Making an acquisition should not be a strategic objective in itself. Objectives for drilling contractors should read more like, "We will grow annual revenues and profits 20 percent by expanding our core capabilities or increasing our geographic markets." In this growth scenario, acquiring a company or companies is a strategy that supports the corporate goal. Acquisitions can play a key part in several different potential strategies. However, some companies appear to forget about the underlying strategy that led them to choose to make acquisitions.
One of the reasons companies lose sight of their strategy when they start to think about acquisitions is that growth by acquiring a company is so much more dramatic and sudden than organic growth. Twenty years ago, it was the norm in the industry to assign an estimator or project team to a new geography or type of project. After a successful bid or sales effort, a project was obtained, the organization was built and a new initiative was started. This process was notably slow and sometimes expensive. Over the past 20 years, however, acquisition has become the preferred alternative to organic growth. However, firms often tend to start their discussions with the acquisition criteria for expansion or the companies that are available and fail to adequately analyze what they want to accomplish with an acquisition. They also fail to consider the impact the acquisition will have on both organizations and the implications of the acquisition on ownership and management succession issues. The acquisition becomes the strategy, whereas the original strategy was to enter a new market or to grow.
Planning an acquisition should begin with a discussion of corporate strategy in which other tactics to achieve corporate goals are considered and rejected if appropriate. Time frame considerations often lead companies to determine that a strategy calls for acquisition. Once you determine that the strategy calls for acquisition, the acquisition process itself must be planned and periodically monitored for fit with the overall strategy within your company's mission.
Here are a few observations from our mergers and acquisitions work with contractors:
Contracting is fragmented for a reason -- The ENR 400 performs less than 50 percent of construction in the United States. Besides the top 400, there are hundreds of thousands of contractors. Some of the reasons the industry is so fragmented include:
- Geography -- The ability to travel is limited for most contractors.
- Lack of economies of scale -- Contractors don't necessarily gain efficiencies or buying power with size.
- Propensity of the business of larger firms to unravel -- As contractors grow, they often lose focus and discipline at the project level.
A contracting firm basically is a group of people who know how to procure, perform and get paid for construction services. Take a few top people out of most construction companies, and the company loses focus quickly. Key people can lose motivation, go to competitors or even start new competitors. So the phrase, "Our people are our key assets," is particularly true for construction companies.
Market opportunities come in waves -- Five years is an eternity for planning in the contracting business. It is not so much that the technology changes, but what is built does. Construction may grow overall with gross domestic product, but within the market for construction, sectors are going up and down, sometimes radically. Therefore, a contractor cannot rely on the work it does today to grow consistently.
Contractors do not do very well in downturns -- Construction suffered severe downturns in the early 1980s as interest rates soared and in the early 1990s in the wake of the savings and loan crisis. These downturns bankrupted many developers and contractors. Perhaps the recent downturn has been less onerous for contractors, but generally a lot of contractors do not do well in a downturn. In fact, one sign of a savvy contractor is the ability to get small when economic conditions call for it. Other considerations for contractors in downturns include:
- Falling backlogs cause contractors to reduce margins.
- Contractors may lay off people needed in an upturn.
- Banks and bonding companies periodically embrace then later turn away from an industry.
Acquisition FundamentalsWhen your strategy calls for acquiring a company, first consider this frequently cited statistic: 50 percent of acquisitions fail in all industries. While acquiring a contractor may provide great strategic opportunity, be aware that there are perils to be avoided.
Acquiring a company often destroys some of its value -- An acquisition changes almost everything about a company unless you never plan to integrate the companies. However, there is really no such thing as not integrating. For better or worse, the whole corporate culture will likely change. We mentioned above the importance of key people in determining value; it's not surprising that much of the value of a construction company may be in its culture. Think of the values that may be gained and lost when integrating the acquisition.
Cash flow is king, but the balance sheet matters in contracting -- A contracting firm must be able to bond and bank. A number of the consolidators in recent history have proven that bad things happen if you do not have a strong balance sheet when the tide of fortune turns against you. The reliance of cash flow on people issues, the uncertainty of the length of the construction economic waves and the potentially destructive impact of the very act of acquisition tempers reliability of the discounted cash flow method for valuation.
A contractor usually is worth more to the seller than to the buyer -- Sellers understand the risk profile of the company better than the buyer does because they have "lived the company." From the buyer's perspective, the very act of acquiring the company can destroy value. Therefore, there must be motivation by the buyer or seller to bridge the value gap.
