A record level of mergers and acquisitions in the engineering and construction sectors has U.S. companies navigating an entirely new competitive landscape, finds a new report from FMI Capital Advisors Inc., FMI Corp.’s investment banking subsidiary.

M&As in the sector have more or less hovered at the same levels from the end of the Great Recession to 2017, with somewhere between 390 and 440 deals annually. But last year a record 534 transactions were announced — a 26.5% increase over 2017 and the highest level ever recorded, according to FMI’s 2019 M&A Trends for Engineering and Construction report.

Demographics are partially behind this spike as baby boomers retire and succession plans kick in, the report shows. Meanwhile, a highly competitive environment is fueling buyer interest, as firms look to differentiate themselves by growing their capabilities and scale.

New strategy for a changed competitive landscape

To take advantage of a strong economy before it tips into uncertainty in the coming years, construction and engineering firms are reassessing their corporate strategies to give more weight to core strengths and capabilities, the report said. This includes not just acquisitions but also a shedding of noncore assets.

Jacobs Engineering Group, for example, acquired CH2M Hill for $2.8 billion in 2017, and subsequently divested its energy, chemicals and resources business to WorleyParsons for $3.3 billion in 2018. “This transaction marks an inflection point in our portfolio transformation focused on more consistent, higher-margin growth,” said Jacobs Chairman and CEO Steve Demetriou in a letter announcing the latter deal.

Deals like this send ripples through the competitive environment. In fact, almost two-thirds of respondents said one of their competitors had been acquired in the past three years, including companies like MWH Global (acquired by Stantec), Parsons Brinckerhoff (acquired by WSP) and Layne Christensen Co. (acquired by Granite Construction Inc.). This type of consolidation takes place, according to FMI, “as firms address customers’ desire for large firms offering an integrated, single-source solution.”

Companies can also see better employee retention with the growth opportunities such transactions present, the study noted. At the time of Granite’s acquisition, Layne Christensen CEO and President Michael J. Caliel said, “Our employees will benefit from the upside and strong growth prospects of being part of a larger infrastructure company.”

Coming out of this active period, M&A activity is expected to “remain strong but likely to return to more regular levels in 2019 and beyond,” FMI found. Of the respondents, 60% said acquisitions factored into their current strategy, down from 70% in last year’s study.

More than half also said that their firms are less likely to acquire in 2019 than in 2018. That’s likely because a fair share of respondents had undergone and are adjusting to recent transactions; 20% had made an acquisition in the past year; and 40% within the past four years.

The trends ahead

The civil infrastructure and industrial sectors — in which the pressure to self-perform and find labor is high — are most ripe for acquisition activity this year, the study found. Buying appetite in the civil sector, specifically, was down in the second half of 2018 when it became clear that a federal infrastructure bill wouldn’t come through. Elevated interest this year may signal optimism that a package will be passed soon.

In addition, the western, southwestern and southeastern U.S. regions are drawing the bulk of their interest from the 80% of firms looking to expand geographically, the report said.

Vertical integration is the theme for acquisitive companies, which are looking to the pool of MEP contractors, energy service companies, and building technology providers for firms that standout for their technology implementation, according to FMI.

“More and more, we are seeing acquirers target those specialty contractors who have demonstrated success in navigating the changing IT landscape within construction,” said FMI Capital Advisors’ Managing Director Ryan Foley. “Those MEPs who embrace BIM, complex data center expertise and prefab capabilities have become hot prospects for interested buyers in the built environment.”

In addition, more than half of respondents indicated they’re thinking about acquiring a technology solution or commercializing an in-house technology solution.

“E&C firms need technology as a differentiator to win projects, not just deliver them,” Kaustubh Pandya, principal at Brick & Mortar Ventures, told Construction Dive, adding that the market is brimming with investment from both venture capital firms and corporate investors. His firm, which targets innovative software and hardware solutions for the AEC and facilities management industries, recently raised a new $97 million fund. “We are just getting started,” Pandya said.

Finally, wider acceptance of integrated delivery methods is pushing contractors toward partnerships that bring design capabilities in-house, according to the study. FMI’s Design-Build Utilization report from June 2018 predicted that design-build will represent almost half of construction spending across a wide range of markets by 2021.

Katerra is the most extreme example of firms looking to profit off this trend toward integrated design, noted the M&A report. The tech-based modular design and construction firm was also named Construction Dive's Dealmaker of the Year in 2018. It acquired two general contractors, two architectural companies and two specialist firms last year to stack design, supply, manufacturing and assembly capabilities, and is now rumored to be worth $4 billion.