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Opinion: Simon Gillott
High hopes for SME service providers
Two recent insights make the SME (small and medium enterprise) services sector an interesting space right now: the UK service sector is growing at its fastest rate since May 1997 and the UK has a reported 28,000 mid-market companies collectively turning over £2.2 trillion. So whether its telecoms, data analytics, legal services or recruitment, there’s an ocean of opportunity for businesses that supply services to SMEs, and the ones that do it well are flourishing.
From what I've seen this is often an area neglected by the larger service providers because supplying services to SMEs typically requires a dedicated approach; it involves dealing with a large number of small customer accounts demanding the same levels of service as larger businesses, but at a lower price and often with a greater emphasis on customer experience. This means the enterprise / large cap-focused service providers often find it uneconomical to directly target those businesses towards the smaller end of the corporate spectrum.
Therefore, dedicated SME service providers that get the delivery mix right are able to operate largely unchallenged by their larger cap ‘competitors’ and consequently grow very quickly. So its no coincidence that we’re seeing a lot of private equity interest in this space. This end of the market tends to be more fragmented, so there's plenty of buy and build opportunities and there's often a compelling exit story as high growth rates attract the larger trade buyers to look at M&A as a way to enter the market without changing their business models.
SPIE surges forward with another UK deal
SPIE has completed another UK M&E deal with the acquisition of Energy Network Solutions (“ENS”) for an undisclosed sum, announced earlier this month.
SPIE, a company I’ve been tracking, continues to be an active acquirer in the M&E space, which is not really a surprise given the group’s recent history and track record. SPIE has been owned by private equity since PAI acquired it from Amec in 2006, PAI oversaw the acquisition of more than 50 businesses before it was sold to a private equity consortium in 2011 for €2.1 billion. The current owners have continued to use strategic M&A to create Europe’s largest multi-technical and support services group and the ENS deal takes the new owners’ acquisition tally close to 20.
ENS provides SPIE with access to the UK power line service sector, an attractive industry set to benefit from huge investment over the next 10 years and another example of an overseas group buying a UK M&E business to bring new technical capabilities in-house. Other notable examples this year include South African integrated service provider Servest acquiring Maxwell Stewart; the deal enables Servest to provide a full range of services to its UK clients seeking a multiservice solution, and Holland’s Royal BAM Group enhanced its UK presence with the acquisition of Sutton Group in January. Sutton is a UK facilities management provider specialising in building services and commissioning so BAM can now provide UK customers with a full range of services across the construction life cycle.
So whilst MITIE and Emcor have turned their attention away from M&E (both companies announced they will no longer compete for UK M&E contracts), Europe’s low growth environment has also created M&A opportunities in the sector as trade buyers consider acquisitions as a means to bring in new capabilities to drive growth. In fact, many of the larger businesses we speak to have spent the last couple of years evaluating internal operations such as cost structures and repairing balance sheets and now have the resources and appetite to look externally for new sources of growth. Therefore we expect to see strategic M&A move up the corporate agenda across the industry with demand strongest for those specialist operators that bring new services and open new markets. These will be the companies on the trade buyers’ radar when the cheque books come out.
M&A spotlight moving towards M&E
Business services has proved to be a “hot sector” for M&A over the last year. Indeed, Catalyst has recently completed two more deals in the sector – MML’s investment in Instant Offices and the sale of Celerant Consulting to Hitachi Consulting (see our latest news www.catalyst.co.uk/news for further details).
Activity will continue in 2013 but will favour high value specialised services. There has been evidence of this already as Spie completed its acquisition of Plexal Group in early January. Spie is the European leader in M&E engineering and HVAC services, energy and communication systems. Plexal is an Australian-based specialist engineering firm focused on the oil and gas sector. This acquisition ticks all the boxes for text book strategic acquisition rationale because Plexal will provide Spie with enhanced geographical reach, additional technical skills and exposure to an attractive high growth industry.
From an M&A perspective, we have long considered M&E an attractive sub sector within FM due to the technical nature of services, which generally command higher margins. However, as a result of the downturn and in particular, a depressed construction sector, UK M&E has had a rough ride and the number of company administrations has been uncomfortably high. Yet there has been some interesting M&A activity – Spie, Imtech and Rentokil are all recent acquirers of quality UK M&E businesses. The current ultra competitive market means that demand for financially strong M&E contractors is ever increasing and therefore quality businesses are likely to stand out. M&A remains an important way of delivering additional growth in a difficult economy, but buyers won’t make an acquisition unless they are convinced it makes strategic sense; specific industry exposure and geographical coverage must fit with a buyer’s defined strategy, whilst the composition of a target’s customer base and revenue mix (contractual vs project revenues) and the quality of revenue and earnings are put under even greater scrutiny from the outset.
Quality M&E businesses are likely to attract more attention from both trade and financial acquirers as momentum builds in the economy, but the focus will be on strategy-led M&A rather than M&A-led strategy. So if you are selling your business, understanding what buyers are looking for and proper sale preparation are critical to the success of your deal.
Synergies across FM and healthcare could be Mitie
Mitie’s acquisition of Enara this month caught my attention because it highlights some interesting trends in the support services / facilities management space.
The UK is generally accepted to be the most mature FM market in the world following several waves of consolidation over recent years. Combine this with the current low growth environment and its no wonder many businesses have looked to developing markets to deliver growth. Healthcare services on the other hand are increasingly being outsourced and represent a major growth area right here in the UK. One such instance is the shift away from hospitals/residential care homes to care provided in the community by companies like Enara.