An acquisition in contracting is more like a marriage than an investment -- There are no good hostile takeovers in contracting. Financial analysis is meaningless without cultural fit and consideration for compatibility and retention of the organization. Divorce is never pretty in construction.
Acquisitions do not fail because a buyer pays 10 percent or even 20 percent too much. They fail because of people issues such as poor integration or poor cultural fit. The more you study the financials of an organization, the fuzzier financial projections for the future become. Ultimately, the acquisition's success is dependent on the ability of the acquirer to maintain and enhance the organization's ability to procure, perform and get paid for its services.
If you are certain that acquisition is the move to make to implement your strategy, our experience shows that the following fundamentals will improve your chances of success when making acquisitions.
Don't outrun your people, and don't assume the acquired troops will follow -- It is easy to become enamored with marketing strategy, operational efficiencies and financial potential. Remember that the business is fundamentally the people's ability to procure, perform and get paid for its services. Strategies without people to execute them will fail. Plan according to your organization's ability to get the troops aligned behind the strategy.
Formulate an operating strategy to build people -- This will support organic growth and provide leaders for acquired companies to bring them into your culture. It is important to remember to develop leaders and not just managers. There is a difference between management and leadership. Managers implement plans and direct people. Leaders drive the organization and set direction for the business. You need both, but leaders often are forgotten in development efforts. Leaders can be developed, and it is best if they are developed internally. Leaders are hard to hire without upsetting the organization. Make leadership development part of your long-term plan for growth and, ultimately, the continuity of the firm.
Don't outrun your balance sheet -- Financial advisors often counsel aggressive growth or distribution of earnings. Construction is a cyclical business, and markets can turn quickly. Bad jobs happen even to the best of contractors. History tells us that banks and bonding companies are not very forgiving when times get tough. In the recessions of the early 1980s and early 1990s, it was the contractors with perseverance and a solid balance sheet that emerged stronger. We expect that will continue to hold true.
A bit of a Depression mentality helps in construction. Anyone who has spent time with a parent or grandparent who lived through the Great Depression should understand what I mean by this. There is a certain way of thinking that says, no matter how good things get, you should be prepared if things get really bad. Boomers and Generation Xers are less likely to think this way. In construction, markets can turn sharply, a job can be a disaster, people can be lost and lawsuits can defy comprehension. If your fortunes turn, a strong balance sheet is a good thing to have when those you have counted on are less than supportive.
Forecasting beyond five years is based on your confidence to deal with a changing market -- Be realistic when making projections beyond five years. By years four or five, the buyer will have far more impact on the success of the operations than the seller will. Cash flow and earnings are the basis of valuation, but the reality in contracting is that after you make the acquisition, your culture will change the acquired company's culture, some people will be lost, and markets will change. Thus, cash flow in the short term will be driven largely by what you buy, but over time your responsibility for cash flow will increase for better or worse.
If you are going to forecast beyond five years, you really are basing it on what you do to the company to make it successful in five years. A lot of buyers five years into an acquisition wonder what they were thinking when they started, because their initial vision was so different than the world they now face.
Analyze the waves -- Study the trends in the market(s) where the seller performs work. Look for the likely cycle in various sectors. Buyers often look at companies as financial machines that generate cash. Underpinning that assumption is another assumption, which is that the market that generates the cash flow will be there as long as the cash flow model projects. The reality in construction is that most market sectors go through peaks and valleys of activity and that good margins draw competition. Successful companies are able to move with the markets.
Have a strategy to deal with the change you will inflict on the company -- You will change the company you acquire, and some of the change will likely be destructive. Think this through realistically and develop action plans to make the best of it. You need to perform an organizational analysis before you close, and you should take it to some depth before you value the company. This organizational work will lead directly into your integration plan. The seller, and as much of the organization as the seller will let you work with, should be involved in developing the integration plan. This involvement should enable you to surface as many of the problems you will face in the acquisition as you can. As we discussed earlier, the very act of acquiring the company will often destroy value. Your goal is to minimize the destruction and set the stage for building future value.
Look for companies with similar cultures -- We sat at a meeting of a potential buyer and seller recently and noted that, after the buyer finished the presentation of the acquiring company, the potential seller said, "You sound like us describing our approach to the business." That type of cultural similarity is important in acquisitions. Drastic culture change is risky.
Focus early on culture and motivation, but don't procrastinate on value and structure -- You can spend a lot of time getting to know an acquisition candidate, and that should be the focus, initially. However, if the seller is not motivated or is unrealistic on value, cultural fit will not get a deal done. Don't rush to numerical analysis, but after basic fit is determined, begin a discussion of value and structure.