Strict building safety regulations and increased interest in energy efficiency are creating demand for specialty engineering services and attracting interest from private equity firms, despite high competition in this fragmented industry.
In an effort to capitalize on the opportunity, Detroit-based Huron Capital Partners has taken a buy-and-build approach, investing in smaller companies within specialty niches, such as fire and life-safety detection systems, energy efficiency solutions, and fire suppression and HVAC systems.
Huron was attracted to the industry, in part, because of the consistent drivers of demand, says Sean Roberts, a partner at the firm. Strict building codes require regular renovations and upgrades to fire systems, which create a steady stream of revenue for the companies that service these needs. Meanwhile, property owners are increasingly investing in technology that can improve energy efficiency, such as sensors that detect a building’s occupancy levels, motion and temperature.
One Huron portfolio company, Albireo Energy, provides energy efficiency and smart building services, and it helps design automation systems that enable owners to monitor energy usage from a remote location. According to Roberts, those remote monitoring services provide a consistent source of recurring revenue.
The market for specialty engineering services spans both new buildings and those in need of retrofitting, says Michele McHale, a partner with Plante Moran, an audit, tax and consulting firm that has worked on more than 40 engineering services transactions, including with Huron. Managers have good reason to pay for property enhancements, she adds. “The U.S. is flush with residential and commercial buildings, and owners of buildings are incentivized to keep the occupancy rate up by adding lifestyle conveniences that are attractive to tenants.”
“People and culture make all the difference. You have to get the people and culture part right.”
Partner, Huron Capital Partners
A Fragmented Industry
Investors have recognized the industry’s appeal, and that has created a challenge: more competition for deals. The engineering services industry is highly fragmented, which can further complicate the search for acquisition opportunities.
“There are lots of great small companies out there, but it creates a challenge in that you have to go find them, you have to convince the owner to do a transaction with you, you have to make sure there’s a mutual interest in joining your organization,” Roberts says. “You’ve got to spend a lot of time on the road having meetings with business owners.”
There are accounting challenges, too. Small engineering services companies are often not GAAP compliant, particularly in the area of revenue recognition. These issues typically center around long-term contracts where the company should be recognizing revenue using the percentage of completion or proportional performance method and deferred revenue related to maintenance contracts, McHale says. In addition, in a buy-and-build context, integration of systems and processes can also present an obstacle. Each company may have different IT systems and operation processes, for example, and investors should be prepared to help them adopt a single platform, she says.
Creating value in an engineering services business starts with a strong team, according to Roberts. He cites the example of industry veteran Terry Heath, with whom Huron partnered to lead its fire-safety business Sciens Building Solutions. Heath had strong relationships in the industry, which helped give the company credibility with employees, customers and owners of potential add-on acquisitions.
Employees throughout the organization—not just the management team—are a key asset in the engineering services industry for their skills and industry relationships, Roberts says, and that has shaped Huron’s approach to acquisitions.
“People and culture make all the difference,” he says. “You have to get the people and culture part right.”
Kathryn Mulligan is the editor-in-chief of Middle Market Growth.