Latest:
Support wanted
17:03 14 Mar 2003
|
A year is a long time in the City. Twelve months ago, the support
services sector was seen as the promised land for construction
companies. Seduced by its high margins and the extra credibility it
offered their PFI bids, many had bought into the sector and happily
watched their share prices rocket.
But then it all turned sour. Amey's accounting scandals, the train crash at Potters' Bar and increasing concern about the bid costs involved in PFI projects, particularly on the London Underground, caused uncertainty to sweep through the City. Against the background of a bear market, most of the big support services players - which invariably had hefty PFI commitments as well - saw their stocks plummet during the second half of the year.
The question is, how much of that crash was down to widespread panic in the City, which saw the whole support services industry dragged down by the problems of just a few? In which case, will 2003 see a recovery?
Andrew Nussey, support services analyst at Arburthnot, is cautiously optimistic. He concedes that the support services sector was "unfairly tarnished" by the problems of Amey in particular. But he suggests there is a general consensus in the City that the support services market was grossly overvalued this time last year. Amey, for instance, was trading at 27 times its projected earnings in March 2002.
And he makes it clear that the City will not stand another company that tries it on with similar confusing accounting practices. "The bottom line is still a secure long-term forward orderbook, but importantly, a high degree of marginal visibility," says Nussey.
Cashflow problems
He is concerned that some firms that have bought into the support services market in the past few years, particularly on the soft FM side, have underestimated the high level of investment required in the early years of such contracts. This, he continues, can lead to problems with cashflow, particularly if the company in question is also trying to service costly PFI bids.
Amey is the classic example of that. Despite a high forward orderbook, its cashflow problems have brought the company to its knees, with its share price plummeting from more than 400p a year ago to just 17.5p last month.
The group has been forced to sell off various parts of the business, including its PFI equity stake to John Laing for £29m most recently. With questions still hanging over some of its other activities, notably Croydon Tramlink, the company may yet be forced to sell off its most prized asset - its roads business.
Amey's Tube Lines stablemate Jarvis has also suffered a heavy fall from grace, after being one of the most consistent performers on the support services market since transferring from construction four years ago.
The Tube bid costs are part of the story, but more damaging has been the fall out since the train crash at Potter's Bar last spring. The big worry for Jarvis, aside from the possibility that Network Rail may take all of its infrastructure maintenance contracts back in-house, is that its wider businesses may be affected by the impact of the rail disaster.
However, Jarvis Workspace FM regional director Paul Cottam feels the company is still well placed. "We've been operating in this market for much longer than many of the more recent entrants to support services," he says, "so we know what to look out for when we bid for work. For example, we won't touch contracts that are less than five years' duration because we know it's very difficult to get payback on our investment over the contract. But there are firms that will take contracts for three years or less."
He also believes that Jarvis's strategy of building its reputation in key market sectors will stand it in good stead. "We built the first PFI school in Dorset, we've invested a great deal in that sector, and we've gone on to being a leading player in PFI schools," he points out.
PFI still the driver
PFI remains the main driver for construction companies looking to make acquisitions or build up their support services businesses, although to varying degrees.
Interserve, for instance, expanded its FM capability cautiously on the back of PFI deals, then boosted its capacity enormously with the purchase of FM specialist Building & Property Group in December 2000.
Now FM accounts for almost half the group's billion-pound turnover and has helped the company become a key player in the PFI and support services markets, picking up deals such as January's £250m Army Sixth Form College PFI, which might once have been expected to go elsewhere.
The group feels confident enough to look for white-collar FM businesses to complement its existing blue-collar capabilities. Executive director John Vyse says: "Because there are clients that want companies to take on payroll management, accounting requirements or IT support, it is an area that we are looking to become more involved in."
The idea of being able to offer clients a complete, total FM service has also driven John Mowlem's aggressive FM acquisition drive. The group has made a series of FM purchases over the past few years, the most significant being the £42m buy of the Pall Mall cleaning business in 2001.
