UK Facilities management M&A remains strong in Q2 2022.

With the strongest first half year performance regarding M&A activity, our Q2 analysis shows what is behind this drive. With high levels of private equity, US interest and a decarbonisation focus, facilities management services have remained a resilient asset class within the current economic uncertainty. Lenders also seem to be taking a similar view.

You can find full details on the current prospects for facilities management in our Q2 2022 sector review.

 

In the first quarter of 2022, there were 42 deals – the highest number since this report began in 2009. This contributed to another record, the strongest first-half performance, at 69 deals.

Why? Maybe it's because the UK is facing recessionary headwinds that this resilient sector is so active. Investors are seeking haven in its strong recurring revenues, regulatory-driven and critical demand, and visibility on forward order books.

A growing focus on ESG, and specifically energy management and transition, has also helped drive deals in 2022, with strong interest from US acquirers, two themes we’ll explore below.

UK FM targets - quarterly M&A activity

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Sector spotlight – hot investment areas

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Throughout the whole of 2021, there were no deals involving catering businesses in the first half of 2022, due to uncertainty around post-pandemic working patterns.

We continue to see a steady flow of deals involving soft services, which benefit from economies of scale and performed well during COVID-19.  Notable H1 deals in this space include Atalian Servest’s acquisition of Incentive FM Group. We provided sell-side advisory services.

Otherwise, fire and security continued to dominate deal activity, accounting for the majority (25.7%) of deals in the first half of 2022. New regulations continue to drive demand in this subsector.

Private equity involvement

Deals with private equity (PE) involvement accounted for 41% of deal volume versus 48% in 2021.

PE views FM as better placed to stand up to macroeconomic challenges than other sectors.

In particular, it's piling into hard and technical FM, such as fire services, which benefit from regulated and non-discretionary spend.  

Trade buyers and PE-backed trade buyers, on the other hand, are targeting soft services for consolidation opportunities. 

Cross-border activity

The ratio of domestic deals to UK deals involving another country in H1 2022 remained the same as in 2021 at c20%:80%.

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A special relationship - US investors target the UK

There were eight deals involving US buyers in the first half of 2022. This accounts for more than half of cross-border transactions.

US buyers are benefiting from a devaluation in Sterling and relatively cheaper multiples than their domestic market. Post-Brexit, there's also a trend towards more regulatory synergy between the two nations in addition to the historical cultural ties.

  • In March, Allied Universal, through its UK company G4S Secure Solutions, acquired TSS (Total Security Services) to strengthen its position in the UK. We provided sell-side advisory services
  • The Polygon Group (backed by US investors AEA) strengthened its market leadership position through the acquisition of ISS Damage Control. We provided sell-side advisory services
  • NYSE-listed Johnson Controls has been on a UK acquisition spree, scooping up decarbonisation specialist Asset Plus (see more below), as well as fire and security firms Xcell Misting and Envision
  • New York-based private equity firm ASGARD Partners acquired cleanroom design and production firm Connect 2 Cleanrooms, through its portfolio company, Angstrom Technology

Emerging trends – ESG

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In line with the UK Government’s pledge to reach Net Zero by 2050 (and the accompanying regulation), we're seeing an increasing number of deals involving both commercial and residential decarbonisation and energy transition firms.

To combat rising energy costs and ensure regulatory compliance, property owners and building managers are having to think green in all aspects of operations, from upgrading existing appliances to installing new infrastructure such as solar panels and EV charging points.

Going green – H1 ESG deals

In April, Nasdaq-listed Blink Charging acquired Electric Blue (EB Charging) to gain a foothold in the UK. The deal adds more than 1,150 chargers to Blink’s footprint and provides access to clients such as local authorities, NHS healthcare trusts, universities and private fleets. We provided sell-side advisory services.

In May 2022, NYSE listed Johnson Controls acquired Asset Plus to “supercharge its UK decarbonisation strategy”. Asset Plus provides strategy and project management for energy efficiency measures and retrofitting. Its clients include the NHS, educational establishments, and local authorities. We provided sell-side advisory services.

In June 2022, Mitie Group acquired Custom Solar, a solar power solutions company specialising in the development, design, installation, and maintenance of solar power systems for public and private sector clients. The deal is part of Mitie’s ambition to be a leading provider of end-to-end green energy solutions, having previously acquired Rock Power Connections in November 2021 as part of building out its EV charging capabilities.

