The market for design in the U.S. and around the world is as strong as it has ever been and large design firms are reaping the bounty. But with the strong market come challenges that are promising to bring significant changes to the industry as firms struggle to cope with the climbing volume of work, staffing issues, new client demands and a shift toward a more sustainable building model.
The scope of the current construction boom can be measured by the huge surge in revenue from design. The ENR Top 500 Design Firms as a group generated $69.61 billion in design revenue in 2006, 17.5% above the $59.25 billion level they achieved in 2005 and 31.4% over 2004, when the Top 500 garnered $52.99 billion. The Top 500 enjoyed volume increases both domestically and abroad. The Top 500 revenue level from projects in the U.S. reached $54.72 billion in 2006, up 15.5% from 2005, while design revenue from work outside the U.S. topped out at $14.89 billion, up 25.7% over 2005.
The market’s growth was such that many firms that enjoyed banner years did not move, or even dropped in the rankings on the Top 500. “We topped $800 million in revenue last year and are on pace to approach $1 billion this year,” says Dennis Hirschbrunner, executive vice president of HDR Inc. Yet, despite enjoying a 21.2% increase in revenue from 2005 to 2006, HDR actually fell two places on the Top 500 list.
One of the reasons for HDR’s drop in ranking was the huge level of growth of Foster Wheeler, which has rebounded in a big way from its difficulties in the 1990s and early 2000s. In the 1990s, the firm accumulated uncomfortable levels of debt and had problems on the contracting side of some of its power projects. Amid doubts among investors and clients about the company’s future, Foster Wheeler recruited Raymond Milchovich in 2001 to try to turn things around.
“After investigating, we found that virtually all the problems came from our power group,” says Milchovich. “That left us just one area to fix.” Beginning in 2002, the company concentrated on cutting staff and costs and retooling workflow. “We concentrated on developing world-class service practices,” he says.
But the job was not easy. Foster Wheeler’s markets were relatively soft in 2002 through 2004. “When we made the necessary changes, it was a risk as the market was down and our backlog was shrinking. Turnarounds like that work only when you have a product clients want to buy,” Milchovich says. He credits the firm’s long-term clients who trusted it, despite some initial skepticism, and “a talent-rich pool of employees,” which got the company through its turnaround period.
Having addressed the major issues, Milchovich now is convinced that the turnaround is complete. “Our capital structure is fixed and our debt-to-earnings ratio is excellent.” He also notes that the firm set all-time earnings records for the past three quarters. And the firm received some good news from the investment markets in the past month as both Standard & Poor’s, a sister company to ENR at McGraw-Hill Cos., and Moody’s credit rating services upgraded Foster Wheeler’s debt rating.
The Urge To Merge
The level of mergers and acquisitions among large design firms has accelerated in the past couple years. Four firms on last year’s Top 500 were acquired in 2005-6, including EDAW Inc. and The Retec Group by AECOM, W.H. Linder by Jacobs, and H.C. Nutting by Terracon. And in recent months, AECOM also acquired Hayes, Seay, Mattern & Mattern Inc., No. 114 on this year’s list, and Stantec followed suit by acquiring Vollmer Associates LLP, No. 132. Just last month, Jacobs signed a letter of intent to acquire Edwards and Kelcey Inc., which is No. 67 on this year’s list.
The trend toward consolidation in the industry will no doubt continue for the foreseeable future. Many firms say they have been approached by larger firms or M&A consultants as possible acquisition targets. And AECOM, lately one of the biggest acquirers of design firms, currently is in the process of launching an initial public offering to go public, which could significantly augment its war chest for further expansion. Representatives of AECOM declined comment as they currently are in the “quiet period” under U.S. Securities and Exchange Commission rules limiting comments on forward-looking statements following IPO filings.
“The level of acquisition activity recently has been unprecedented,” says Carl Roehling, CEO of SmithGroup. He notes that SmithGroup has been approached by very large architect-engineers and engineer-architects wanting to make an acquisition. “They were doing it to grab market share and to increase size because publicly held firms need to grow to satisfy shareholder demand,” he says. SmithGroup declined these overtures.
Many firms are in the market for new partners. “We are in the hunt for technical expertise and geographical coverage, and for new services where we have existing capacity,” says Hirschbrunner of HDR. It acquired Daniel Frankfurt, a 135-person New York City-based architect-engineer in November, and Quest Engineers Inc., a 120-person Louisville, Ky.-based engineering firm in February. “We estimate that about 85% of our growth has been organic, but we continue to look for firms that can add to our scope and range,” Hirschbrunner says. HDR now is taking a look at the California market, where the state has passed a series of infrastructure bond issues.
One design firm that took a unique step this past year was architect Davis Brody Bond. In July, it announced it was affiliating with the international architectural group AEDAS, based in London and Hong Kong. But this was not a merger, per se. “We made a substantial financial investment in AEDAS, so it was not an acquisition,” says Steven M. Davis, partner in Davis Brody Bond.
AEDAS was formed initially in 2002 by an affiliation between Abbey Holford Rowe, London, and LPT Architects Ltd., Hong Kong, to help each other in their respective markets and specialties. In 2006, Davis Brody Bond joined to provide AEDAS access to its markets in the Americas and to give DBB broader access to international markets. “This is like how the investment consultant McKinsey operates, affiliating to provide international assets with a local presence,” says Davis. “Design is similar. Design is worldwide, but delivered locally.”
While DBB is affiliated with AEDAS, it continues to work under its own name. “It is fundamentally a strategic alliance moving toward a merger,” Davis says. With the addition of DBB, AEDAS now is the fourth-largest architectural practice in the world, according to World Architecture.
The growth of the M&A trend has had an impact on many mid-sized firms. “When there is a big job in an area where we don’t have a local office, we will often partner with a local firm to bid,” says Roehling. “But we are finding more often that some of our biggest competitors are the local firms in these areas.” He notes that...