insights into facilities management issue 4

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1 Insights into FM - Issue 4

Insights intofacilities managementIS

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Quarter 3 has seen a welcome recovery in activity with a signifi cant increase in deal volume in the Facilities Management sector while our Quoted FM tracker refl ects the on-going pressures at the larger end of the market. In this issue, as well as our regular review of M&A and activity in the quoted market, our experts give an overview of the challenges and opportunities of Healthcare as a vertical sector for Facilities Management organisations.

David AscottPartner, Corporate FinanceGrant Thornton UK LLP

Q3 2012 M&A overviewM&A numbers rebound in Q3

Following the admittedly pleasant distractions of the Diamond Jubilee, the Olympics and the Paralympics, M&A activity in the FM sector jumped to a two-year high in the third quarter. Overall just 14 transactions had been recorded between April and June, one of the lowest totals in recent years, but a strong fl ow of announcements in the following three months saw this fi gure rise sharply to 33. Although the YTD fi gure of 70 deals in the sector is somewhat behind the totals seen at the same point in recent years, the current momentum suggests that there is every chance of meeting or exceeding the 2011 full year fi gure.

• 2012 M&A overview

• Quoted FM tracker

• Healthcare: a new vertical for the FM sector?

The total value of deals where a consideration was disclosed was also sharply up, reaching a little over £935 million – its second highest quarterly total in almost fi ve years. However, this comes largely as a result

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of one slightly unusual transaction – the £840 million acquisition of the university accommodation management services business UPP Group Holdings Ltd by Dutch institutional investor PGGM NV. Broadly speaking, the market dynamic is still driven by dealflow in the small-cap and lower mid-cap segments. Larger FM players continue to steer clear of big ticket acquisitions in favour of smaller deals in niche services areas, with MITIE, Capita, PHS Group, Amey and Rentokil Initial all active during the quarter.

Broad spread of activityCompared with many recent quarters, the flow of M&A activity in Q3 was spread relatively broadly across the FM sector as operators seek to diversify in order to cope with the way procurement patterns have shifted towards bundled contracts. In many cases this involves hard FM specialists looking for soft FM capabilities and vice versa. Ultimately, of course, this process will lead to the FM sector being dominated by companies with very similar capabilities, differentiated only by scale, though a certain number of niche specialists will surely remain.

Nevertheless, the utilities sub-sector remains one of the standout areas in terms of M&A activity thanks to the multiple drivers of rising energy costs and fragmentation within the industry. This year has already seen 13 transactions in that space, compared with just three in the whole of 2011 and two in 2010. The

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Source: Zephyr

UK Facilities Management transactions 2008-2012 YTD

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UK Facilities Management transactions 2008-2012 by quarter**

**see back page for Grant Thornton subsector split between hard and soft FM

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third quarter alone witnessed six deals in the area, including the acquisition of the cable installation business Nationwide Distribution Services Ltd by Amey. What’s more, within the utilities area there is growing interest around the civils segment as FM businesses increasingly look to resource up in areas where the government expects to tackle the problem of underinvestment – for instance the national grid and the motorway network.

By acquisition type, the Q3 stats show a familiar pattern, with acquisitions by domestic entities continuing to dominate (21 deals versus 11 the previous quarter). But deals by both international and private equity acquirers also rose to relatively high levels. For PE buyers in particular, this quarterly activity (half a dozen deals) may be modest compared with some periods in the past, but it is notable given the challenges they face in raising the leverage they would like and in competing against cash-rich strategic buyers. However, ECI’s acquisition of Rhubarb Food Design Ltd is a prime example of where private equity buyers will continue to be a feature in the market, namely acquiring niche, high-margin businesses in areas like catering, which are dominated by low-margin, scale-based companies.

Other Hard FM

Utilities

M&E

Maintenance/Fit-out

Other Soft FM

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Source: Zephyr

2011 Q1 2011 Q2 2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q30%

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UK Facilities Management transactions by subsector 2011-2012 by quarter

UK Facilities Management transactions Q3 2012 by subsector

Other Hard FM

Catering

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Utilities

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Source: Zephyr

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Looking ahead: distress deals and a shift to the private sectorTaking a step back from the latest quarterly figures and casting a glance at the market ahead, it is likely that distress deals will figure prominently in future quarters. Inevitably, given the tough trading conditions, recent examples, such as the acquisition out of administration of Rotary Ltd by Lorne Stewart Plc and the issues surrounding Mouchel, will become more common.

Another growing market driver will be the push by many FM businesses into the private sector as a result of the pressure on the public purse. And one area that is attracting particular attention is the private rental sector: there are a large number of private and institutional landlords with portfolios of rental properties, and these landlords will be looking to procure services centrally. As a result there is likely to be consolidation among providers of services to that niche and the private rental sector. In fact this is already happening in areas like student accommodation.

