The A/E industry has transformed significantly in the last 18 months. Entire sectors have gone into deep freeze, competition for projects has increased ten-fold, consolidation within the industry has slowed down, and revenue and profits have plummeted. Yet as we come down the stretch in 2009, there is a feeling around the industry that we may be taking our first tentative steps on the long road to recovery.

We asked several A/E firm leaders a few questions about the coming months. In general, the sentiment about the next two quarters appears to be cautious optimism.

What does your crystal ball tell you about the
A/E industry for Q4 09 and Q1 10? Thumbs
up or down?

Frank Dudek, President, Dudek Associates (www.dudek.com): We're optimistic about the next two quarters. Environmental work has been steady in the public sector, growing in the energy sector, and we're seeing some activity with private development and landowners. Engineering is retooling for our market niche, mid-sized and smaller agencies, or mid-sized projects with large agencies. The combination of engineering with supporting regulatory and environmental permitting has been attractive to many of our clients.

Arnie Cohen, President, CP&Y (www.cpyi.com): From our vantage point, Q4 09 and Q1 10 look OK. Funding for many of the projects we are working on near-term is already in place and/or is benefiting from stimulus dollars. Things get considerably uncertain as we look beyond the second half of 2010. Tax receipts are down, political will to address the funding shortfalls is either not there or is focused on other issues such as health care reform and financial re-regulation. Re-authorization of a new transportation funding bill appears hopelessly stalled which is of grave concern to those of us who operate in the transportation space. The economy may be bottoming, or even be in the early stages of recovery. However, at this juncture, it looks like it will be a long slow climb out.

Rich Grubel, Senior Vice President, The PBSJ Corporation (www.pbsj.com): We believe that the demand for design services is at bottom, but will not recover as rapidly as some industry pundits believe. There are three reasons for this: First, the Federal stimulus program has only a minor impact—the emphasis is on “shovel ready” projects, meaning those that have already been designed. Secondly, it will take quite some time for the housing market to utilize excess inventory, so the need for new private development will continue to be depressed. Thirdly, the commercial market will get worse before it gets better; loans, including those with balloon payments, are going to be coming due for the next five years with payments based on valuations that are now far in excess of current market value. Most likely, it will be 2-3 years before the industry truly gets healthy again.

Marc Solomon, Corporate Development Officer, Winzler & Kelly (www.w-and-k.com): We are not expecting Q4 or the first half of 2010 to be any better then the past 12 months. In fact we are expecting the next 6+ months to be a tougher market for A/E firms. This has to do with the fact that we are largely in the municipal and government markets and these markets tend to lag the overall economy by 12+ months. Having said that Winzler & Kelly is having a good year.

What are some of the major obstacles in the way of a recovery for our industry?

Dudek: Public agencies in CA are uncertain about funding as a result of the recession and the State's budget black hole. Thus, projects are being cancelled or delayed. However, scaled-back public agencies are seeking as-needed technical support to get what projects they have done and keeping their organizations lean. There appears to be pent up demand to get some furloughed projects done and to optimize and economize their systems once the economic uncertainty abates.

Cohen: The major obstacle is most certainly funding. Where will the money come from? Where will the political will come from to address the funding issues? Can we, as an industry, work together with owner, agency, contractor, consultant, politician, government staffer, to get the needs of the country met? Ultimately I believe the answer is absolutely yes. Unfortunately, the time it takes to work through to a solution and the gyrations we go through to get there will affect a lot of lives.

Grubel: The funding environment for public sector work is a major obstacle. U.S. infrastructure needs have never been greater— highways, bridges, mass transit, and water/wastewater systems all have been neglected and require massive renovation and upgrade. However, state and local governments are struggling to fund even basic services; even the Federal government cannot continue to spend at current levels indefinitely.

Solomon: For the municipal market the major obstacles are of course local tax revenue which drives local projects. There is a 12+ month lag between the economic recovery and the local market recovery and this is largely due to local tax revenue. This has the effect of delaying many local projects. Those local projects tend to be small in terms of revenue which we would normally use as “fill in” work for our staff. On the government side we’re seeing a continual move towards much larger projects. This tends to attract the larger national/international firms, which puts pressure on the mid-size firms like Winzler & Kelly. Thus we’re seeing a more competitive process on the government projects due to the size of the project rather then the fact that more firms are jumping in to the market. The other obstacle that both professionally and personally offends me is a lot of firms are jumping into the municipal market and they are “buying” projects. This is terrible for our industry. We’ve spent the past 15 years trying to elevate the value of engineering services and in one year these desperate firms start “lowballing” their fee. I wish we could educate those firms on the long-term damage they are doing to our profession and how they are unknowingly assisting in moving our profession closer to commoditization. I am not speaking about profit as much as the value that society places on our services; we are our own worse enemy when it comes to establishing the value of our services! As you can tell I’m passionate about this subject.

