uk contractors’ acquisitions strategy for central and eastern europe

Engineering, Construction and Architectural Management 2000 7 � 3, 322–328

UK contractors’ acquisitions strategy for Central andEastern Europe

PA TR I C I A CARRILLO & IAN HEAVEYDepartment of Civil and Building Engineering, Loughborough University, Loughborough, Leicester LE11 3TU, UK

Abstract Large construction companies operate in geo- highest turnover in overseas business, were chosen asthe subject group. The paper finds that, although thesegraphically diverse locations, often in very competitivecontractors acknowledge that there is a potential market,conditions and in a dynamic environment. A strategy for

continuing growth in earnings is necessary. Acquisitions they are adopting a very cautious view by not setting upare a way of achieving external growth. The aim of this permanent offices and by hoping to win work through

contacts with Western clients.paper is to investigate the acquisitions strategies of UKcontractors towards the emerging markets of Central Keywords acquisitions strategy, Central and Easternand Eastern Europe. Five UK contractors, which had the Europe, construction companies

INTRODUCTI ON

The last recession dramatically affected the major UKconstruction contractors’ strategic and business think-ing (Hillebrandt 1995). During the late 1980s andearly 1990s, companies were encouraged to look to-wards Europe. The Single European Act, signed inFebruary 1986, launched the Single Market Pro-gramme. Ironically, this was the point at which thehome market collapsed in the housing and commercialsectors. Cost reduction and cost control were theactions of the time, resulting in staff redundancies, thelowering of overheads, control over capital expenditureon new acquisitions, etc. The inherent risks of enteringnew overseas markets meant that this aspect was not atthe top of the agenda. Instead, emergency tactics wererequired.

The UK business environment has changed sinceHillebrandt’s distillation of the construction industryin and out of recession. Construction output is forecastto rise to 2.4% in 2000 (Construction Forecasting andResearch Limited 1999), construction order bookshave improved, and partnering and alliancing are alter-native forms of procurement.

Companies have doubtless learned lessons from therecession. The improvement in management at theboard level that Hillebrandt noticed will be muchneeded as European companies look to the UK con-struction market to satisfy their own needs. Already,Trafalgar House is under Norwegian control, Costainis under the influence of Skanska, HBG has acquiredthree medium-sized construction companies and Red-land has been purchased by Lafarge of France. In the

other direction, AMEC acquired a 48% stake in SpieBatignolles of France and is looking to make furtheroverseas acquisitions (Fishlock 1999b), and the RMCGroup has acquired a German cement business and isin talks with Castle Cement’s Scandinavian parentcompany (Fishlock 1999a).

Mergers, acquisitions and alliances are frequentlyreported in other industrial sectors. In the oil sector,BP and Amoco are undertaking the biggest industrialmerger (UK Business Park 1998). In the aviationsector, British Airways and American Airlines are at-tempting an alliance, as are KLM and NorthwestAirlines. The fifth biggest car company was formed bythe merger of Daimler-Benz and Chrysler, whileFrench Peugeot and Japanese Nissan now form analliance and Wal-Mart’s acquisition of ASDA is set torevolutionize UK supermarkets (Financial Times1999).

In the construction sector, the mature markets ofWestern Europe may be saturated but the EuropeanUnion (EU) is due to expand. Some of those countriesdue to join the EU (such as the Czech Republic,Hungary, Poland and Slovenia) are in need of con-struction services, particularly to satisfy their in-frastructure demands. Construction Europe (1997)reported that the CEEC 10 (the growing economies ofCentral and Eastern Europe) require ECU 94 billionof infrastructure spending alone; however, the sourceof funding is a problematic issue. Ways of overcomingthis funding issue would be to obtain loans fromregional and international lending agencies or privateinvestment, all of which would require the use ofinternationally recognized contractors.

