Balfour Beatty PLC’s acquisition of U.S.-based privately owned Parsons Brinckerhoff Inc. could well mark the beginning of a signifiant consolidation of the evolving U.S. infrastructure delivery landscape. Indeed, with the U.S. market for infrastructure experiencing fundamental shifts on the buy-side as state and municipal governments look to change the way they procure everything from highways to schools, it seems a good time to consider last month’s merger in the context of what will be needed in the U.S. in an age of increasingly scarce public sector resources.
Balfour Beatty, already the largest construction and engineering concern operating in infrastructure in the U.K. and one of the top three in PPP investments, knows what it is doing in both areas. An early and significant participant in major U.K PFI projects, BB has built up one of the most successful track records in the delivery of PFI projects and one of the largest portfolios of investments in the sector in the U.K.
The company has also been steadily building up its U.S. infrastructure activities in rail transport and military accommodation, most recently with the acquisition in April 2008 of GMH Military Housing for $350 million. But the acquisition of Parsons Brinckerhoff for $626 million puts BB into a whole new league, positioning it to challenge the biggest players in the U.S. just as budget pressures are forcing states and municipalities to turn to the private sector to fund, deliver, operate and maintain infrastructure.
It’s increasingly obvious that governments at all levels in the U.S. will need to ramp up their use of alternative long-term financing to get big infrastructure projects off the ground, particularly in transportation. There are some 27 states that have enabled the use of PPP as a means for delivering infrastructure assets, with Arizona and Massachusetts becoming the latest two to enact state legislation – and that was just over the summer. The speed with which PPP is moving to the forefront of state and municipal thinking now is an important, if little noticed trend in the U.S. market for infrastructure, especially considering that a framework for the use of PPP in the U.S. was first put in place as far back as 1995.
PPP is a model for infrastructure procurement that involves public authorities selecting through a competitive tendering process a consortium of private sector developers and their financial backers for the design, delivery, operation and maintenance of a public asset. In return for the providing the financing necessary to build or restore the asset, the private consortium earns the right to recoup its investment and earn a share of long-term revenue through the charging of tolls or from tax revenue for its operation. It has been in use in the UK since 1992, and has seen increasing acceptance in countries in Europe, Canada, Africa, Asia and Australia.
One clear area where businesses operating in public sector contracting in the U.S. need to adjust their models is to accommodate a market where PPP plays a significant, if not dominant role in the delivery and long-term management of public infrastructure. Among the new skills that these companies will need to develop will be to manage the life-cycle demands of contracts that will typically run 30 years or longer. It is a challenge to do without greatly expanding the size of a business, though developing or acquiring those services can be very rewarding because the work produces steady and reliable revenue flows that help to reduce the notorious boom-and-bust cycle of traditional contracting work.
What BB has successfully achieved in its home market, and what the Parsons Brinckerhoff acquisition moves it towards achieving in the U.S. (and to a significant extent in other nascent markets for PPP around the world) is to give the combined company both critical mass and a leading position among the relative handful of active project management service providers in the U.S. that can offer the full range of skills that are needed to build, operate and maintain these big projects throughout their life-cycle. In particular, Parsons Brinckerhoff brings its own extensive experience with alternative financing learned from international activities, which should make for a healthy cultural fit with BB as they work to grow the business in the U.S. But it also brings excellent, well-established long-term relationships with public authorities and people in policy-making positions. This strength is not to be ignored in a country where foreign company motives are continually viewed with suspicion, and where their participation in large projects can lead to unpredictable and unfortunate outcomes. (Consider the furore over the Trans-Texas Corridor and failed effort to lease the Pennsylvania Turnpike)
Besides helping to quell suspicions of foreigner intentions, Parsons Brinckerhoff brings to Balfour Beatty a particular strength in U.S. domestic transportation infrastructure development that could prove decisive to winning much of the coming wave of projects that go to tender. It brings not only experience, and an operating margin that is roughly twice that of its acquirer, but size to a business where size really matters. Unlike the U.K., distances in the U.S. tend to be much larger, so that questions about the capabilities of bidding consortia are never far from the minds of decision-makers. The combined business takes BB’s U.S. revenue base to 32% from 29% immediately and significantly towards its goal of a 40% U.S., 40% U.K. balance, and towards taking the perception of dependency on U.K. sources off the table once and for all.
From a business diversification perspective as well, the acquisition makes great sense for BB, which faces not so much the risk, as the certainty of seeing its U.K. public sector project pipeline shrink. This is due in part to public spending cuts, but also to the reality that government spending on big PFI projects in healthcare and transportation are now moving towards completion. Indeed, with 50% of BB’s current group earnings coming from the public sector, and 25% linked to U.K. public sector work, a move to diversify geographically would appear to be well-timed.
The overwhelming enthusiasm that has greeted the Balfour-Parsons deal should logically lead one to ask who might be next to go. The question has special relevance now, while the weak dollar would seem to favor companies making a play out of Europe or Australia. Parsons Brinckerhoff occupies a fairly special place in the firmament of leading U.S. project management service providers, but there are others. There are publicly traded companies in the sector with international expertise, but these are generally of a size that would make them too big to swallow. However, the shifting landscape of procurement in America could shake up thinking at Fluor Corp., KBR Inc, and Jacobs Engineering Group Inc. And it certainly will cause companies with similar profiles to Parsons Brinckerhoff to consider their future as part of something larger. With eight times 2008 earnings the new standard by which they might expect their businesses to be valued, it seems likely there will be more tie-ups of the Parsons Brinckerhoff variety in the very near future.