FMInsights into. facilities management. Strong recovery in deal flow after slow quarters

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1 FMInsights into ISSUE facilities management Strong recovery in deal flow after slow quarters David Ascott Partner, Corporate Finance Grant Thornton UK LLP The downward trend in M&A activity, which had seen deal numbers in the FM sector fall for six successive quarters, was brought to an abrupt halt in the three months to the end of June. In total 24 transactions were recorded during the period, a 50% increase on the number seen in and the highest level reached since the second quarter of (25). Nevertheless, in half-yearly terms activity will still have to continue to pick up pace rapidly if it is to match or exceed the levels seen in the last three years: the slow market in the first quarter means that only 40 deals have been completed in the first half of 2014 and this remains 23% down on the same period in, and below the 5-year average for H1 of around 45 deals. 1 Insights into FM - Issue 11 PE buyers back in business Quoted FM Tracker Looking ahead in 2014 Sector spotlight on the energy sector

2 FM All of the deals with a disclosed value fell in the smaller or lower mid-cap brackets, which means that the published aggregate value for the period is low compared with previous quarters. In reality, the actual value for the deals will be much higher, boosted by one larger transaction: the key deal during the quarter came in the shape of PAI Partners secondary buyout involving the European operations of TDR Capital-backed empty property security specialist, VPS, for a sum widely reported to be over 150 million. TDR Capital, which originally acquired a controlling stake in VPS in March from Axial European Partners, is retaining VPS s US division. The VPS deal underlines the continuing interest in the Security segment of Soft FM, which has produced deals in each quarter since the beginning of (some 35 transactions in all). This sector has also helped swing the balance of deal flow in the favour of soft FM over the previous two quarters, though in this latest period an uptick in activity in all of the hard FM spaces has levelled the balance off. UK Facilities Management transactions by quarter** UK Facilities Management transactions by subsector quarterly 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Volume Value million ,000 3,500 3,000 2,500 2,000 1,500 1, **see back page for Grant Thornton subsector split between hard and soft FM Other Hard FM Utilities M&E Maintenance/Fit-out Other Soft FM Security Hygiene Cleaning Catering 2 Insights into FM - Issue 11

3 FM PE buyers back in business The VPS buyout by PAI also marks something of a turnaround in the trend that had seen PE buyers largely steering clear of the FM sector in recent times. The second quarter saw six deals involving PE backers, just one fewer than the total number of PE deals seen in the previous five quarters; among them were Key Capital s 11 million MBO of school caterer, Alliance in Partnership, a 10 million investment by the Business Growth Fund to fuel the expansion of estate management and landscaping consultancy TCL Holdings and the 10 million MBO of Intelligent Office UK, the Edinburgh-based document management company, backed by YFM Equity Partners. Aside from the generally more positive market and economic fundamentals (see opposite), as well as a need for PE investors to deploy their significant reserves of capital, the main factor behind the reappearance of PE investors in the FM market is most likely to be the rapid growth in availability of leverage. This, driven by new alternative debt funds and returning appetite among the main lenders, has meant that PE buyers have once again been able to use senior and subordinated debt to put the sort of bids together that will win deals even against cash-rich trade competitors; in the case of the highest quality assets, debt multiples are reaching the pre-crisis levels of 4x or 5x leverage. UK Facilities Management transactions quarterly by acquiror type 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% UK PE International UK Facilities Management transactions yearly by acquiror type 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% UK PE International YTD 3 Insights into FM - Issue 11