© 2000 Blackwell Science Ltd322

323Acquisitions strategy for Central and Eastern Europe

G ROW TH THROUGH ACQUIS IT IONS

Top UK contractors realize that they are ill equippedto operate in a market that is increasingly global. Themarket is currently driven by long-term, privatelyfinanced projects and the high expectations of majorclients and shareholders, who are not satisfied withhigh turnover but low profit margins (Knutt 1998a).The trend in the industry is towards a two-tieredmarket made up of large, international contractors andsmall, speciality firms (Ball 1988; Schriener & Angelo1995; Carrillo 1998). This is mirrored in continentalEurope where contractors adopt a more long-termview of the industry, as witnessed by the UK acquisi-tion of HBG and the large size of German and Frenchcontractors. The momentum for expansion is slowlyincreasing in the UK with pressure from financialanalysts for some of the country’s major contractors tomerge (Knutt 1998a).

According to Langford & Male (1991), there arethree ways to achieve strategic growth:

1. internally—a firm uses its own capital to start anew operation;

2. externally—by the use of mergers and acquisitions;and

3. a combination of internal and external—joint ven-tures are one such example.

Whilst the former two are permanent arrangements,the latter is a temporary commitment for a definedduration or task. Internal growth to finance overseasbusiness is not an option owing to its costly nature.International joint ventures are on the increase butthese are short-lived arrangements and do not providethe sustained business required.

Crosthwaite’s (1998) study of major UK contractorsfound that 89% of the respondents had increased theiroverseas turnover, citing an increase of long-termprofitability as the main objective for this. In the samesurvey, all companies state that they expected theirturnover to either increase or remain stable in Europe.Birbeck (1995) also recognized that UK contractorswere once again turning towards exporting their skills,particularly in the development of infrastructure.

As part of a company’s expansion plans, one optionfor growth is an acquisition. It may form part of aninternationalization strategy. It is a high risk option asit is generally agreed that about 50% of acquisitionsare considered failures by some measure (Kitching1967; Bleeke & Ernst 1991). Within the constructionsector, there has been a constant stream of acquisi-tions, mainly targeted at small- and medium-sized

firms. Recently, however, failed attempts at mergers,such as Bovis–WS Atkins and Tarmac–Aggregate In-dustries, have shown how difficult even the negotiationphase may be (Macalister 1998; NCE 1999).

Rockwell (1968) stated that size by itself is aninsufficient motive if it fails to produce increased earn-ings or a more favourable price/earnings ratio. At thetime, he focused on earnings and reinforced this bystating that there is only one valid all-encompassingobjective for making an acquisition: to produce in-creased earnings for the stockholders of bothcompanies.

One noted objective that is very relevant to theconstruction industry is acquiring businesses withcountervailing cycles in order to smooth the peaks andvalleys of company business.

THE EUROPEAN CONSTRUCTION

MARKET

The construction output in Europe for 1996amounted to ECU 876 billion, about £588 billion(Davis Langdon Consultancy 1998). Of this, ECU615.1 billion (or 70.3%) originated from:

� Belgium (2.6%);� France (11.3%);� Germany (24%);� Greece (1.7%);� Italy (10.9%);� Netherlands (3.8%);� Spain (6.1%);� Turkey (2.0%); and� UK (7.9%).

With the exception of Turkey, these countries arecharacterized as large mature markets with populationsof more than 10 million and a construction output percapita of more than 1000 ECU.

A further ECU 112.8 billion (or 12.8%) originatedfrom:

� Belarus (0.4%);� Czech Republic (0.7%);� Hungary (0.4%);� Poland (1.4%);� Romania (1.1%);� Russia (7.7%); and� Ukraine (1.1%).

These countries are characterized as large potentialmarkets with populations of more than 10 million buta construction output per capita of less than 1000ECU (Table 1). They are sometimes referred to as BigEmerging Markets (BEM).

© 2000 Blackwell Science Ltd, Engineering, Construction and Architectural Management 7 � 3, 322–328

324 Carrillo, P. & Heavey, I.

Table 1 Construction output of selected Central and EasternEurope countries

Country Construction output 1996 (ECU billion)

3.3BelarusCzech Republic 5.9Hungary 3.9

12.8Poland9.9Romania

67.2RussiaUkraine 9.8

112.8Total

Source: Davis Langdon Consultancy (1998).

standing of company policy in relation to the twotopics for discussion, namely:

� corporate attitudes towards Central and EasternEurope; and

� acquisitions strategy for the region.

