GT - Facilities Management Q1 2012 M&A overview

FM

1 FM Quarterly Update - Issue 2

Insights intofacilities managementIS

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Continuing challengesAnecdotal reports from across the Grant Thornton network leave no doubt that the facilities management (FM) sector is continuing to face significant market challenges, with little sign of any respite. In the public sector spending cuts are certainly beginning to bite and this is hurting both margins and working capital lines. Meanwhile, margins in the private sector are also under major pressure as falling sales drive many large businesses to review their procurement processes.

• 2011 M&A overview

• Quoted FM tracker

• Internationalisation

• OCS: a global outlook

• Public Sector - driving the pace of change

David AscottPartner, Corporate FinanceGrant Thornton UK LLP

Q1 2012 M&A overviewPursuing scale and niche capabilitiesConsistent deal volumes in challenging conditions

While M&A activity in the sector may not be reaching pre-crisis levels, it is certainly showing a consistency that has been absent for several years. In the first three months of this year 23 FM sector transactions were recorded – up slightly from the final quarter of 2011 and the fifth successive quarter to see 20 or more deals done. The Q1 volume is also higher than the average quarterly total in both 2009 and 2010. At £121 million, the value of Q1 deals also compares favourably to the previous periods, though the scarcity of larger deals is a persistent theme in these debt-strapped

times, and as a result the annual total for 2012 is likely to remain subdued. The largest disclosed deal to take place in the first quarter was the LDC-backed management buyout of Airline Services Holdings in a deal that valued the business at some £30m.

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Subsector highlights: security and utilities deals stand out

In volume terms hard FM subsectors continue to dominate the market, but one exception to this was visible in Q1, when five deals in the security subsector were recorded. In the current market conditions, this level of activity is perhaps not so surprising: alongside other areas such as cleaning and catering, security companies effectively operate in a highly commoditised environment, with low barriers to entry and significant pressure on pricing. To survive in such conditions it is vital to build scale in order to maximise cost efficiencies and this is driving significant dealflow among mid-cap firms looking to boost their competitiveness. Although two of the five deals in Q1 were actually strategic acquisitions by large corporates (G4S and Capita plc), the remaining three were more typical examples of this trend towards the pursuit of scale.

On the hard FM side there was a notable spike in activity in the utilities subsector in Q1 after three straight quarters without a deal. Interestingly, in all five cases recorded, the transactions involved businesses operating in and around the energy consultancy area – a niche that has been tipped as a strong growth market for some time.

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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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Among them was the acquisition by MITIE of Utilyx Holdings for up to £16.2m in cash and earn-out payments. Right across British industry there is a growing focus on energy efficiency in the face of rising fuel and energy costs, and consultancy/advisory businesses that provide this expertise are increasingly attractive. Q1 also saw some activity in the environmental compliance and recycling space – effectively another facet of the energy management industry. For some operators, acquiring expertise in the provision of non-discretionary environmental compliance services could offer the potential to up-sell higher value energy-related services.

Domestic M&A dominates, PE buyers hang back

For the first time since Q4 2010, all of the M&A activity registered in this latest quarter was driven by domestic acquirers. While this may not be a unique occurrence over the last few years, it is relatively rare and may well point to the fact that foreign acquirers are looking on the UK FM market with increasing caution. It is also likely that many international bidders would struggle to compete in competitive processes given the synergistic advantages strong domestic bidders hold.

Other Hard FM

Utilities

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Maintenance/Fit-out

Other Soft FM

Security

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Source: Zephyr

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UK Facilities Management transactions by subsector 2011-2012 by quarter

UK Facilities Management transactions Q1 2012 by subsector

Other Hard FM

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UK Facilities Management transactions 2009-2012 by acquiror type

UK PE International

Source: Zephyr

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Meanwhile another important class of buyer that is certainly taking more of a back seat role in the current market is the private equity industry. Despite the fact that many financial buyers are still sitting on large reserves of unspent capital, the number of PE-backed deals is clearly dwindling – down to just three in Q1 2012 (from six in Q1 2011 and ten in Q1 2010). Given the continuing problems in the debt markets, which are severely restricting the amount of leverage PE houses can raise to support their acquisitions, they are simply not as competitive as they once might have been, especially when up against well-funded corporate buyers. Another factor which may be discouraging PE buyers from deploying some of their capital in the FM sector is that in the process of tendering for contracts the often highly-geared

PE-backed businesses can be viewed by the potential clients as being more risky and therefore are unable to be as competitive. Nevertheless, as the £17m acquisition of Garretts International by Growth Capital Partners underlines, appetite for high quality businesses operating in niche areas remains high. In addition, as Lyceum Capital demonstrated at the very end of 2011 with its acquisition of Drain Control Ltd, PE buyers are likely to remain active in the search for opportunities to build scale for the FM platforms.

