Deal Watch: Peering into 2003
- By Sabrina Barker
- Jan 01, 2003
With the start of another new year, it is perhaps an appropriate time to gaze into the crystal ball and try to prognosticate about what the future may hold for the environmental services industry. By most measures 2002 has been a rather undistinguished year -- a fairly flat, "wait and see" type of year for many firms in the industry -- not a catastrophe by any means, but certainly not as strong and robust as the prior two or three years. Perhaps many of us became a bit "spoiled" with the stronger growth and profitability that we experienced from 1999 through 2001, making 2002 seem a little tougher than it really was.
Firms in the environmental engineering and consulting business are reporting internal (non-acquisition related) growth for 2002 in the four to six percent range -- not bad, but again, not very exciting for an industry that has grown at rates of as much as twice that high in the last few years. According to market researchers ZweigWhite, revenues per employee seem to be substantially higher in 2002, at a little over $92,000 vs. only about $85,000 last year -- presumably demonstrating that firms continue finding ways to get more efficient. Not surprisingly, ZweigWhite also reports that average profitability rates are down - pre-tax, pre-bonus profits average 8.8 vs. 11.1 percent last year. (After-bonus profit rates are not as much affected obviously, because when profits are down most firms don't pay out as much in bonuses.)
Factors that Led to the Current Slowdown
At least three separate factors have conspired to lead us to this "lull" or plateau in terms of business activity. First, after several years of heady growth and "bull market" spending activity -- spending that certainly extended to the environmental services arena -- the economic engine was beginning to slow down by early 2001 and continued soft throughout 2002. Second, the terrorist attacks of September 11, 2001, certainly had a direct impact on the American economy; in retrospect, they probably did more to demarcate and exaggerate the softness that was already characterizing the economy, as opposed to doing much to "cause" it. Third, the less environment-friendly regulatory policies and spending activities of the Bush presidency -- as well as the inevitable delays and confusion that results when political administrations change -- have directly or indirectly caused environmental projects, spending, and overall activity levels to slow. Observers report that traditional levels of bipartisan support for environmental legislation seem to be weakening in Congress, and the recent elections may have broader implications for the future growth of this business. With all of these factors at work, it is not surprising that most environmental service firms report a flattening in their business growth.
As many of us are only too painfully aware, the stock market has substantially retreated from its high point of early 2000; the publicly traded environmental stocks are now hovering at about 60 or 70 percent of where they were about a year ago. Valuations of public and private environmental companies vary broadly, depending upon both individual performance, as well as the sector in which the company participates; however, as recently reported by leading environmental consulting industry analyst Paul Zofnass, valuations for the typical firm have stayed fairly constant at about five and a half times earnings (or some thirteen times net earnings)before interest, taxes, depreciation and amortization (EBITDA), which is the most widely used measure for true cashflow or operating profit.
Bullish Signs on the Horizon
One indication of positive change in this industry is that the competitive arena seems to be stabilizing, and that we are no longer "losing" companies at the rate we once were. The Environmental Benchmarker and Strategist, which follows the performance of publicly-traded firms in the industry, has in the past typically seen at least five or six public companies disappear each year from the industry through consolidation, business exit or bankruptcy. That is no longer the case; the public company population has now settled down to a fairly stable and consistent group -- evidence of a more stable and predictable business environment.
The pace of intra-industry transactions dwindled somewhat during 2002 -- primarily as a result of tightness in the financial markets. Although financial constraints make it more difficult to borrow money and hence to finance transactions, deals do continue to happen. The string of major deals that characterized 1999 through 2001 has slowed a bit, but if and when cheaper financing becomes available, it seems likely that consolidating transactions will pick up again.
Brownfields redevelopment work and economically driven real estate projects also continue to grow in terms of significance and in overall importance within the traditional environmental services industry. This transition to an increasingly restoration-based economy, or "Land of Re" as it was recently designated by Weston Solutions Chief Executive Bill Robertson, will be a more critical aspect and driver of future environmental work - redevelop, remediate, re-use, recycle, renew, re-engineer and so on.
Many leading environmental consultants emphasize the current opportunities presented by emerging international markets, particularly in Europe, the Far East and South America. Many indicate that, after years of more talk than action, they are seeing substantial and real environmental business opportunities in some of these areas. Although many firms have been disappointed by the international markets in the past, it is clear that these markets will continue to grow, albeit at differing or unpredictable rates.
