Business Valuation Trends in the Construction Industry
Not surprisingly, the construction industry goes as the economy goes. Lately, that has been challenging to say the least!
The Ontario construction and real estate industries employ over 400,000 people and the construction industry alone contributes $25 billion to Canada’s gross domestic product. Large sub-sectors include residential construction (permits valued at $12.4 billion) and nonresidential ($9.4 billion). Issues impacting the construction industry include material, equipment, insurance, and labor costs; land planning and acquisition; environmental regulations and building codes; worker safety; interest rate changes; and cash flow and liquidity management. Annual capital expenditures total $6.9 billion.
Specific to the construction industry, Ontario has actually seen a 3.6% decline in the number of jobs in December 2012 relative to December 2011.
What does all this mean relative to business values within the construction industry?
First and foremost, getting paid for the intrinsic (ie – goodwill) portion of your business is more difficult in the construction industry than almost any other. The competitive nature of the industry ensures that “excess profits” are more difficult to maintain and it is the profit in excess of a reasonable return on time and resources that drives value above the value of the underlying assets of the business.
Specific industry metrics that can impact this include your company’s economic cycle, leverage, number of projects per year, profit per project, conversion rate and labour relations.
The best companies exhibit many, if not all of the following characteristics:
1) Their economic cycle is relatively smooth with minimal peaks and valleys. They convert revenue to cash better than the average and are in market segments that are more resilient relative to the general economy.
2) Working capital requirements are well managed and cycle so that there is not a large “permanent” owner investment required.
3) They do not rely on only a few projects to make up the bulk of work each year. Diversification is critical and a large number of projects that are not reliant on the owner/manager to be obtained will enhance value. It also helps tremendously if you don’t rely heavily on bid contracts.
4) Profit comes from many projects rather than only a few large “winners” masking many other below average contracts. A high reliance on fixed price contracts will negatively impact value.
5) A history of winning a high percentage of work bid on. This particularly holds true in niche areas that can be maintained after sale.
6) Whether union or non-union, a history of stable labour relations and well managed manpower is very important.
Valuation multiples can vary significantly and are often specific to the niche business sector and size of company, as well as other factors including those noted above. What is clear is that valuation multiples have dropped significantly since the heady days of the late 1990s.
To illustrate we have examined data related to private company acquisitions by other private companies. Therefore, this data excludes acquisitions by public companies as they often pay a higher multiple than is the case in private company acquisitions. We do this as most private companies are not large enough to attract the interest of a public company acquirer.
Market Value of Invested Capital (MVIC) is the total consideration paid including any interest bearing liabilities assumed by the buyer.
MVIC multiples of Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) for all industries averaged 4.47 times in 2007, but have been less than 3 times EBITDA for each of 2009 through 2012.
What should you do?
Start with a realistic determination of the fair market value of your tangible assets less liabilities. That should set the floor price for your business. The ability to get more than that will depend on the factors addressed above and the strength of your negotiating position. A strong team, coupled with multiple suitors is necessary to maximize value. Advance planning is also very important. Therefore start the process at least two years before you really want to consummate a transaction.
The content of this article is intended for educational purpose only and should not be relied upon as a substitute for specialized advice in connection with any particular matter. Although the material has been carefully prepared, the writer and Firm do not accept any legal responsibility for its contents and for any consequences arising from its use.
Sources: First Research, Statistics Canada, Business Valuation Resources, CCC Investment Banking