However, despite the undoubted challenges posed by the market conditions as we move into the second quarter of 2012, all the indications are that the M&A market in the FM sector will remain a relatively lively area as operators do their utmost to offset the pressure on margins.

It’s encouraging to see consistent levels of M&A in the facilities management market at present. The large UK FM providers like MITIE, Capita, OCS and G4S remain especially active and have continued in this first quarter to bolster their service offerings, either by adding scale or niche capabilities. Although numbers might be down, private equity houses have also demonstrated a continuing appetite for deals in the space, completed both bolt-on acquisitions for their FM platforms or seeking out strong operators in niche areas.

David AscottPartner, Corporate FinanceGrant Thornton UK LLP

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Quoted FM tracker

Market capitalisation and earnings

In terms of market capitalisation, the three largest FM groups on our quoted tracker all sit comfortably within the FTSE 100. The largest of them - Compass Group - has had a strong start to the calendar year. According to its latest trading updates, the group’s growth track remains robust, driven by strong new business and retention figures, as well as by acquisitions.

Overall, Compass’ market cap has risen by just under 7% from the time of the last snapshot from £11.6bn to £12.4bn. Serco, which ranks third on this list after G4S has also seen growth in its market capital in the last three months, from £2.36bn to £2.70bn. During February Serco released its final 2011 results, which showed a 7.4% growth in overall revenues and a 10.3% growth in operating profit. Of the remaining businesses on the tracker, four currently have a capitalisation of £1bn or more,

Quoted FM tracker at 30 March 2012

while two sit between £500m and £1bn. The remainder are firmly in the mid- and small-cap brackets.

All of the businesses in the sample are profitable and over half of those where a PE ratio is known outperform the FTSE 100 average of 9.75x. Among the stand-out performers by this measure are the most profitable group overall, Compass, with a PE of 16.8x, and London Security, with a PE of 17.2x and an EV/EBIT ratio of 10.36x.

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

Name £m £m £m £m % % % %Compass Group PLC 12,377.9 15,833 1,339.0 1,073.0 7.3% 25.8% 17.0% 24.6%G4S PLC 3,844.1 7,397.0 633.0 397.0 0.3% 2.1% 6.7% 4.2%Serco Group PLC 2,701 4,327 324 241 14.5% 6.3% (2.8%) (9.7%)Balfour Beatty PLC 1,962.4 9,494.0 306.0 170.0 7.8% 11.7% (17.0%) (2.3%)Rentokil Initial PLC 1,549.0 2,544 431.3 179.6 36.2% 19.1% (5.2%) (34.6%)Carillion PLC 1,284 4,153 201.1 138.8 (0.8%) (10.8%) (21.5%) (8.7%)MITIE Group PLC 1,011 1,891 128.0 99.3 15.0% 19.5% 42.2% 22.2%Berendsen PLC 897 992 306.2 112.7 19.9% 21.3% 8.5% 23.4%Homeserve PLC 770.0 467.1 121.3 101.4 (18.5%) (49.2%) (47.5%) (34.9%)Interserve PLC 369 1,848 91.3 56.2 (9.2%) (3.2%) 5.8% 34.4%London Security PLC 226.8 85.5 22.6 19.3 2.4% 5.7% 26.5% 134.9%Mears Group PLC 223.3 524 34.9 21.2 16.1% (7.9%) 4.8% (8.8%)May Gurney Integrated Services PLC 192.4 571.4 33.8 22.9 (2.6%) (1.4%) 5.4% 16.6%Johnson Service Group PLC 77.7 234 39.3 15.9 14.6% 0.8% (7.6%) 58.4%Interior Services Group PLC 45.1 1,195.6 14.5 10.4 (16.9%) (21.7%) (31.8%) (18.7%)Mouchel Group PLC 10.6 539.6 81.7 64.3 70.4% (73.2%) (90.1%) (94.9%)

FTSE 100 3.5% 12.5% (2.4%) 1.6%FTSE All Share Support Services 15.1% 23.4% 10.0% 24.4%

Source: Factset; Datastream. Market data as at 30 March 2012; Financial data as at last announced financial close

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Share performance

Although share price performance among the sample is mixed over the six-month and one-year periods analysed, they hold up well in the longer-term two-year analysis, averaging a 6.1% growth, compared with 1.6% across the FTSE 100. The differential in the latest quarter is even more pronounced, with the sample averaging a 10.2% growth in share prices compared with 3.5% for the FTSE 100. In all cases the FTSE All Share Support Services index outperforms both the FTSE 100 and the sample quite considerably.