Other deals in this space include RSK’s acquisition of Optisol and Agility Eco’s acquisition of Alto Energy.

We expect to see more PE activity in the decarbonisation and energy management space in the coming months.  

UK FM quoted companies fare better than the rest of the market

Post pandemic our index of FM quoted companies bounced back ahead of the FTSE main index. FM stocks remain favoured by investors demonstrating the robustness of the sector in uncertain times.

Looking ahead

Of course, no sector is completely sheltered from economic headwinds. FM is subject to the same pressures concerning materials and wage inflation and employee retention as other sectors.

Investors are seeking companies that are dealing with these issues. In response, several of our clients are exploring ways of reducing attrition, such as increased investment in training and development. Privately owned companies are also looking for alternative ways to incentivise employees, for example by moving to an employee-owned trust model.

Overall, however, we see every reason for FM and the built environment services’ sectors record-breaking run to continue for the foreseeable future.

For more information and guidance, get in touch with Usman Malik.

Facilities management accounts for around 7.5% of UK GDP (depending upon how it's measured). Pre-pandemic it was predicted to demonstrate a compound annual growth rate (CAGR) of 1.42% until 2026. However, the sector now finds itself in a position of sizeable exposure to macroeconomic events. Can it still achieve its forecast growth?

What economic factors are driving change?

COVID-19 still stretching firms’ ability to function smoothly

Pre-pandemic in 2020, the UK facilities management market was valued at £47.2 billion. However, a 2022 report from MTW Research has found that the pandemic alone will account for £11 billion in lost revenue by 2026. Furthermore, due to post-COVID-19 hygiene requirements and national living wage pressure, the Building Cost Information Service (BCIS) predicts cleaning costs will rise 24.4% by the end of 2026, and 6.5% in 2022 alone.

Repairs and maintenance costs in adapting to hybrid working

Working models have undergone seismic change, perhaps permanently. Accordingly, FMs should anticipate adapting physical spaces, working culture and technologies – including artificial intelligence, automation and  Internet of Things (IoT) – to accommodate this shift. This will likely generate growth in repairs and maintenance (R&M) costs in the short run. In the long term, however, BCIS predicts that reduced in-person requirements will cause a modest decline in R&M of around 0.7% by 2026 but increase by 4.2% in 2022, given the demand and size of undertaking to adapt to these models. Such overhauls have led bundled FM contractors to dominate the market, with 15% market share, but have encouraged the emergence of specialist offerings from contractors.

Inflation and wage growth set to have wide impact in FM

ONS figures show inflation growing to 9%, and at a significantly faster monthly rate of 2.5% in April 2022 compared with 0.6% in April 2021. Given the massive scale and remit of facilities management, costs can be expected to increase everywhere. The cost-of-living crisis has also generated significant growth in labour costs, as wages must increase to keep pace with inflation. Even preceding national minimum wage and national living wage increases beginning in April, the ONS found real average total pay growth increased 1.4% in Q1 2022. To this end, BCIS primarily attributes a predicted 3.5% rise in maintenance costs in 2022 to wage growth.

Recession risk may revise positive growth prospects

Inflation triggers a perfect storm for FM firms. As interest rates begin to rise to manage inflation so borrowing costs increase, which increases repayments for variable rate loans and disincentivises investment. This creates conflict with the need to adjust facilities post-pandemic. Even so, MTW Research expects real-term growth from mid-2022 onwards for FM, which should outpace inflation by 2023. This will, however, likely depend on the extent to which a recessionary environment follows the current inflation shock.

What can FM firms do now?

Facilities management firms should be open to mobility. Savills notes an uptick in fitting costs and service charges globally while land prices remain at record highs – this is compounded by the end of the stamp duty holiday and rising interest rates. Even for rental spaces, it’s likely that landlords will pass through these costs through higher rent. Consequently, it may be beneficial to relocate (and potentially downsize) offices, which can accommodate an increasingly flexible labour force.

However, FM leaders also need to consider potential detriment to talent retention. Compounding relocation prospects with wage inflation, hybrid working and both pecuniary and non-pecuniary competitiveness, firms should ensure they can attract and retain employees to meet demand and grow.