UK Facilities Management transactions 2009-2012 by acquiror type

UK PE International

Source: Zephyr

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Quoted FM tracker

A good number of the FM businesses on the quoted tracker continue to perform well versus the FTSE All Share and the FTSE Support Services indices. Among them Compass Group, MITIE, Berensden and Interserve stand out as the strongest performers in share-price terms.

However, the overall performance of the sample has declined slightly against the

Quoted FM tracker at 30 September 2012

Source: Factset; Datastream. Market data as at 28 September 2012; Financial data as at last announced financial close.

“Certainly we are still seeing continuing pressures on FM company margins. Over the last quarter there have been various announcements by local authorities pointing to further cutbacks in their spending. In particular this seems to be aimed at the property elements of their portfolios. And this kind of announcement only adds to the overall pressure on operators in the FM space.”

Q2 snapshot. Then, if the two smallest groups on the list were excluded, the sample group would comfortably outperform the FTSE 100 in all but the 1-year snapshots. Now, the average performance has slipped back a little.

According to Grant Thornton’s Martin Gardner, it is difficult to pin-point any one reason behind this and it is more likely to be a reflection of the overall challenges facing the sector:

Share price change to 30 September 2012Market cap Sales EBITDA EBIT 3 months 6 months 1 year 2 years

Name £m £m £m £m % % % %Compass Group PLC 12,682 15,833 1,339 1,073 2.2 4.3 31.2 28.8G4S PLC 3,748 7,522 625.0 390.0 (4.8) (2.5) (0.5) 4.4Serco Group PLC 2,891 4,646 349.5 264.0 8.2 6.9 13.6 (5.7)Balfour Beatty PLC 2,090 9,494 306.0 170.0 1.9 6.4 18.8 13.5Rentokil Initial PLC 1,475 2,544 431.3 179.6 10.5 (4.7) 13.5 (21.1)Carillion PLC 1,166 4,153 201.1 138.8 (1.9) (9.2) (19.0) (13.6)MITIe Group PLC 1,058.5 2,003 132.6 102.7 12.0 4.2 24.5 52.4Berendsen PLC 938.1 992.0 306.2 112.7 9.1 4.5 26.7 35.9Kier Group PLC 513.4 2,123 77.6 59.7 2.9 14.2 2.4 9.3Interserve PLC 462.5 1,848 60.3 25.2 16.9 25.2 21.1 81.2Mears Group PLC 249.9 589.0 37.5 25.8 7.2 10.8 2.0 (5.4)London Security PLC 220.1 96.3 24.5 20.7 (1.0) (3.0) 2.6 99.4May Gurney Integrated Services PLC 88.8 695.3 46.9 26.3 (45.7) (53.8) (54.5) (33.8)Johnson Service Group PLC 83.8 233.5 39.3 15.9 23.6 7.4 8.3 40.9Interior Services Group PLC 43.9 1,196 14.5 10.4 (3.0) (2.6) (23.8) (25.1)Green Compliance PLC 2.7 21.2 1.8 -1.4 (56.5) (65.1) (87.6) (92.5)

FTSe All Share 3.7 (0.1) 13.0 4.6FTSe Support Services 9.0 3.7 27.9 24.0

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On the other hand, whereas domestic markets are proving to be difficult, some of the businesses on the tracker continue to see strong gains from contracts abroad. Groups like G4S, which has clearly had a difficult year in 2012, stand to benefit in 2013 and beyond from contracts relating to PPP- or PFI-type projects to build schools and hospitals in emerging markets like Egypt.

Overall at home the dominant theme within the market remains the need for FM businesses to diversify, as is shown by MITIE’s first foray into the domiciliary healthcare space via the acquisition of Enara early in the fourth quarter. The other continuing theme is the growth in the size of outsourcing contracts in the private sector. Following on from the £775 million contract secured by MITIE in Q2 to deliver FM services to Lloyds TSB, anecdotal reports suggest that there are even larger potential private sector contracts waiting in the wings, and this continues to fuel the drive to construct integrated and bundled services.

Finally, it is worth noting that the third quarter is traditionally a quieter period for many of the larger FM businesses as they are approaching their financial year-end. Also, for those that provide services to the public sector, this time of year is typically when FM firms are preparing their pitches for April appointments. News of contract awards and annual trading statements should start to drip through early in the new year.

Martin GardnerPartnerGrant Thornton UK LLPE [email protected]

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Healthcare: a new vertical for the FM sector?

Clearly one of the key challenges for UK FM businesses today stems from the changes being implemented by local and national government in order to achieve major cost savings.

However, as is so often the case, where there is change there are opportunities, and the healthcare market may well be a prime example of this. It is an area to which some UK FM businesses have already gained exposure: Serco, Mears and Capita all have a track record in the sector. MITIE also recently entered the space in a significant way via its £111.7 million acquisition of Enara, one of the UK’s largest providers of domiciliary care services, from private equity owners. But what is driving the flow of opportunities for FM operators and what risks might be entailed?