All things we discussed in our Healthcare Services research report, issued well in advance of Mitie's acquisition btw...
Therefore Enara’s acquisition provides Mitie with a great platform in a high growth sector where it can apply its outsourcing knowledge and experience of managing and developing large diverse teams of people. This operating synergy has clearly been picked up by other outsourcers because Serco and Sodexo were also amongst the reported bidders for Enara. I’m keen to see how this new partnership plays out but I believe it’s a real indication that there will be more deals of this nature to come.
More Olympics feel good factor
The Atos leadership team had a lot to be happy about on the opening night of the Olympics as it released strong half year trading results just before the ceremony started.
The European outsourcer is the worldwide IT partner to the Olympics and Paralympics Games. It grew profits by 6.7% which is a great result considering a number of its counterparts are having a tough time. The group offers an attractive mix of BPO and specialised IT services, plus some interesting developments in cloud and social networks - just the sort of attractive offering referred to in my last post.
This strong performance was driven by the current momentum in the BPO space, new contract wins, tight cost control and continued development of attractive higher margin services. Atos also completed four small scale acquisitions/JV agreements this year.
I would expect to see more M&A activity in the pipeline because the Siemens integration is expected to be finalised later on this year, Atos is cash rich and investors will soon be keen to hear the next good news story.
Outsourcers look to the UK
Rewind 10 years and discussions around outsourcing probably conjured up images of UK call centre jobs heading off shore to India. Therefore you may be as surprised as I was to hear that the Philippines has overtaken India as the biggest call centre operator in the world for ‘voice-related services’. Apparently the main reason for this shift is American customers’ preference for English spoken with a neutral accent.
India still leads the way across the full business process outsourcing (BPO) spectrum. However voice-related services tend to be lower margin so India’s giants have turned their attention to higher value services and are using M&A to enter new markets. WNS’ acquisition last week of Fusion Outsourcing Services, a South African BPO provider, illustrates this perfectly.
So India has slipped to number two, however even bigger news is that the UK is fast becoming an outsourcing hot spot as well!
Our regular dialogue with many of the key international BPO players reveals that they are looking for M&A opportunities in attractive sectors such as healthcare, insurance and financial services. These are more sophisticated, complex services requiring technical knowledge and therefore are higher margin.
Financial services outsourcing, or "FS BPO", is really booming in the UK making it a key strategic market for many global businesses. PPI claims alone are expected to cost banks up to £10 billion over the next few years, which will drive growth for a range of outsourced FS related services including staff training, customer and complaint handling, claims, compliance and risk management. So keep an eye out for deals in this space as the financial sector continues to set the agenda in the UK.
More to Japan than meets the eye
Our Japanese partner was in town last week for a knowledge sharing session prior to our international partner conference in Paris. It was fascinating to hear first hand about what’s been going on in the world’s third largest economy, particularly given the turbulent last twelve months the country has experienced in the wake of natural disaster.
As we at Catalyst have put on record before, 2011 was a record year for outbound Japanese M&A. The market experienced what can only be described as a ‘perfect storm’ for outbound transactions: cash rich corporates, unprecedented strengthening of the yen and perhaps most significantly, shrinking demand from domestic markets. These dynamics have been so powerful that even Japanese mid market businesses are hiring advisors to help them to acquire overseas.
From a target destination perspective Japanese corporates place high importance on developing manufacturing and distribution networks in neighbouring China, however rapid price inflation there and the floods in Thailand (another favoured destination) have highlighted the importance of diversification across South East Asia and even India. The view on more established markets is that the UK is a favoured destination in Western Europe and typically used as a platform to serve the wider European and western markets.
The high profile Japanese takeover of RBS Aviation Capital by Sumitomo at the start of the year received lots of press coverage because of UK tax payers’ shareholding in the banking group. However there have since been five further Japan/UK deals including Wacoal Holdings’ acquisition of Eveden Group, a mid market Northamptonshire underwear manufacturer and Optex Co Limited’s acquisition of Raytec, a Northumberland LED manufacturer.
Our understanding is that the main driver behind Japan’s increased outbound M&A is structural change in its domestic markets. Therefore the trends we see now, I am pretty sure will have momentum and for that reason i'll be keeping in touch with our Japanese colleagues throughout 2012 since I think we'll be busy together.
Some light at the end of the (services) tunnel
At the start of 2012, the message from financial press and other economic forums was far from rosy. 'Zero growth economy', 'decade of deleveraging', and 'debt crisis' dominated the headlines for months.
As we now move into the second quarter of the year the businesses we meet remain cautious and realistic regarding the challenges ahead however, dare I say, there is optimism out there nonetheless. Volumes and rates are starting to move in the right direction and we continue to hear positive noises from large trade players looking to transact in the UK.
Sluggish organic growth has put M&A high up the agenda across the entire Business Services sector. The UK continues to be perceived favorably due to the number of established international blue chip businesses, high value service propositions in attractive vertical markets and highly skilled employees and management teams.
The macro picture is also starting to give the impression of light at the end of the tunnel, which we hope will continue to shift the pendulum from caution towards confidence to transact. The UK currently sits ahead of the other European representatives of the G7 for the latest 2012 and 2013 growth forecasts (averaging 1.4%) whilst pro business initiatives in George Osborne’s recent budget are expected to drive additional UK investment of 6.4% and 8.9% in 2013 and 2014 respectively. The growth figure may be nothing to shout about but this was the first budget for four years in which forecasts did not deteriorate much.
Compared with the start of the year this feels like a much better place to be.