4 Quoted FM Tracker Share prices suffer following poor quarter for quoted FM businesses After a number of quarters in which UK stocks had performed well across the board, share prices came under significant pressure in the second quarter of 2014 and the quoted FM peer group was not spared this pressure. Looking at share price performance, the peer group average contracted by 3.8% in the three months to the end of June, while the FTSE All Share index rose modestly by 1.3%. Nevertheless the peer group fared less badly than the FTSE Support Services index, which fell back by 5%. However, although the poor has had some effect on the longer terms analyses, these still compare favourably with the All Share and Support Services indices. In the most recent six months snapshot, the businesses on the FM Tracker performed comparably to the FTSE All Share declining 0.3%, while outperforming the wider FTSE Support Services index, which fell by 3.3% over the period. But it is in the two longer-term snapshots that the peer group stands out: in the 12- and 24-month periods, the average share price of the businesses on the Tracker grew by around 24% and 47% respectively. This significantly outstrips the average growth in the All-share index (9.4% and 24.5% respectively) and the Support Services index (9.7% and 36.5%). Looking at individual groups over the last quarter, only five of the 14 businesses on the tracker saw any growth in share price, whereas 10 of the group had grown in the previous quarter. Of the larger businesses in the peer group by far the most robust performance came from Compass Group, whose share price recovered from a poor first quarter to grow by over 11%; its long-term trend is similarly strong, with growth of 21% and 52% in the 12 and 24 month periods respectively. Compass performance has been boosted by news of strong global growth in all markets, as well as improved margins. It also announced the return of 6 billion to shareholders in May s half-year statement. G4S, the second largest group on the tracker in terms of market cap, grew during the second quarter by close to 6%, bringing to an end a downward trend in its share price. The reversal in fortunes was underpinned by a positive set of top-line results in March, as well as the group s 109 million settlement with the Ministry of Justice, which brought to a close a long-running dispute regarding over-charging on prisoner tagging contracts. However, Serco, the third on the peer group list and the other business affected by the prisoner tagging problems, saw further falls in its share price during the latest quarter (down by 13.2%). The business, which also saw more disappointing news at the very beginning of the third quarter when it lost its Docklands Light Railway (DLR) contract, has seen its share price decline by over 40% in the last 12 months (32% over the 24-month timeframe). The next five largest companies on the list all saw declines in, ranging from the 2.1% for Mitie to 22.1% for Balfour Beatty; the latter announced a 30 million shortfall in its construction business and saw the resignation of its CEO. Among the smaller businesses on the tracker the best performances came from London Security (up by 20% in the quarter and 41% in the last 12 months) and Kier Group, which saw its share price rise by 7.3% in the three months to the end of June. 4 Insights into FM - Issue 11

5 Quoted FM Tracker Share price change to 30 June 2014 Share price change to 31 December Market cap Sales EBITDA EBIT 3 months 6 months 1 year 2 years Name m m m m % % % % Compass Group plc 18, , , , G4S plc 3, , (2.78) (8.56) Serco Group plc 2, , (13.18) (26.78) (40.71) (31.81) Rentokil Initial plc 2, , (9.43) (3.80) Balfour Beatty plc 1, , (22.06) (18.61) (2.06) (21.64) Berendsen plc 1, , (12.43) Carillion plc 1, , (8.43) MITIE Group plc 1, , (2.09) Kier Group plc , (3.27) Interserve plc , (17.81) (3.69) Mears Group plc (11.17) (2.11) London Security plc Johnson Service Group plc (1.72) ISG plc , Average (3.8%) (0.3%) 23.6% 47.2% FTSE All Share 1.3% (0.3%) 9.4% 24.5% FTSE Support Services (5.0%) (3.3%) 9.7% 36.5% Source: Factset. Market data as at 30 Jun 2014; Financial data as at last announced financial close A significant increase in Private Equity Investment in the sector has driven a recovery in the overall deal market in FM. With investment activity in security, catering, landscaping and document management PE has found a range of FM Sector opportunities across a broad size range within the mid-market. A slowdown in trade buyer activity coupled with renewed growth prospects and improved financing conditions is creating a more fertile climate for PE Investment in the sector which is encouraging particularly ahead of any uncertainty created by the 2015 election year. David Ascott, Partner, Corporate Finance 5 Insights into FM - Issue 11

