch

Private equity cited as a significant source of activity

The credit crunch has made life difficult for acquirers contemplating major strategic moves, and corporate deal volumes have declined in the UK as the financial markets continue to struggle. However, environmental consultancy alongside the wider business services sector is bucking the trend with increasing merger and acquisition (M&A) activity, according to a report by PricewaterhouseCoopers last month. Private equity activity is cited a significant driving force for transactions in this area.

According to PwC's M&A analysis, business services deal volumes reached a five-year high with a total of 517 transactions recorded between 1 July 2007 and 31 June 2008, compared with 480 in 2006/07. Although deal values dropped during the same period, increased deal flow is attributed to the business services industry being dominated by medium-sized companies completing mid-size transactions such as ‘in-fills’ and ‘bolt-ons’ as firms seek to fill gaps in their expertise, skill-sets and geographic coverage. Hence, the lack of credit availability has had less of an impact than in other sectors. Business services have also remained popular with private equity (PE) investors, many of which have been pursuing ‘buy-and-build’ strategies in the mid-market.

Simon Hawes, head of business services at PwC, comments: “Private equity firms have a real opportunity to pick up some good assets. In the last major downturn in 1991/92, corporates began spinning out non-core assets following rationalisation and restructurings. If this trend is replicated it will produce attractive buying opportunities.”

Although deal values were depressed, seven transactions valued at £500 million or more were recorded in the UK business services sector in 2007/08. The largest of these was the £1.7 billion leveraged buy out (LBO) of waste management firm Biffa plc in April 2008 by a consortium comprising Montagu Private Equity, Global Infrastructure Partners and HBOS. Biffa is an attractive target, says PwC, due to its “market-leading, cash generative qualities and the fact that it operates on long-term contracts in a market in which there is rising and sustainable demand” as the UK attempts to meet EU landfill diversion targets.

Another notable mega-deal was construction group Carillion’s £572 million takeover of UK rival Alfred McAlpine plc in February 2008, described by PwC as “neatly illustrating the ‘design-build-operate’ trend”. Twelve months earlier, Alfred MacAlpine had itself completed the £30 million purchase of Enviros, a 300 strong UK environmental consultancy. Both the Biffa and Carillion deals fall within the ‘facilities management and services’ sub-sector as defined in the PwC review.

However, the most active sub-sector for M&A in 2007/08 was ‘professional advisory’ with 181 deals completed in the reporting period, equating to 35% of the total business services transactions. The majority of these came from the environmental consulting and testing and inspection fields, which “have seen their growth and expansion prospects boosted by the raft of rules and regulations emerging at both UK and EU level,” states the report. “Companies struggling to keep abreast of the latest edicts in terms of health and safety issues or potential environmental liabilities, for example, are increasingly hiring specialists to deal with the complexities and to add value.” However, the deal environment is noted as being “more difficult” for other professional advisory firms such as architects and consulting engineers due to their exposure to the property industry.

Environmental consultancy has been a magnet for PE investment in recent years, with strong underlying growth and some profitable exits. In May this year for instance, ISIS Equity Partners sold its minority shareholding in the environmental consultancy SLR to another private equity investor 3i. The deal valued the Aylesbury-based company, which has particular strengths in the oil, renewables and waste management industries, at around £100 million (3x turnover, 15x EBITDA*). SLR management and employees continue to hold the majority shareholding.

ISIS first acquired a stake in SLR in September 2004 for £4.85 million. Over the next four years, the business delivered substantial organic growth in the UK and North America, with new offices opening and service diversification. ISIS also supported the completion of two major acquisitions for SLR in 2007 – Insite Environmental, a UK landscape, architecture and masterplanning firm, and Seacor Environmental, a leading Canadian environmental consultancy. As a result, employee numbers at SLR rose from 168 in 2004 to 650 at the time of the secondary buy-out. The SLR deal yielded an impressive multiple of 6x and an internal rate of return (IRR) of 72% to ISIS’ clients.

