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Wanted: partner to Share good times

Merger talk is sweeping through the contracting sector following a few near miss deals at the end of last year. Neil Doyle reports.

Over the last six months an unprecedented number of contractors have announced plans to merge with or be taken over by other businesses. Until last autumn who was up for sale and who wanted to merge was a matter of speculation. Since then Tarmac, Bovis, Lovell and Mansell have all gone public and admitted that they are either pursuing mergers or looking for a buyer.

None of the deals got off the ground, but these near misses are a sign that others may resurface in the coming months (see box).

Over-capacity is the driving force behind the latest bout of activity. It never really went away after the last recession ended and margins are as tight as ever. As a result many contractors agree drastic action is needed to end what one City analyst described as a 'continuing saga of misery'.

'With so many companies chasing a finite amount of work, it stands to reason that there will be further consolidation over the next couple of years,' says one major contractor.

Mergers need not necessarily involve contractors tying up with other contractors. Though efforts to merge consultant WS Atkins and contractor Bovis failed, many in the industry expect more link-ups of this kind. Such multi-disciplinary tie ups have the advantage of producing higher margins and more diverse portfolios across a range of niche markets. Contractors and industry commentators alike see little advantage in size for size's sake.

Robin Hardy, analyst at stockbroker Panmure Gordon, says: 'The core of the problem is over- capacity in the market and poor margins. There have got to be better ways of working: take out the adversarial nature of contracting, get the client to agree to share the risks. 'Do it better' is the only answer unfortunately, and that does not necessarily come with being large. In fact it's probably worse if you're large because you've got more overheads to support and you're desperate to generate profit or cash at any level.'

It has taken the best part of this decade to reach the point of no return. The start of the construction's great slump of 1990 prompted much navel-gazing about how the industry operates, culminating in Sir Michael Latham's report setting out wholesale reform of the industry.

A great post-boom cull of major contractors was predicted to cure chronic over-supply where below cost tendering became the norm.

But while medium-sized contractors suffered considerable damage, the doomsday scenario never happened and oversupply has dogged the sector ever since.

The Latham charter for a new lean and effective industry has permeated the industry. As a result and, like a slowing supertanker, contractors are falling in line with clients, consultants, the City, and the Government and looking for less confrontational ways of working.

As a result some contractors are looking to partnering arrangements as a way of producing higher margins and more stable workloads.

One of these is Laing. It announced in November that it was to bring all of its construction businesses under one roof - Laing Ltd - to create a more flexible, more client-focused business. Once linked last year to a merger with Bovis, the company categorically denies that the reorganisation is preparation for a sale. Laing is also diversifying and developing an investment business on the back of stakes in PFI projects and through its planned acquisition of M40 trains. If its new strategy works it could avoid pressure to find a merger partner.

'I think there will be more shuffling around where companies with certain niches will buddy up to others with different niches over the next 24 months. The industry is realising that we shouldn't go around scratching each other's eyes out and that perhaps there is more to be gained by having a sensible look at it all,' says one of the directors of a major contractor.

But merging is all about finding the right fit between businesses and this is not as easy as it looks. 'It's a bit like a jigsaw; some have got certain bits and others have different bits. If you've got two parties buddying up where the overlap is already too great, it's never going to fit. It's not easy and that's why these things have fallen down - it's very hard to find a fit,' he adds.

Pressure from the City for better quality earnings has been a substantial driver behind the current shakedown. Some clever surgery is required as better earnings will not come from more of the same. 'You look at the situation and it's all strife and difficulty. It's just a rolling saga of misery for everyone involved. You've got to have a level of service to sell to the client that is worth paying more for,' says Hardy.

One of the major stumbling blocks in any merger is likely to come from the clash of management egos and this is one of the reasons why consolidation has been a long time coming. Fierce and prolonged rivalries have created a culture of mistrust in the industry.

The ego factor certainly played a part in the collapse of the merger between Aggregate Industries and Tarmac, where a clash of personalities was reported between Tarmac group chief executive Sir Neville Simms and his AI counterpart Peter Tom. 'Egos are a big issue because egos at the top of the tree are absolutely huge,' says Hardy.

The City has been increasingly disinterested in contracting because of its reputation as a serial producer of poor earnings. Another analyst says that contractors have only themselves to blame for destroying their own market and questioned the capabilities of senior management at the top of the industry: 'I don't think the industry attracts the high calibre of people that it does in Europe.'

Industry forecasters predict a downturn for the new millennium, threatening to further exacerbate over-supply and offering the prospect of shrinking margins. EC Harris economist Mike Moorehead says: 'We haven't seen a big increase in tender prices, which is what a lot of pundits were forecasting last year. That means there's not as much work around as would have been expected.

'I think it goes back to the big guys - those who can do any type of work and are flexible can get their order books full when required. If you cannot get into a certain type of work, or conversely you cannot get out of a certain type of work, then you will certainly have a problem in 2000/2001.'

Jim Turner, economist with Construction Forecasting & Research, says: 'What is emerging is a more mature market. We see things heading for a high plateau. In those circumstances where you have still got a highly competitive environment, there is a case for some consolidation. More has been going on than most people are aware of. The larger firms have been picking up smaller firms in the regions; it's an on-going process.'

The last recession brought an expectation that the giant continental contractors, which tend to be more diverse and have stronger balance sheets, would storm the UK and take advantage of weak defences. These have been born out to some extent. Norwegian conglomerate Kvaerner bought out Trafalgar House and Higgs & Hill was snapped up by Dutch group HBG two years ago.

More recently Skanska has taken a 7.6% stake in Costain, but beyond this, foreign interest in British contractors has been limited. Most activity has been through joint ventures on major contracts, no doubt reflecting concerns about risks and hidden liabilities.

'Selectively, it's already happened over the past 18 months. But whether that's the end of it, I don't know. I think that depends on whether people see the UK economy delivering the type of work that would make it attractive for predatory investment. If you can answer that one you can tell me or the Chancellor; I'm sure he doesn't know either,' says a director at one major contractor.

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