6 FM Looking ahead Growing optimism as UK economy sets pace in Europe After a relatively protracted period of declining M&A activity one would be forgiven for questioning whether the uptick is actually a sign of an improving market or whether it is more of an anomaly. However, there are a number of factors that suggest the stars may well be aligning in favour of the M&A markets in general and the FM space in particular. The first, and most important, driver is undoubtedly the continuing strength of the UK s economic recovery especially compared with other key European economies. The promise of 3% GDP growth is obviously good news for local FM businesses, but it is arguably more attractive for other international groups and although non- UK buyers have not been especially prominent in the quarterly stats in 2014 so far, reports from the market suggest that they are still actively looking at potential acquisitions. Against this backdrop of improving economic news, another factor that has become increasingly evident as this year has progressed is the extent to which FM businesses have come to terms with the full impact of the public sector spending cuts. Intelligence coming out of the Grant Thornton corporate finance network suggests that the processes in play currently compare very favourably to those that were being negotiated six to nine months ago; then the stakeholders were still showing a significant degree of nervousness as to how the impact of the government cuts would filter down to operating companies, whereas now it seems that all parties are much more comfortable with the issue; in fact in certain sub-sectors there is good evidence to suggest that much of the funding has been ring fenced and this has provided real confidence to buyers The greater confidence that has emerged over the course of 2014 and is beginning to reflect in the M&A statistics for the FM sector is also being influenced by the fact that many of the mid-market businesses in the sector have actually performed well in recent quarters again perhaps a measure of how well they have coped with the changing market conditions. As the M&A window opens wider, it is likely that these high-quality assets will be the ones to come on to the block. Finally, the other window that is having a positive impact on the market is the IPO window, which has been open for some time. This affects the market in two principal ways. To start with, as equity markets are riding relatively high, there is significant potential for simple multiple arbitrage-buying businesses that are trading at a lower multiple than your own. Then there is another driver which centres on the drive among companies that have listed recently to make sure that their share price remains buoyant: one of the most effective ways of doing that is to engage in some M&A activity. So overall, while the summer season could yet see a lull settle over the market, making the figures look like an anomaly, there is good reason to be optimistic for a sustained recovery in M&A activity in the FM Sector. 6 Insights into FM - Issue 11

7 FM Sector spotlight FM activity in the energy sector M&A activity in the energy sector has been an increasingly prominent feature within the FM market for some time (note the 30 utilities deals completed since the beginning of ) and there is strong evidence to suggest that this will continue. Certainly, anecdotal reports from Grant Thornton s corporate finance network reveal that there are a number of energy-related deals being negotiated, among them a few larger transactions. But also the fundamental drivers behind the market are compelling: the rising price of energy means that both corporate and private energy consumers are increasingly keen to reduce their energy costs and (especially for corporates) their carbon footprint. Overall the market is split into two main segments: the supply side, which is perhaps less likely to produce any major M&A dealflow, which would include companies that focus on reducing the cost of energy procurement; and then the demand side, which would cover businesses that specialise in helping consumers monitor energy usage and reduce overall spending. While this is especially important on the corporate side, it is growing in importance on the domestic front too as fuel poverty rises up the political agenda. Although, as we outlined in Issue 8 of Insights into FM, the government s Green Deal initiative has suffered from a lack of traction since its launch, the area will undoubtedly continue to drive some dealflow in the area. Another factor to add to the M&A mix in the energy sector is the likelihood of a flow of deals coming from the PE community. These investors were somewhat ahead of the curve as far as energy efficiency is concerned, spotting the emerging trend three or four years ago and deploying capital in what was then a defensive space. As multiples pick up PE buyers are likely to try and cash in and put some of the better performing assets on the block, adding to the flow of interesting opportunities we expect to see in this space. 7 Insights into FM - Issue 11

8 FMContacts For any further information, please contact: David Ascott T E david.p.ascott@uk.gt.com Pete Dawson T E peter.dawson@uk.gt.com Martin Gardner T E martin.n.gardner@uk.gt.com Usman Malik T E usman.b.malik@uk.gt.com Grant Thornton Facilities Management subsector map Hard FM Fabric maintenance Fit-out Mechanical & Engineering Fire Protection Grounds Maintenance Utility Maintenance Reprographics Soft FM Security Cleaning Catering Washroom hygiene Textile/Laundry Pest Control Space planning Relocation and Storage 2014 Grant Thornton UK LLP. All rights reserved. Grant Thornton refers to the brand under which the Grant Thornton member firms provide assurance, tax and advisory services to their clients and/or refers to one or more member firms, as the context requires. Grant Thornton UK LLP is a member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. GTIL and each member firm is a separate legal entity. Services are delivered by the member firms. GTIL does not provide services to clients. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another s acts or omissions. 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. grant.thornton.co.uk V24339