Consolidation in the construction industry – opportunity and risk of increasing earnings through M&A

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Consolidation in the construction industry – opportunity and risk of increasing earnings through M&A

Due to the pressure on margins, there have always been many takeovers, especially in the medium-sized construction industry. Despite promising numbers before the takeover and an apparently great strategic fit, the hoped-for success often does not materialize. Quite frequently the following years are characterized by devaluations and slumps in earnings.

To get closer to this empirically observable phenomenon, it is worth taking a more detailed look at the object of purchase. Basically a construction company essentially consists of the following assets:

  1. Its current construction sites and the results that can be achieved from them
  2. Its construction equipment
  3. Know-how of the employees through which future projects are to be gained and processed profitably
  4. Its brand

Let’s analyze the value of these assets step by step:

  1. Current construction sites and the results that can be achieved from them

In retrospect, it often becomes apparent that the current projects were reported too good at the time of purchase. This is not (necessarily) a fraudulent practice, but rather a known phenomenon. Construction sites often report their originally calculated margin as the current project result for a long time before they lose part of the margin on the last 10-20%.

Graphic: frequently observed presentation of earnings from construction sites

  1. Construction equipment

Construction equipment is mostly leased. For one thing because of the capital commitment for the other because of the specific maintenance issue. Therefore it usually does not represent any real added value. Moreover, the value of the construction equipment owned is mostly insignificant relative to the purchase price.

  1. Employee know-how

The know-how of the employees is probably the objectively best reason to buy a construction company, but it should not be forgotten that, thank God, slavery was abolished long ago. Every day employees choose whether they want to work for the company. It is often found that employees leave the company in the course of takeovers. There are many reasons for this, ranging from personal ties to managers to the brand of the company car.

  1. Target brand

The brand of the target is theoretically another good reason to buy a construction company. At the same time, this usually disappears within a short time after the takeover in the course of integration.

On closer inspection, many of the assets acquired turn out to be of no value. However, the liability risks that are also purchased should not be underestimated. E.g. a professionally operating construction companies may have made mistakes in the past for which the buyer will later be liable.

Last but not least, the one-off integration costs that have to be earned again in the low-margin construction business should not be underestimated.

Does this mean that acquisitions in the construction industry generally lead to failure?

This statement would obviously be too general, but the business model of the target should be subjected to a critical suitability test in the new, larger setting beforehand. The following questions might help:

  • Are speed and flexibility key to the company’s success?
  • Are the personal contacts of the previous owner important for success?
  • Has the company provided lucrative services that the new owner cannot offer for image reasons?
  • Is the company’s success based on very lean administration and thus low overheads?

The more of the above questions can be answered with yes, the lower the chance of a financially successful development in the (group) network.

On the other hand, it is important to develop a realistic assessment of the expected fluctuation and the associated brain drain. Specifically, I recommend:

  • an analysis of the salary structure
  • an analysis of the target agreements and bonus structure
  • a comparison of the company car policy including the agreed costs
  • a critical look at the corporate culture and
  • a realistic assessment of the non-monetary work motivation, especially with a view to second level managers of the target. For example, smanagers who have reported fully motivated to a charismatic company owner may not have the same level of motivation when reporting to a department head of a larger unit.

With regard to the manager of the target in particular, targeted, step-by-step poaching before the takeover offer appears to be an interesting alternative. Come and increase the bottom line for your new employer, a risky takeover may not be necessary. If they do not come, the probability that they will remain in the course of a takeover also decreases.