By now, we all know that the term "environmental industry" is probably a bit of a misnomer; the "business" is in reality a loosely-defined collection of what are actually quite different businesses - with widely differing future growth and profitability profiles. Certain sectors are likely to experience more rapid growth than others. For example, almost all observers expect that the broader water and wastewater services sector will show above-average growth for years to come. A quick review of the recent plethora of water and wastewater treatment demand reports quickly demonstrates vast future needs in this area, both in the United States and abroad. Although it is one of the critical prerequisites of all life, as Americans we still spend well under one percent of total household income on water. Outright water shortages in certain areas, declining infrastructure, continuing population shifts, as well as overall population implies that the water business will experience robust growth. Serious drought conditions in many parts of the country during 2002 served to bring many of these concerns into rather sharp focus. In addition, there are potentially huge remaining opportunities in the privatization and out-sourcing of water and wastewater services, as well as increased levels of concern about water system security issues. All of these factors will combine to ensure that the overall water industry will show sustained and robust growth into the long-term future.
Similar observations can be made about the country's transportation infrastructure - highways, bridges, airports and harbors. Like the water sector, much of our transportation infrastructure is in need of upgrading, and continuing shifts in population are leading to demand for new infrastructure in certain areas -- particularly the "Sun belt." There is also a new focus here on security issues as well -- especially in the ocean shipping and aviation sectors. In both the water and transportation markets, the need for engineering services is clear -- the only question is only how much money the federal government and state agencies can afford to spend on upgrades and expansions in a given year.
A quick note about some of the other key sectors of the business: The solid waste management industry continues to boast many of the best-performing companies in the broader environmental services industry. The Environmental Benchmarker and Strategist reports that out of its 10 highest performing public companies this year, seven are from the solid waste business. With its substantial capital requirements and potential economies of scale, players who can build a strong regional position seem poised to make well above average profits. The hazardous waste side of the business has suffered through many consecutive years of tough economic conditions, declining demand and cut-throat competition, but it now seems to be stabilizing, as more and more capacity is gradually concentrated in the hands of just a few players.
Much has been made in recent years over the shift in the environmental business from a regulatory driven business to more of an economically driven business. As perhaps opposed to the situation of a decade ago, ever-expanding and all-encompassing regulations can no longer be counted on as a sure guarantee of success for environmentally oriented service businesses. However, neither are environmental regulations going to "go away." The proliferation of new regulations -- even if at a more gradual and studied pace than in the past -- and the stronger enforcement of existing regulations, are still a key and underlying foundation of this industry.
In sum, it seems highly unlikely that the need for environmental management and engineering services will wane in the future. We will continue to see the industry evolve and adapt and perhaps continue to merge into the broader infrastructure and engineering services industry, but the environmental component of those services, if anything, seems likely to increase.
Success Factors for Environmental Businesses
And what will distinguish the future winners from the losers in this industry -- in "25 words or less?" As the environmental business becomes more mature, several specific functions represent more critical success factors for companies:
- Build a strong strategic planning process and mentality within your company -- know where you are headed, have a practical "road map" for getting there and be flexible enough to change course when the internal or external circumstances dictate.
- Don't skimp on marketing and sales effort -- many firms cut back in this area when things get tough. Indeed, ZweigWhite reports that sales and marketing expenditures are down this year. As the old saying goes "you don't have anything until you have a sale" -- continue to build a strong and consistent sales and business development effort, even through difficult economic times.
- Maintain a strong focus on customer service -- yes, it seems obvious, but many firms fail to focus on keeping their existing customers fully satisfied. Remember, it's a lot easier to keep a customer you already have than to find and develop a new one.
- Emphasize strong management and leadership -- this is probably the most important factor for success. Attracting and retaining top leaders is the challenge of every organization, and organizations in this industry are no different.
This article originally appeared in the January/February 2003 issue of Environmental Protection, Vol. 14, No. 1, p. 38.
This article originally appeared in the 01/01/2003 issue of Environmental Protection.
Sabrina Barker is a senior policy advisor with the United Nations GEMS/Water Programme and has 15 years' experience in international socioeconomic development. Her background is in international relations and biology. Currently, she is working on international relations and political economy of water resources and ecology. Barker can be reached through www.gemswater.org or by phone at (819) 953.0912.