Looking at individual cases, the first quarter of 2012 has proved to be a solid one for most of the sample businesses in the £1bn+ (market cap) bracket. Only Carillion saw any fall in share price, while G4S stayed flat. Of the large cap firms, Rentokil Initial saw the most robust share performance, with prices up by 36.2% over the end of the previous quarter. Serco Group also performed well with a 14.5% rise in stock price. Compass Group continues to perform solidly, with 7.3% rise in stock over the three-month view and an impressive 24.6% over the two-year period.

At the other end of the scale only two businesses saw any significant downward movement in share price in Q1: the larger of them, Homeserve, dropped 18.5% in Q1, while Interior Services Group slipped back by nearly 17%.

*Methodology

This analysis is designed to offer a broad overview of the quoted FM sector. It focuses on a snapshot of data on a 17-strong sample of businesses that best represent the broad range of activities within the sector as a whole. The snapshot for this quarterly edition was taken at the close of business on 30 March 2012.

Internationalisation: seeking growth overseas

The comparatively robust performance shown by many of the larger quoted FM businesses belies the extent to which they have been impacted by the on-going changes in FM business models. The shift towards joint working business models, rather than wholesale outsourcing, is clearly biting and the optimism of just a few years ago has steadily been eroded as the anticipated volumes of outsourced work from the public sector have not yet materialised. Looking ahead, there is clearly still uncertainty surrounding the UK market and its ability to deliver growth. So where are the bigger players going to have to look for their growth?

Although the M&A statistics have yet to reflect internationalisation in any major way (with activity from only OCS and Compass in the last quarter*), what we are hearing across the larger cap market is that these businesses are increasingly looking to international markets to drive growth. Serco, for example, which has targeted domestic savings by stripping out layers from its UK-based management structures, has gone on record to state that the only major growth it anticipates will be from its international operations. G4S, too, attributes much of its recent organic growth to emerging markets, with muted growth in its core territories, while OCS has recently shown itself to be actively pursuing cross-border acquisitions (see case study). Against this backdrop, as well as the latest fears surrounding a possible double-dip recession, it seems likely that the larger UK FM businesses will continue to internationalise, thereby driving outbound M&A activity in the quarters to come.

Martin GardnerPartner, Business Risk ServicesGrant Thornton UK LLP

*Source Zephyr


OCS: a family-owned company with a global outlook

The FM market in the UK is undoubtedly a challenging place to be at the moment. In such a mature market everyone has to work harder than ever to maintain margins, and this is making it a highly competitive space. Of course on the flip side, while the market may be tough, it is also creating an environment rich in innovation and the drive for greater efficiencies through product improvements and contract re-engineering is generating real opportunities to build stronger, closer relationships with our clients. Another advantage has been the drive for consolidation and OCS has benefited from this, in particular with our acquisition of Legion security in 2010 and Fountain horticulture in February of this year.

But nowadays, despite being a UK private company with a 112-year history, we increasingly see international markets as ‘home’ territories. OCS began to expand its geographical horizons over 30 years ago, initially via moves into countries like Thailand, though the pace of our international expansion did not hit top gear until much more recently: as a result of a series of important overseas investments over the last two or three years, we will generate two thirds of our work from overseas territories in 2012, compared with less than 40% in 2009.

Despite the fact that OCS now has a presence in some 40 countries globally, it is clear to us that the power is shifting Eastwards and therefore countries in the Asia Pacific region are at the heart of our growth strategy. These countries have fast-growing and increasingly affluent populations, yet typically have far less developed FM markets. As a result they offer a great opportunity for FM businesses that have both the skill-sets and the nerve to take on the increased risk that operating in these markets can bring. Certainly, individual territories can present a whole host of non-industry-related risks and a ‘one size fits all’ approach will simply not work. At a basic level there is the purely economic risk created by less economically developed countries. At the same time there are also more complex political and structural risks (i.e. labour and border controls), as well as cultural hurdles and restrictive regulations surrounding what overseas entities can and cannot do. However, these are risks we are prepared to face and in our view, being a family-owned business offers certain advantages, particularly in terms of business culture.

Overall, we are confident that the number of M&A deals will remain strong in the FM sector whether these are in the UK or overseas, because they are being driven by the same overriding trends towards globalisation and a recognition that pursuing growth by organic means or via start-up may not keep pace with market developments. It is something we have to accept: there will be further consolidation and we will have to get used to working in a smaller world.