"There is an increasing tendency in the market to bundle contracts together - everything from the cleaning to the M&E," explains Mowlem development director Arthur Moore. "But that's not to say everyone will go down that route; different people want different things. However, with our wide portfolio, we are well-placed to offer a solution to most clients."
Its FM companies also give Mowlem added weight in its PFI bids. But the group believes there is another very good reason why having such a broad portfolio of clients will serve it well: it sees the opportunity for cross-selling among its various businesses. For example, if the group's piling business wins a contract for the groundworks of a new supermarket, then Mowlem should be well placed to bid for the cleaning contract when the supermarket is built.
The jury is still out as to how successful this latter strategy will be. But the signs are that Mowlem is becoming increasingly competitive in the FM market. Last October, Mowlem Aqumen, the group's FM company, was appointed by HSBC to maintain almost 2,000 of its branches and offices for five years in a deal worth £400m.
So does that mean the City will react positively to further soft FM acquisitions by construction companies? In the past few years it has: Mowlem's share price shot up after its acquisition of Pall Mall, and a year ago, Alfred McAlpine's share price rose almost 10% after its acquisition of Stiell.
Arbuthnot's Nussey is doubtful if there will be the same share price hikes as in the past, but points out that for serious players in the support services market, acquisitions are the way forward, as a directly-owned labour force is the only way to ensure high-quality delivery of service standards.
"If you're in a long-term contract, particularly a 25-year PFI contract, you need reliability; you can't afford to rely on subcontractors, particularly with a looming skills shortage," he says.
But as an increasing number of firms enter the support services market, will its margins remain as high? One danger is that some firms may pay inflated prices for averagely-profitable FM companies, as the number of those available to buy shrinks. Even Alfred McAlpine's Stiell acquisition was hardly a bargain; it paid £85m for a firm with profits of just £5m.
The other more serious issue is that as the market becomes more crowded, particularly with players from a construction background, then a construction mentality on margins may take over.
Mowlem's Moore admits this is a worry. "The product lifecycle in FM is very quick - about five years - and as long as the product is changing and we are adding value for the client then it's fine.
"But when the product stops changing and effectively becomes a commodity then maybe we will see more pressure on margins."
This may become a particular concern among the lower-skilled FM services, such as cleaning.
Jarvis's Cottam however, believes that the longer-term nature of the contractual relationship will make support services contracts much less prone to a low-margin culture.
"Because FM is over a long term, you put in more investment, and build up a better relationship with the client - you get to understand each other's issues," he says. "By contrast, most construction contracts are much shorter, you've got less time to make things stack up financially, so the culture becomes much more adversarial."
No shortage of firms lured to FM
It seems as long as margins are high, there will be no shortage of construction firms lured towards FM. The likes of Carillion and Interserve have made it clear that they have ambitions to make acquisitions in the area.
As Mowlem's Moore says: "The support services sector was overvalued last year, but it still has far better earnings pound-for-pound than traditional contracting."
His company's construction business reported a 1.7% margin last year, which is considered almost healthy by industry standards. Carillion, for instance, could only return 0.3% on a £500m turnover in the first half of last year - little wonder it is hungry for FM acquisitions.
And with the commercial construction market shrinking, there will probably be even more incentive to move into support services.
"There's still a lot of opportunity in the support services sector," says Hussey, "and as 2003 develops, the long-term picture may begin to look much healthier. We will see more of the companies that entered the PFI and support services markets a few years ago start to get a return on their investments.
"Serco, for instance, the grandfather of blue-collar service providers, recently delivered a very healthy set of results, with a 20% increase in profits. That should be encouraging for the sector as a whole."
It is a sector that is still some way from realising its full potential (see box), and the government continues to encourage local authorities and other public sector bodies to outsource.