SLR’s new partner 3i has a track record in the environmental consulting sector, successfully supporting the growth of Environmental Resources Management (ERM) which it later sold to Bridgepoint Capital for $535 million in what was claimed to be the largest deal of its kind in the professional advisory sector in 2005.

“Several factors in combination have made environmental consultancy particularly attractive to private equity investors,” explains Sam Toulson, PwC’s professional advisory business director. “These include: strong legislative drivers at both UK and EU level; double-digit market growth record over a sustained period; the focus of environmental consultants on vertical sectors such as oil and gas, nuclear, renewable energy and waste management which are also growing strongly; the fragmented nature of the market; and also the potential for expansion in the UK and moving into other high-growth regions of the world such as the Middle East and Former Soviet Union.”

As a management consulting firm, PwC has advised on many transactions in the environmental field, including the latest 3i and SLR deal, and also RSK’s refinancing in 2006 to enable the buyout of its former partner ENSR as well as the sale of Casella Consulting to Bureau Veritas in 2005. The table below lists major M&A deals in the sector over the last couple of years.

KEY UK ENVIRONMENTAL CONSULTANCY DEALS: 1 OCT 2006 – 30 SEP 2008

*latest annual turnover. Source: Environment Analyst

The PwC report also notes “a steady increase in the pricing metrics” during 2007/08, with double-digit EBITDA (earnings before interest, tax, depreciation and amortisation) multiples seen for both environmental consulting and testing and inspection firms. Sam Toulson told Environment Analyst: “There’s been an upward trend in multiples within the professional advisory sector in general, which is being driven by strong private equity as well as trade interest, which makes for extremely fertile conditions. A few years back, PE firms were not so interested in this space but in the last five years they’ve become more comfortable with investing in people-driven businesses. Another factor has been the sustained share price performance of publicly listed firms such as RPS – at least up until October last year.”

Meanwhile, depressed stock market values seen over the past twelve months could give rise to some public sector takeover activity. The multidisciplinary engineering and environmental consultancy White Young Green plc announced during the summer that it had received an unsolicited approach, although takeover discussions were said to have been terminated a few weeks later (EA Newslink, 13/08/08). Many legacy partnerships – of which there are a substantial number in the environmental consultancy arena – are also now reviewing their ownership structures, as directors approach retirement age for instance. This trend, coupled with the rise of large global projects, means that several more environmental consulting firms are likely to seek PE capital to fund their next phase of development.

Looking forward, PwC concludes that “confidence in the professional advisory sector is generally good,” and with the booming oil and gas and renewable energy sectors it is likely to remain a high growth area for the foreseeable future. Large-scale consolidation is still overdue – although mergers and acquisitions are being talked about, the uncertain economic outlook has made prospective acquirers wary. “While transactions at the bigger end of the market are likely to remain depressed due to the impact of debt-raising difficulties, banks are still happy to finance smaller deals at the lower end of the mid-market,” says PwC’s Simon Hawes. “With the current market conditions, there will also be a ‘flight to quality’ as people will be much more choosy about which firms they acquire or invest in.”

Addendum 13 October 2008 - private equity deals on hold as debt market freezes

In the space of less than a fortnight since this article was first published unprecedented events in the financial markets have resulted in nearly £1 billion of mid-market private sales being postponed so far in October, according to the national press. Banks are reported to be unable to offer debt packages that would encourage interested parties to make strong bids.

One deal known to have been affected in the environmental consultancy sector is Close Growth Capital's disposal of Entec, valued at around £100 million. According to an inside source, the sale has been suspended although there are still some discussions with potential bidders, and is unlikely to go ahead until January 2009 at the earliest. CGC backed the £30 million management buy out of Entec UK Ltd from Northumbrian Water Group plc in October 2005.

*EBITDA = earnings before interest, tax, depreciation and amortisation

• PwC M&A report