We are pleased to present BaseRock Partners’ Q1 2022 Engineering and Construction M&A Outlook. This quarter we address the inflationary pressures facing the U.S. economy, the threat presented by Russia’s invasion of Ukraine, and the changing acquisition strategies of strategic buyers.
Inflation will be the most critical challenge facing businesses operating in the E&C market in 2022. All sectors of the engineering and construction market are impacted by input costs—whether related to labor, commodities (lumber, copper, steel, fuel) or finished building products. According to the Federal Reserve, year-over-year producer prices are up by more than 30% since the beginning of the COVID-19 pandemic. Russia’s invasion of Ukraine and the West’s resulting sanctions are likely to further exacerbate inflationary and economic pressure in the U.S. as the world’s 2nd largest commodity producer and 11th largest economy is critically isolated.
Will margins be stable in 2022? We have witnessed a decline in the quality of gross margin in WIPs in recent months, as some contractors have poor (or non-existent) price escalators in existing contract portfolios. Given the recency of inflation, many contractors are not prepared to manage rising prices, and will face increasing levels of project fade as prices rise. Couple this with the pressure of attracting and retaining talent and the pressure on project backlogs is substantial and growing, particularly for contractors operating in environments with limited pricing power (e.g., hard-bid markets).
Changing Acquisition Priorities in an Active E&C M&A Market. We are seeing buyers restructure their acquisition priorities to incorporate inflationary risk, with many acquirors seeking to be closer to the customer through service capabilities, feasibility, design, and advisory services, and a preference for more negotiated and pass-through contract types. A further byproduct of the political uncertainty is likely an increased focus by large international acquirers on acquisitions in the United States, long a safe haven for companies exposed to less politically stable markets.