And conversely, while the commercial slowdown may not help construction, it may lead to increased outsourcing as private companies seek to cut overheads, thereby further boosting the private sector support services market. n
But then it all turned sour. Amey's accounting scandals, the train crash at Potters' Bar and increasing concern about the bid costs involved in PFI projects, particularly on the London Underground, caused uncertainty to sweep through the City. Against the background of a bear market, most of the big support services players - which invariably had hefty PFI commitments as well - saw their stocks plummet during the second half of the year.
ADVERTISEMENT
The question is, how much of that crash was down to widespread panic in the City, which saw the whole support services industry dragged down by the problems of just a few? In which case, will 2003 see a recovery?
Andrew Nussey, support services analyst at Arburthnot, is cautiously optimistic. He concedes that the support services sector was "unfairly tarnished" by the problems of Amey in particular. But he suggests there is a general consensus in the City that the support services market was grossly overvalued this time last year. Amey, for instance, was trading at 27 times its projected earnings in March 2002.
And he makes it clear that the City will not stand another company that tries it on with similar confusing accounting practices. "The bottom line is still a secure long-term forward orderbook, but importantly, a high degree of marginal visibility," says Nussey.
Cashflow problems
He is concerned that some firms that have bought into the support services market in the past few years, particularly on the soft FM side, have underestimated the high level of investment required in the early years of such contracts. This, he continues, can lead to problems with cashflow, particularly if the company in question is also trying to service costly PFI bids.
Amey is the classic example of that. Despite a high forward orderbook, its cashflow problems have brought the company to its knees, with its share price plummeting from more than 400p a year ago to just 17.5p last month.
The group has been forced to sell off various parts of the business, including its PFI equity stake to John Laing for £29m most recently. With questions still hanging over some of its other activities, notably Croydon Tramlink, the company may yet be forced to sell off its most prized asset - its roads business.
Amey's Tube Lines stablemate Jarvis has also suffered a heavy fall from grace, after being one of the most consistent performers on the support services market since transferring from construction four years ago.
The Tube bid costs are part of the story, but more damaging has been the fall out since the train crash at Potter's Bar last spring. The big worry for Jarvis, aside from the possibility that Network Rail may take all of its infrastructure maintenance contracts back in-house, is that its wider businesses may be affected by the impact of the rail disaster.
However, Jarvis Workspace FM regional director Paul Cottam feels the company is still well placed. "We've been operating in this market for much longer than many of the more recent entrants to support services," he says, "so we know what to look out for when we bid for work. For example, we won't touch contracts that are less than five years' duration because we know it's very difficult to get payback on our investment over the contract. But there are firms that will take contracts for three years or less."
He also believes that Jarvis's strategy of building its reputation in key market sectors will stand it in good stead. "We built the first PFI school in Dorset, we've invested a great deal in that sector, and we've gone on to being a leading player in PFI schools," he points out.
PFI still the driver
PFI remains the main driver for construction companies looking to make acquisitions or build up their support services businesses, although to varying degrees.
Interserve, for instance, expanded its FM capability cautiously on the back of PFI deals, then boosted its capacity enormously with the purchase of FM specialist Building & Property Group in December 2000.
Now FM accounts for almost half the group's billion-pound turnover and has helped the company become a key player in the PFI and support services markets, picking up deals such as January's £250m Army Sixth Form College PFI, which might once have been expected to go elsewhere.
The group feels confident enough to look for white-collar FM businesses to complement its existing blue-collar capabilities. Executive director John Vyse says: "Because there are clients that want companies to take on payroll management, accounting requirements or IT support, it is an area that we are looking to become more involved in."
The idea of being able to offer clients a complete, total FM service has also driven John Mowlem's aggressive FM acquisition drive. The group has made a series of FM purchases over the past few years, the most significant being the £42m buy of the Pall Mall cleaning business in 2001.