How are you dealing with these obstacles?

Dudek: From what I understand about the industry, the publicly traded companies are seeing values rise again with optimistic forecasts of projects in sustainable water, energy, and transportation. We encourage many clients to invest for the future in smart infrastructure, and for large landowners, to start/resume planning/environmental documentation for future rebound in building. Valuations recover with increased revenue and profit margins.

Cohen: We’re continuing to focus on relationships to stay on top of opportunities and to help create opportunities. We’re also making sure we are continuously educating our staff on our business and our clients and empowering them to help make things happen. Longer term, we are constantly looking for ways to expand our services into a more diverse product mix with a more diverse client base. Over time we are confident this will serve us well through all economic conditions.

Grubel: We were fortunate in recognizing years ago that private markets were nearing a peak and that Federal government agencies would have very significant needs for engineering, architecture, and planning services. We invested a great deal of effort in upgrading certain technical capabilities and preparing ourselves to serve our Federal clients better, which has helped us to offset the decline in private sector business. Now, seeing the funding problems facing state and local government, we have been upgrading our capabilities in public/private partnership and other creative funding options. For us, it’s all about thinking ahead and being proactive in meeting clients’ needs—thinking years ahead, because if we wait until the need is almost here, it’s too late to prepare.

Solomon: In this tough economy we have used a number of strategies to maintain our position and in fact grow. First, it has been one of our core business strategies to be diversified. By diversified I mean in terms of the markets we are in, the services we offer, and the geographic locations we serve. In any given economy we can be firing on 6 or 7 cylinders with our diversified markets, services, and locations. This is a strategy we have been employing for over 10 years and it has been rewarding to see it pay off in such a difficult time. With our diversification we can seamlessly move from one market to another based on the economic situation of the time. In direct response to the economic times we have made a conscientious decision to stick to fundamental business practices. These include 1) providing one of the best places for our staff to work, 2) paying attention to aligning ourselves with our clients, 3) running an efficient business, and 4) giving back to the communities we live and work in. We call it “getting back to the basics”. Most firms will tell you they are paying attention to the fundamental business practices. However it is the number 4 that most firms are not doing. In these tough times our community involvement is really a win-win-win; our communities need our support more then ever, our staff is proud to be part of supporting nonprofits that are important to them, and our clients really see how we’re stepping up.

There will be more obstacles to overcome before happy days are here again for the A/E industry. What are you doing to keep your firm strong in the meantime? Drop us a line at info@morrisseygoodale.com.

- MARK GOODALE

Jury Still Out on A/E Firm Valuations

While M&A activity is down compared to last year (and from 2007, for that matter), it hasn't come to a complete standstill. For those firms that are currently contemplating or negotiating a deal, coming up with meaningful multiples in this business environment can be a significant challenge. “Business is percolating, and a far cry from last September and October when the world was crashing down,” says George Christodoulo, Attorney, Lawson-Weitzen, LLP (www.lawson-weitzen.com). “But it’s not instant coffee. We won’t see tangible signs, whether backlog or proposals, that the pace of work is picking up until the second half of 2010. You hopefully will see something that starts to look like a bottoming out in the first or second quarter of next year.”

Yet even though the economy may be stabilizing, Christodoulo says it’s still much too early to tell which way valuations are headed. “To the extent that they are recovering, there is going to be contingent payments,” he says. “Too many buyers are afraid the future is choppy and uneven, and past performance is not an indicator of what you might be buying. There may be a little bit of a recovery, but buyers don’t know what multiples to use, and a multiple of what? You don’t use ‘07 or ‘08, and ‘08 was three quarters good performance and one quarter horrible.”

The uncertainty associated with projecting performance over the next couple of years appears to be putting buyers and sellers on high alert during negotiations. “The industry is grappling with 2010 through 2012 and trying to figure out a fair price,” says Christodoulo. “Buyers are not prepared to pay a fixed amount on a hope and a prayer that the seller performs well, and sellers don't want to sell at the bottom. The key is to try to work out ways to reward sellers on future performance. You may have more flexibility, however, if it’s a niche deal where high synergies are involved and the buyer will fold the seller into the organization.”

If you are a buyer or seller right now, you won't have the luxury of relying on rock-solid industry multiples to accurately peg a value. So if you expect to close, be flexible in your thought process and open to considering various deal structure options.

- MARK GOODALE