Following the COP26 climate summit, there is a renewed onus on ensuring that new initiatives are achieved sustainably under increasing governmental scrutiny. As facilities management businesses look to reconfigure working models, now is the perfect time to integrate this goal. Ultimately, FMs must be patient and gather ample data to make well informed decisions regarding sustainable operating strategies while navigating the next few years.

MTW Research projects that the facilities management sector will reach 98% of pre-pandemic sales in 2022. Considering the web of complexities which lie ahead, this would be a positive outcome. To deliver on these forecasts, agility and innovation will be essential given the nature of the economic headwinds that will directly and indirectly impact the sector.

With UK inflation set to reach a 40-year high of 11% in the autumn, and predictions of rising interest rates and recession, facilities management financial officers and treasury teams may be concerned with the implications for financing.

It’s important to bring some perspective, however. The UK economy has recovered the GDP decline experienced during the pandemic. UK GDP is higher now than it was in Q4 2019, according to ONS. The negative sentiment on economic growth stems from the month-on-month GDP growth rates being negative: March GDP growth was -0.2%, followed by April GDP growth of -0.3%. And there’s been a slew of negative business confidence surveys and the projected impact of the cost-of-living squeeze on consumer spending.

Facilities management businesses have also shown resilience through the pandemic disruption and the major listed FM groups have reported strong results of trading performance over the past year. Lenders have historically viewed the FM sector’s contracted revenue and cash flows as an attractive credit proposition. They will also be aware that management teams have streamlined cost bases to offer a more efficient business model for future profitability for post-pandemic period. Moreover, FM businesses have also used contractual indexation provisions to pass some inflationary cost rises on to clients. Moreover, many FM businesses are finding that the ESG agenda is creating new pipeline opportunities from existing and new customers.

As part of their credit considerations for the changing economic climate, lenders will be focusing on the following key downside risk considerations for FM businesses.

Six risks affecting lenders’ credit considerations in FM

1 Contract renewals

Lending facilities that were extended during the pandemic will be approaching maturity over the next 18 to 24 months. Lenders will be focusing on how that facility maturity wall compares with the businesses’ contract maturity and renewal wall. There’ll be concern over contract churn as clients review their own cost base and seek to renegotiate terms following their own cost pressures. Lenders will therefore be closely following contract churn and changes to terms on contract renewals.

2 Staffing

In soft FM businesses lenders will want to understand how operations and service delivery is being affected by high staff churn and any staffing shortages, and what implications this will have for overall contracted service levels.

3 Time lag and inability to pass through all cost increases

Lenders understand that it’s difficult for all inflationary cost increases to be passed through under contractual provisions for inflationary rises. This will inevitably squeeze contract margins and impact net operating cash flows. Lenders will want to understand how management is incorporating product substitution and productivity gains to address and maintain contract margins.

4 Outsourced catering and food service

The prospects for outsourced catering, which is predominately office-based, will be reliant on a return to office working. While more workers have returned to the office during 2022, this segment of the FM market will be structurally affected by the changing working patterns, and the segment is unlikely to recover to pre-pandemic levels.

5 Realism of growth plans and stress testing

In the context of a stagflation outlook, lenders will expect realistic growth plans to underpin lending proposals. They’ll want to understand the robustness of those plans against stress testing for revenue and cost downside sensitivities. It will be important for management to pre-empt the lender questions with appropriate scenario analysis within their lending proposals and to articulate what mitigating actions they’d take in downside scenarios. An independent assessment of those business plans and financial forecasts provides independent assurance to lenders’ credit considerations and may be required by lenders.

6 Working capital and pandemic liabilities

Many businesses have good cash reserves and headroom against facility commitments. But, as the trading environment becomes more challenging, lenders will be concerned about contractual clients stretching payments and collections slowing. Therefore, lenders will want to understand how the working capital cycle of a business is being affected and seek to get clarity on liquidity outlook as part of their credit considerations. If there’s an overhang of pandemic liabilities to HMRC or other creditors, lenders will expect transparency on how those liabilities will be addressed from forecast cash flows, and will scrutinise the total leverage on the balance sheet.

As lenders recalibrate their appetite for the bearish economic outlook, it’s critical that FM businesses give appropriate consideration and plan ahead for any refinancings due in the next two years or planned growth financings. Borrowing proposals will need to robustly address lenders' concerns for the economic headwinds ahead.  

For more insight and guidance, get in touch with Senthil Alagar.

 

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