It was likely, therefore, that the suitable candidateswould hold senior company positions. Interviews werekindly afforded by:

� Company A: Commercial Director (specialist andlargest subsidiary of a construction plc);

� Company B: Financial Director (international con-struction subsidiary of construction plc);

� Company C: Business Development Manager (spe-cialist services part of the construction arm of aconglomerate plc);

� Company D: Financial Director (subsidiary con-struction group of construction-related plc); and

� Company E: Business Development Director (Eu-ropean division of construction group of conglomer-ate plc).

INTERVIEW RESULTS

The importance of internationalization

All of the companies were members of groups that hadat least 25% of their 1998 turnover originating outsideof the UK. Bryan et al. (1998) stated that business asusual was not good enough and companies would haveto look outside of their traditional markets to achievetheir aspirations. Hewes (1997) also stated that thetraditional English-speaking markets were mature andefforts were being concentrated on those economieswith the best growth prospects, such as Central andEastern Europe.

The companies affirmed continuance of internation-alization. Company D stated that this approach wasrequired in order to develop the earnings stream.Company E drew a clear distinction between having apermanent office in a country and trading (by virtue ofhaving a current construction project) in a country.Companies A, B and D relied on opportunism, as faras additional Eastern Europe presence was concerned.They ‘piggy backed’ on major projects and investi-gated what else was available during the currency ofthe major works. This form of entry into a market isnot unusual: Hill (1983) described how several UKmanufacturing companies successfully used the samestrategy 20 years ago in the same region.

The population sizes of Russia, Poland, Hungaryand Turkey make them of potential interest in thelong-term. In the short-term, however, the state of theeconomy in Russia and the resulting effect in Polandmeans that doing business in that region carries a highrisk. Analysis of the construction output per capita forthe BEM, however, highlights the long-term possibili-ties for UK construction companies. WS Atkins(1994) acknowledged the economic reforms occurringin Central and Eastern Europe. These reforms attractinvestment and will attract increasing levels of aid fromthe EU to the region following the accession of theCzech Republic, Slovenia, Hungary and Poland to theEU. In particular, the infrastructure and the transportlinks demand large sums of investment.

The region has also strengthened in recent years andthe types of construction projects are now gearedtowards the demands of the local population. Feweroffice buildings and luxury hotels are being built whileretail names, such as Tesco, Carrefour and B&Q, arenow appearing (Knutt 1998b).

UK CONTRACTORS IN CENTRAL AND

EASTERN EUROPE

Semi-structured interviews were conducted to investi-gate the views of major contractors towards Centraland Eastern Europe. The interviewees were five seniorstaff from the UK’s top 10 overseas contractors ob-tained from the Contractors File NCE (1998). To-gether, their annual overseas turnover exceeded £5billion. It was felt that in order to address the issuesopenly, anonymity would need to be assured to boththe companies and the respondents. In addition, theinterviewees would need to have a thorough under-



Opportunities in Eastern Europe

Companies A and B were interested in work aroundthe Caspian Sea, Companies B, C and E in the CzechRepublic and Poland, and Companies B and C inHungary.

Interest in the Caspian Sea stems from its huge oilreserves. This fits well with the requirement of workingwith Western clients, such as Shell, BP and Amoco.The different stages of development of the Eastern andCentral European countries means that the region isnot looked upon as a whole, but as pieces of a jigsaw.Company D is the notable exception, not seeing anyfuture in the region. The reasons for this are stated ina later section. These countries correspond to Knutt’s(1998b) selection of countries with high growth expec-tation in future years and where, coincidentally, anincreasing number of British consultants are operating.