Chris Cracknell, Chief ExecutiveRod Holdsworth Group Finance Director, OCS


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Public sector: driving the pace of change in the FM industry

Despite what it may seem like, it wasn’t so long ago that we were ushering in a new government after many years of Labour administration. At the time, it is probably fair to say that the FM industry collectively expected to see a growing number of new opportunities to engage with the public sector, with fiscal and cost pressures leading it to outsource more. But the scale of the economic challenges over the last couple of years means it has not been as easy a ride as many had hoped. In fact, some areas have even seen the market turn the other way, with insourcing taking place; in social housing, for example, we have seen housing associations taking more control and bringing some services back in-house from external contractors.

And it looks as if the public sector will continue to force the pace of change as the government looks to roll out a major drive for value for money in its procurement and outsourcing processes. But how will this shake up effect FM providers in the UK? Will it encourage a new wave of innovation and dynamism among UK providers or will bold public sector plans prove a step too far and add major strategic uncertainty to the already difficult economic environment?

Paying for results not activity

One of the clearest new examples of the government looking to achieve value for money is the move towards ‘payment for outcome’ contracts under which financial payments are tied to achieving policy outcomes rather than merely providing a process. Under these programmes, the likes of which are already being trialled by contractors providing re-employment services, the government can be much clearer as to what it is getting for its money. From the public sector perspective it also achieves a level of risk transfer, as the outsourcing agent is incentivised to deliver results, not just carry out a process.

The Ministry of Justice has also taken up the rallying call for this kind of change, indicating that it would like to move to payment-by-results as its commissioning model for all contracts from 2015 and is already trialling a number of pilots with public and private sector agencies in the running of prisons and probation services. Under this model, a significant element of the payment is based on reducing rates of re-offending.

Bold moves create opportunities...

An important part of this new thinking is that focusing on the outcome will encourage both private and public sector contractors to innovate. However, there is also the recognition by some that solving these highly complex social problems cannot simply be achieved by the private sector alone, and delivering such innovation needs more effective links between the public and private sectors. This is creating opportunities to build new business models, such as strategic partnerships or joint ventures between the public and private sectors. For example, the Prison Service is partnering with MITIE and Working Links to bid for the operation of existing prisons, nine of which are currently up for tender.

With commercial return linked to outcomes, transparency will be absolutely vital for these new ventures and models to work and this will require sophisticated data, reporting and monitoring systems. And this is certainly one area in which the private sector arguably holds the upper hand.

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It may even be the case that the private equity industry has a role to play in these new ventures by importing across the sort of rigorous reporting disciplines put in place in typical PE-backed businesses.

..but also challenges

However, given the sheer scale and boldness of the government’s philosophy shift there remains significant doubt about how – and perhaps even whether - the changes will come to fruition in the medium and long term. To begin with the changes may not work for everyone in the private sector. The shift to payments for outcome requires contractors to absorb significantly higher levels of both risk and up-front investment. This may effectively restrict the opportunities to the larger, multi-disciplinary FM providers, thereby leaving smaller specialist players on the peripheries. Ultimately this would also further fuel the trend towards consolidation within the sector, resulting in the building of more powerful, multi-faceted FM organisations. We have seen similar pressures on the voluntary sector, which also lacks the financial strength to take on more risk from the public sector. It is also possible that the changes might lead to a different competitive

environment in other ways. With the contracts being tendered out to both public and private sector entities, the former (in many cases the incumbent providers) are effectively being market tested. Having to fight to maintain their share of public sector spending could make them much more efficient, heavyweight players, which could spell trouble for private sector competitors. The health sector looks like such a battleground, with patient choice being extended into community and mental health service under the Any Qualified Provider regime.But perhaps the most important overriding concern surrounds whether or not the present administration has the will to push such far-reaching changes through. The Health and Social Care Act 2011 was, for example passed last month, but only after major amendment by parliament. Certainly, there are many that do not support such fundamental shifts and resistance from both within the public sector and the unions is to be expected. As a result, it is quite possible that the gradual unfolding of the full implications will encourage many in government to hold back on the pace of change. Whatever the outcome, both mid-cap and larger private sector FM businesses will need to follow the developments in the public sector very closely.

Neil RutledgePartner, Government & Infrastructure Advisory ServicesGrant Thornton UK LLP

FMContactsFor 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.

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Grant Thornton is a member firm of Grant Thornton International Ltd (Grant Thornton International). References to ‘Grant Thornton’ are to the brand under which the Grant Thornton member firms operate and refer to one or more member firms, as the context requires. Grant Thornton International and the member firms are not a worldwide partnership. Services are delivered independently by member firms, 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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GT - Facilities Management Q1 2012 M&A overview

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