Although the well-known issue of an ageing demographic certainly has a lot to do with it, the most important factor behind the opening up of the healthcare

sector is ongoing regulatory change. Driven partly by a need to generate increased efficiencies in the NHS and partly by a policy shift from secondary to primary care provision, the door is increasingly being opened to a wider range of service providers.

This new dynamic, outlined in 2012’s Health and Social Care Act, effectively paves the way for any business to pitch for healthcare contracts as long as they meet the selection criteria outlined by the sector regulator, Monitor. The latter, too, is seeing a change in its role. It will become less paternalistic with regards to those in the space and this means that healthcare providers, be they public or private, will be allowed to fail as long as key services are maintained.

So far, as is evidenced by the MITIE/Enara deal, the most obvious areas of opportunity for FM providers are in niches such as domiciliary care, an area that has been attracting the attentions of a range of investors for some time. To

begin with, this niche offers the advantage of not requiring significant investment in physical assets – namely property. It also offers some FM businesses the chance of leveraging existing contracts, say in social housing, by offering bundled services to local authority clients.

Groups like MITIE are also well-positioned to introduce the latest technology and draw on their large logistics infrastructures. Especially at the lower end of the acuity scale, a large part of the value that can be created is in the efficiency of logistics. Arguably, FM businesses would also be more adept at planning ahead: whereas the NHS has historically been reactive, the more commercial operators in the private sector would typically be better set up to create meaningful forecasts relating to the UK’s changing demographics and therefore would be better placed to respond to a market that is shifting from a supply-driven to a demand-driven model.

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There are certainly opportunities for FM operators to move into the healthcare vertical, either by acquisition, as MITIE has done, or by joint venture, but of course there are also risks. In part these risks are fi nancial; they are to do with the diffi culties in getting to grips with the right pricing models in a rapidly changing landscape, or with the fi nancial risks attached to technology investment in a sector which sees rapid take-up of new technologies. Another important area of risk is reputational: as high-profi le cases such as Southern Cross have shown, the failure of a business to provide acceptable levels of care can have far-reaching consequences for a company’s brand. In both cases, not having a background of clinical expertise would put FM companies at a disadvantage.

But perhaps the more important risk is driven by the sheer complexity in the healthcare market, with its wide range of approaches to procuring NHS contracts, and the current uncertainty in the space only accentuates this. Although the passing of the 2012 Health and Social Care Act addressed some regulatory concerns, there remains signifi cant uncertainty as to how the NHS itself will evolve structurally. The re-allocation of staff between Clinical Commissioning Groups, Commissioning Support Units and the Local Area Teams (of the NHS Commissioning Board) is still very much a work in progress and this obviously makes it diffi cult to predict exactly where the most interesting opportunities might arise. As Grant Thornton’s Bill Upton explains:

Certainly, although opportunities in the domiciliary care space may play to the core strengths of FM businesses, pushing further into classical healthcare territory is a much more complex undertaking. Nevertheless, if FM providers do begin to prove that they have a sustainable advantage and can translate it into positive impact on their bottom line the provision of healthcare services could change radically.

FM“There is a lot of organisational change taking place, which means it can be unclear where the best future opportunities lie. Local intelligence is key: commissioners in different parts of the country are taking very different approaches. Quality local relationships are needed which of course are time consuming and expensive to build from scratch.”

Bill UptonHead of Healthcare AdvisoryGrant Thornton UK LLP E [email protected]

Neil RutledgePartner, Governance & Infrastructure Advisory ServicesGrant Thornton UK LLP E [email protected]

Mark NaughtonHead of Healthcare, Corporate FinanceGrant Thornton UK LLP E [email protected]

FMFMFMContactsFor any further information, please contact:

David AscottT 020 7728 2315 E [email protected]

Pete Dawson T 020 7728 3197 E [email protected]

Martin Gardner T 020 7728 2847 E [email protected]

Grant Thornton Facilities Management - subsector map

Hard FM Soft FM

Fabric maintenance Security

Fit-out Cleaning

Mechanical & engineering Catering

Fire Protection Washroom hygiene

Grounds Maintenance Textile / Laundry

Utility Maintenance Pest Control

Reprographics Space planning

Relocation & Storage

© 2012 Grant Thornton UK LLP. All rights reserved.

‘Grant Thornton’ means Grant Thornton UK LLP, a limited liability partnership.

Grant Thornton is a member fi rm of Grant Thornton International Ltd (Grant Thornton International). References to ‘Grant Thornton’ are to the brand under which the Grant Thornton member fi rms operate and refer to one or more member fi rms, as the context requires. Grant Thornton International and the member fi rms are not a worldwide partnership. Services are delivered independently by member fi rms, which are not responsible for the services or activities of one another. Grant Thornton International does not provide services to clients. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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