Winning market share

Responses to this theme were varied. Companies Aand C intended to rely on their specialist expertise,using their technological advantage and better man-agement expertise. Companies B and D considered theacquisition route. Company B intended to use thecontacts and experience gained on a recent powerstation contract in Hungary. However, Company Bdid not recognize any benefit in paying money for aconstruction business because, essentially, it is thepersonnel who are bought. Company E opposed ac-quisition and opted for organic growth through work-ing from existing business unit bases in adjacentcountries. It also focused on Western multinationalscrossing borders, keeping an eye on other companieslikely to succeed and targeting those doing well.

The 1997 American Construction Congress iden-tified that the key to success in international marketslay in the use of new management techniques, newconstruction methods, new technology and new mate-rials (Russel et al. 1998). The countries of Central andEastern Europe, particularly those earmarked for EUexpansion plans, can therefore benefit from some ofthe management and technological expertise availablefrom UK contractors for major infrastructure projects.

Barriers to entry into Eastern Europe

The perceived high risk of establishing permanentoffices in Eastern Europe was a major concern. Com-panies A, D and E specifically stated that politicaluncertainty was a top concern. Companies A and Dhighlighted ‘the ability to get paid’ and ‘earn hard

currency’ as significant considerations. This concurswith Crosthwaites’s (1998) findings that ranked politi-cal stability as an extremely important considerationfor working overseas. However, in Knutt (1998b),contractors state that the region has strengthened inrecent years and the appearance of major US in-surance companies have given the market confidence.

Data on countries

A combination of internal and external sources wasused for obtaining data on the available constructionopportunities. The statistical data emanating from theEuropean Commission are not extensively consultedexcept in the broadest sense at the macroeconomiclevel (for example, when examining potential countriesto target). In that sense, they are consulted early in thestrategy process. Company E acknowledged consultingthe Official Journal every day, although they admittedthat it was indeed rare to read about something ofsignificance to the company that they were not alreadyaware of. This view was supported by Company B’sstatement that contacts at the Ministry of Energy weremore likely to bear fruit. Company B suggested that itwas more important to have a local presence and tohave local people collating data and marketing thecompany. Corroboration came from Company E,where they employed consultants to assess markets.Other sources quoted were trade visits, the press, tradejournals and banks (a source of free country profiles).

A point expressly made by Company E was the needto judge the intentions of multinationals that may belooking to cross borders as part of their own expansionplans. Thus, contact with key individuals within suc-cessful companies was regarded as essential to businessdevelopment and offered the potential to be the firstcontractor on the scene. Companies A and B alsoalluded to similar opinions, mentioning the importanceof strategic alliances including partnering.

Acquisition strategy

The two conglomerates, Companies C and E, alreadyhave a strong presence or are working on a strategy fora more permanent presence. Both view Central andEastern Europe as significant to future earnings. Inter-estingly, Company E pointed out that they have beenin Russia for some time but are not making a profit.This suggests that a long-term view is being taken.This is in accordance with Lynch’s (1990) view onprofits from overseas work and the findings of Crosth-waite (1998).



On the other hand, Company A was not anticipat-ing the setting up of a permanent presence, prefer-ring first to undertake project work in a specialistarea for large Western clients. An opportunistic ap-proach to business development would be carriedforward from that position.

Company B held a similar view. It hoped thatsome of their current work would act as a possible‘launch pad’ for obtaining further work. This can besaid to follow the Langford & Male (1991) contin-gency strategy. Company D had firm plans not toenter into any acquisitions because there was no per-ceived added value.

Choice of company

The use of formal analyses such as SWOT(Strength, Weaknesses, Opportunities and Threats)and PEST (Political, Economic, Social and Techno-logical) was not widespread. Two companies statedthat the opportunistic nature of acquiring anotherbusiness is a key element in their identification. Thisis not as haphazard as it may first appear becausemore projects now take place within partnerships, al-liances and joint ventures. There is room for bothends of the spectrum. However, as Company Cpointed out, too much analysis may result in theopportunity being lost.

Measuring success

Company B acknowledged that post-acquisition as-sessment is particularly difficult. The success of anyacquisition in financial terms can be measured eitherby:

� operating a formal mock business plan over a 5-year period with low, medium and high scenarios;or

� carrying out a post-acquisition audit.

