ZOFNASS

Engineering and construction firm leaders were reveling in even more excitement than usual over their superheated market in 2007 and their new cachet to Wall Street and equity investors as evidenced at an Oct. 18 CEO conference in New York City that drew nearly 250 participants. Even as the dollar’s falling strength relative to other currencies is drawing more foreign firms to U.S. shores to invest in or acquire their American peers, the sub-prime mortgage crisis could create some market bumps in the next year. Firms also may need to rethink and reconfigure their management style, investment profile and organization structure or risk losing the advantage of the current strong business climate, said panelists at the event, sponsored by management consultant EFCG Inc.

 

Paul J. Zofnass, EFCG president, noted the positive outlook in his review of corporate business results submitted by 194 companies that collectively report $60 billion in 2007 revenue. The number of the publicly held firms surveyed rose by four to 26, but their collective revenue soared to $29 billion for 2007, up from $20 billion a year earlier, CEOs report. Total revenue for the 168 private firms remained flat at $32 billion for this year.

Companies that have grown or acquired their way into the industry’s billion-dollar club are flexing their new muscle. The 15 firms on that list, up from 12 in 2006, report revenue up 14.3% in 2006 and an estimated 15% this year and 10.5% in 2008. But they were not so rosy on profitability, with the three-year average hike totalling 21.3%, the second lowest of the five revenue groups measured. However, firms in the $100-million to $250-million revenue category, dubbed “micro majors” by Zofnass, report their three-year operating margin growth averaging 24.5%. They also say their revenue increased an average of 16% in 2006. By geography, results seem to show some cooling off in the red-hot Southeast market. Firms in that region report that revenue and profit growth from 2006 through 2008 will total an average of 21.8%, down from 26% reported last year for the three-year period from 2005 through 2007.

Such blips have not prevented company stock prices from zooming up or keeping institutional investors, venture capitalists and private equity funds from viewing the industry as the perfect nesting ground for their billions, Zofnass says. He said there was a $50-billion increase in capital invested in the 194 reporting firms since 2006, a 170% hike. “That’s 10times what it was just a few years ago,” he said.

EFCG reports that the 22 publicly traded firms on its own index, including AECOM, Michael Baker, Foster Wheeler, Stantec, URS and Willdan, saw their valuation increase 85% between Sept. 30, 2006, and this past Sept. 30, compared to a 35.3% hike for the Standard & Poor’s 500 index. The two indices grew 432% and 153%, respectively, since Sept. 30, 2002. EFCG index companies are trading at an astronomical 27 times their price- to-earnings ratios, compared to 17 times for the S&P index. (S&P, like ENR, is a unit of the McGraw-Hill Cos.) But Zofnass also sees a “certain amount of vulnerability for a stock trading at 27 times,” he told attendees.

Zofnass also sees other risk factors ahead. The total number of offices opened in 2007 jumped to 359, from 277 a year earlier and a similar number dating back to 2000. “This is way above the point where you may be overexpanding if there is a recession coming,” he said. He also cautions firms to determine whether having 100% their of assets existing in the company’s own employee stock ownership program (ESOP) is the best approach as an investment tool. In particular, he hinted that many firms are afflicted with what he terms “dysfunctional decision-making syndrome” (DDS), daunted by internal management structures, including boards of directors, that are not flexible enough to cope with or take advantage of changing economic and industry developments. “The world is changing now faster than ever,” he said. “DDS, it is a killer.” He emphasized that equity investors are tough bosses. “If they are putting money in your company, they expect results,” Zofnass said. “You will operate very differently.”

Company CEOs told attendees that the “war for talent” remains their No. 1 challenge, but not all see it as an industry crisis. “We’re retraining folks from different industries,” said Dan Batrack, CEO of Tetra Tech, Pasadena, Calif. “Demand is localized and turnover is not a problem.” Earth Tech CEO Alan Krusi claims the labor crunch is “forcing changes that are healthy, including being more selective in choosing work and exploring other areas of growth that are not so labor-dependent.”

Firms are mixed on their views about a coming credit crunch slowing down work. AECOM CEO John Dionisio says he “is still optimistic about the market going forward,” but Lee McIntire, chief operating officer of CH2M Hill says, “Any changes will affect us. I’m concerned about the cost of projects.” Uhler is already seeing slowdown in some municipal markets, such as Florida. “Some permits are on hold,” he says.

U.S.-based executives say the devaluing dollar is shifting the industry’s global equilibrium. “It creates a situation where the U.S. looks pretty good, but it has made overseas acquirers more powerful,” says Uhler. But firms such as MWH and AECOM that work globally are not excessively worried. Both companies’ CEOs say that half their corporate revenue is generated outside the U.S. But Dionisio says U.S. companies will benefit from more overseas interest. “Ours is still the best economy in the world,” he says. “It is the mother lode.”