"There is an increasing tendency in the market to bundle contracts together - everything from the cleaning to the M&E," explains Mowlem development director Arthur Moore. "But that's not to say everyone will go down that route; different people want different things. However, with our wide portfolio, we are well-placed to offer a solution to most clients."
Its FM companies also give Mowlem added weight in its PFI bids. But the group believes there is another very good reason why having such a broad portfolio of clients will serve it well: it sees the opportunity for cross-selling among its various businesses. For example, if the group's piling business wins a contract for the groundworks of a new supermarket, then Mowlem should be well placed to bid for the cleaning contract when the supermarket is built.
The jury is still out as to how successful this latter strategy will be. But the signs are that Mowlem is becoming increasingly competitive in the FM market. Last October, Mowlem Aqumen, the group's FM company, was appointed by HSBC to maintain almost 2,000 of its branches and offices for five years in a deal worth £400m.
So does that mean the City will react positively to further soft FM acquisitions by construction companies? In the past few years it has: Mowlem's share price shot up after its acquisition of Pall Mall, and a year ago, Alfred McAlpine's share price rose almost 10% after its acquisition of Stiell.
Arbuthnot's Nussey is doubtful if there will be the same share price hikes as in the past, but points out that for serious players in the support services market, acquisitions are the way forward, as a directly-owned labour force is the only way to ensure high-quality delivery of service standards.
"If you're in a long-term contract, particularly a 25-year PFI contract, you need reliability; you can't afford to rely on subcontractors, particularly with a looming skills shortage," he says.
But as an increasing number of firms enter the support services market, will its margins remain as high? One danger is that some firms may pay inflated prices for averagely-profitable FM companies, as the number of those available to buy shrinks. Even Alfred McAlpine's Stiell acquisition was hardly a bargain; it paid £85m for a firm with profits of just £5m.
The other more serious issue is that as the market becomes more crowded, particularly with players from a construction background, then a construction mentality on margins may take over.
Mowlem's Moore admits this is a worry. "The product lifecycle in FM is very quick - about five years - and as long as the product is changing and we are adding value for the client then it's fine.
"But when the product stops changing and effectively becomes a commodity then maybe we will see more pressure on margins."
This may become a particular concern among the lower-skilled FM services, such as cleaning.
Jarvis's Cottam however, believes that the longer-term nature of the contractual relationship will make support services contracts much less prone to a low-margin culture.
"Because FM is over a long term, you put in more investment, and build up a better relationship with the client - you get to understand each other's issues," he says. "By contrast, most construction contracts are much shorter, you've got less time to make things stack up financially, so the culture becomes much more adversarial."
No shortage of firms lured to FM
It seems as long as margins are high, there will be no shortage of construction firms lured towards FM. The likes of Carillion and Interserve have made it clear that they have ambitions to make acquisitions in the area.
As Mowlem's Moore says: "The support services sector was overvalued last year, but it still has far better earnings pound-for-pound than traditional contracting."
His company's construction business reported a 1.7% margin last year, which is considered almost healthy by industry standards. Carillion, for instance, could only return 0.3% on a £500m turnover in the first half of last year - little wonder it is hungry for FM acquisitions.
And with the commercial construction market shrinking, there will probably be even more incentive to move into support services.
"There's still a lot of opportunity in the support services sector," says Hussey, "and as 2003 develops, the long-term picture may begin to look much healthier. We will see more of the companies that entered the PFI and support services markets a few years ago start to get a return on their investments.
"Serco, for instance, the grandfather of blue-collar service providers, recently delivered a very healthy set of results, with a 20% increase in profits. That should be encouraging for the sector as a whole."
It is a sector that is still some way from realising its full potential (see box), and the government continues to encourage local authorities and other public sector bodies to outsource.
And conversely, while the commercial slowdown may not help construction, it may lead to increased outsourcing as private companies seek to cut overheads, thereby further boosting the private sector support services market. n
ADVERTISEMENT
Most Viewed Articles
ADVERTISEMENT