The most important financial indicators

All of the companies were part of a publicly held,limited liability company and, therefore, the views ofthe financial community on strategic actions affecttheir share price and value. Companies A, B and Dbelieved that as long as the corporate actions con-formed to a known overall company strategy, fittedwith a stated short-, medium- or long-term businessgoal and had been carefully communicated to thebusiness analysts, then the concerns about stock

market sentiment were contained. The role of thecompany’s Chief Executive in communicating thestrategic intent of the company was similarly statedas a success factor.

In addressing which financial indicators were themost important with regard to acquisitions, thefinancial and commercial directors interviewed high-lighted profitability and return on investment. Com-pany B stated that the most important indicator isthe return on investments. The financial directorsdid not consider the return on capital employed(ROCE) a suitable indicator because most of thebusinesses that are run competently are trading onnegative capital employed.

Importance of growth

There was no agreement as to whether the compa-nies needed to undergo substantial growth to sizecomparable with the leading contractors of France,Germany, Japan and the USA. Company E believedthat a restructuring of the industry was underwayand that by 2005 there would be 10 ‘super-global’players emerging (of which they intend to be one).At the other end of the scale, Companies A, B andD held the view that being big in itself held littlemerit, in that:

� there are no real economies of scale in construc-tion;

� niche operations are where the real value lies; and� specialist offerings (technology, finance, manage-

ment) are more significant.

Overall, all five companies recognized the impor-tance of internationalization. Western Europe is con-sidered a saturated market for UK constructioncontractors but Central and Eastern Europe offerssome opportunity for future earnings. The most pop-ular destinations for UK contractors are the CzechRepublic, Poland and Hungary. Company D is thenotable exception in that it considers that littleadded value can be obtained by working in the re-gion. Only two of the five companies have consid-ered the acquisition route for expansion but neitheris currently pursuing new acquisitions. At the mo-ment, acquisitions of local companies are thought tocarry too high a risk. Instead, UK contractors preferto rely on participation in current contracts to winfuture work. The emphasis is on marketing their spe-cialist expertise and using their technological andmanagement advantage to secure work rather thanpurchasing local companies.



CONCLUSI ONS

On paper, the emerging markets of Central and East-ern Europe appear to provide a tremendous commer-cial opportunity for UK construction contractors. Theregion consists of countries with large populations,high growth expectations and poor infrastructure;also, many are due to join the EU in future years. Inaddition, many well recognized service and retail or-ganizations from the USA and Western Europe arenow setting up businesses in the region, which addsto the attractiveness of the market for constructioncompanies.

Top British contractors do recognize the region asan important part of their international expansionplans. However, few are aggressively seeking work,even within the six countries entering negotiations forEU expansion. British contractors appear to beadopting a cautious, wait and see attitude. They high-light risk, particularly political uncertainty in somecountries, as a major concern. Whether this isjustified can be a source of debate but it is the cur-rent perception of some leading UK contractors.However, this concern does not appear to detract themajor commercial companies who are prepared to setup businesses. British contractors tend to rely heavilyon gaining work on the basis of current contracts withglobal clients rather than setting up an office in anarea to actively seek work. The consensus is thatexpansion into Central and Eastern Europe is betterachieved in a non-acquisitive manner, such as the useof joint ventures with local firms. The 5th US Con-struction Congress in 1997 supported this view andrecommended that companies partner with overseasfirms who were familiar with the law, language andcustoms of the region (Russel et al. 1998). Acquisi-tions are thought to carry high risk and one recom-mendation for future work would, therefore, be toinvestigate the strategies adopted by other interna-tional competitors for entering the Central and East-ern European market.

The timing of acquisitions is often opportunistic.Despite the normal financial analyses that act as ajustification for an acquisition, it is quite often theavailability, or the potential availability, of a targetcompany that starts the process. The fear is that thevery cautious attitude adopted by these major UKcontractors may lead to them losing opportunities todevelop their businesses in the region. In the mean-time, contractors from other countries will have es-tablished a more permanent presence.

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