Market developments over the last year have highlighted the need for FM players to adapt their business models to achieve long-term sustainability and profitability. However, the FM sector remains in fairly robust shape despite the challenges of strong competition, import-led inflation and indications of a growing Brexit-related labour shortage putting pressure on operating margins.
A turbulent UK economic and political environment is still weighing heavily on general business confidence and will continue to shape future plans and investment decisions. However, this uncertainty is creating opportunities for some FM players.
The latest UK GDP figures showing 0.4% growth in Q3 2017 was short of the EU28 average of 2.6%. UK economic growth is projected to remain low in 2018, in contrast to strengthening global economic activity, which could accelerate over the coming year.
The continued uncertainty of leaving the European Union means that a weaker pound is likely to remain for the foreseeable future, causing inflationary pressures on imported goods. The Consumer Prices Index rose 2.7% in December 2017, down slightly on November’s rate of 2.8%, which was the highest since March 2012. Meanwhile unemployment remains at historically very low levels. All of these economic forces will have an impact on FM company strategies.
Against this backdrop, FM companies have delivered mixed results. Based on share price performance, some listed FM players have seen substantial gains, as investors seek the relative safe haven of the sector’s strong order books and recurring revenues. This is in preference to investing in consumer businesses struggling with falling disposable incomes.
However, a number of the larger UK listed FM companies have been struggling to cope with pressures on margins in a more challenging environment. This has been brought into sharp focus by the unexpectedly rapid collapse of Carillion and numerous profit warnings across the sector. Analysis has shown that the business services sector has issued more profit warnings over the last 12 months than any other UK listed sector.
The collapse of Carillion raises some fundamental questions over the sustainability of some public sector contracts and will almost certainly cause realignment of pricing, with operators becoming more selective about the contracts they pursue.
Following Carillion’s collapse, there may be a reassessment of the low levels of self-delivery and consequent over-reliance on the FM supply chain in fixed price contracts. The apparent mismatch of risk and returns may require a change in mind-set for both FM operators and their local authority customers in order to maintain high service quality over the longer term.
This may also impact the broader trend of outsourcing public services, with some public bodies and local authorities shifting back to self-delivery or hybrid models for selected services.
In the wake of Carillion, a number of FM players may also re-examine their international expansion plans to ensure they have the coherent strategies and management capability to manage a globally diversified business. Carillion’s difficulties in a number of overseas territories, notably in Qatar, were a key factor in its low profitability. This may raise questions on the overseas M&A strategies of some FM players and encourage them to pursue potentially less risky options such as joint ventures.
While some of the factors behind the demise of Carillion will be a concern to the sector as a whole, it will also undoubtedly provide opportunities for some smaller and more nimble regional operators with flexible operating models. This should be exacerbated by the government’s policy of supposedly encouraging more public sector contracts to go to smaller, regional or mid-market players.
M&A remains solid
Merger and acquisition activity in the FM sector in 2017 was virtually unchanged from 2016 based on the total number of deals, set against a global decline in the M&A market of around 10% last year. Deal value was up significantly across the year and the number of transactions also picked up in the final quarter.
International deal activity during the year was on a par with 2016. It is perhaps a surprise that we didn’t see more, given the interest in UK FM assets the market has seen over the last few years from overseas buyers. This may suggest that potential buyers were starting to see the potential risks associated with Brexit outweighing the benefits of sterling's devaluation.
Nevertheless, there was continued inbound overseas investment in the sector from South African and Asian companies looking to diversify geographically. Interest from the US was more muted, a possible fall-out from the Trump administration's America First stance, which has already seen some overseas transactions vetoed. There are also questions over whether companies from the US and elsewhere will continue to see the UK as the traditional stepping stone to continental Europe.
Tepid interest from French and German companies was more opportunistic response to sterling's devaluation since the EU referendum, as they looked to gain a foothold in the UK market.
Meanwhile, renewed interest in lower value 'bolt-on' trade purchases aimed at extending service offerings or increasing market share, fuelled an increase in domestic M&A deals.
The number of private equity (PE) deals in the sector was down on 2016, although there was still significant activity and the fourth quarter saw something of a rally. It will be interesting to see whether there is greater caution in the short to medium term towards FM investments in the PE world in the aftermath of Carillion.
We may see a further decline in overall M&A activity in the year ahead as Brexit draws closer and overseas buyers focus on integration of their existing UK assets, although some further consolidation and disposal of non-core assets, as well as a possible uptick in public-to-private activity, is likely to keep deals flowing.
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