Adapting to market conditions is not a new concept to the construction industry. While the industry has experienced varying degrees of impact from COVID-19, economic uncertainty is undoubtedly top of mind. During a recent DHG webinar in October 2020 with FMI Corporation professionals Alex Miller and Jay Bowman and DHG Partner Mike Trammell, the panelists discussed pandemic economics, project pipelines, construction financing, merger and acquisition (M&A) markets and what we can expect as we look to the future of the industry. Below is a summary of highlights from the discussion.
In February 2020, the economy was at an all-time high – there were 300,000 new jobs, unemployment was below three percent, consumer activity was strong and wages and salary had increased by nearly four percent. Due to the advantageous economic situation, industry professionals anticipated a slight recession simply due to capacity.
Even so, the economy, including construction companies, have certainly been affected by the COVID-19 pandemic. However, it is difficult to summarize the overall impact regarding how the economic downturn and governmental pandemic responses have impacted the construction industry since each region was impacted differently. In the North East, construction was not deemed essential, so many projects had to halt. But in other geographic areas, most projects were not shut down, although the rate of production may have slowed. This is mainly due to two thirds of construction projects occurring currently are representative of previous years’ projects that are now being completed. Therefore, in areas where construction was deemed essential, work continued to progress. The current issue is that fewer projects have been moved from concept and design to the construction phase, and overall backlog is down 25 percent. There are also variations by industry, with office space construction down 40 percent. However, companies handling pharmaceutical, cold storage and distribution centers, data centers and intelligent transportation systems have seen an increase in production as a result of the pandemic as society seeks a vaccine, continues to shop online and requires contactless travel.
With the existing backlog of projects, the construction industry should be able to continue for nearly a year without exceedingly additional negative impacts. Historically, construction has lagged behind the economy by a year or two, so it is likely companies will not hit the bottom of the current downswing until 2021 or 2022.
Additionally, from a M&A perspective, there was already a slowdown in activity. In 2018 and 2019, 60 and 70 percent, respectively, of respondents to FMI’s annual poll reported that M&A activity was part of their growth plans. In 2020, that number dropped to 50 percent even prior to the pandemic as companies are taking a step back to evaluate their acquisitions and make future plans.
With COVID-19, however, most all transactions that were in process came to a halt. A lot of the tracking shows that diligence is difficult, and it is also challenging to develop an understanding of value. However, the transactions were not cancelled, only slowed. We anticipate that there will be a number of new transactions announced later this fall as the “log jam” of diligence is broken through. Now that companies have pushed past the most difficult initial period, they are able to take into account what the past few months has meant for their business.
As new transactions are being made in the coming months, we can expect that past performance will not be used as an indicator of future performance. Most likely, buyers will not use multiples of earnings as a proxy for the future to determine what level they are willing to capitalize their future earnings. Many buyers are taking the view that business overall remains the same, despite current performance, because they anticipate the stock market returning to normal, and any deficiencies are beyond the business’s control.
As a result, construction companies that are not as reliant on a backlog of business will be more attractive to buyers. Buyers are interested in companies that book and complete smaller, service-based projects that are maintenance based. A higher backlog is reliable and demonstrates the potential future of the company as well as the total dollar amount they will receive from a transaction. Sellers may need to prove the value of the company over time. The terms of the transactions have not necessarily changed, as there has only been a shift in where the value is focused as buyers are shifting more consideration towards earnouts. In the next few years, we may also see a higher diligence and scrutiny of the backlog, as buyers may not give the benefit of the doubt to sellers.
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Originally published on DHG Knowledge Share site on October 14, 2020.