Description

Company Overview 

AECOM is engaged in designing, building, financing and operating infrastructure assets for governments, businesses and organizations. The company is engaged in planning, consulting, architectural and engineering design services to commercial and government clients in major end markets, such as transportation, facilities, environmental, energy, water and government. 

Investment Thesis / Trade Summary

In June 2019 activist investor Starboard Value (Starboard) took a 3.77% equity stake at an estimated price of $34.72 and argued that ACM should sell the company as its history of inefficiently aggregating acquisitions left the segments lagging peers. ACM had previously explored plans to spin its management services business.  A result was on 10/14/2019, ACM announced an agreement to sell management services for $2,255.0MM. Furthermore, on 11/22/2019 ACM and Starboard reached an agreement where Starboard appointed 3 board members, expanding the board initially to 11 (subsequently to 10) and Chairman/CEO Burke notified the board of plans to retire. 

Everything was going according to Starboard’s plan where on 1/12/20 WSP proposed to acquire AECOM (news reports suggested $54-$60+/share).  The management services deal was completed on 2/3/2020. With the March 2020 selloff, the WSP deal was postponed / cancelled and event-driven investors exiting AECOM sent the stock down from $50/share to $25/share, before rebounding to $33/share. The selling was exacerbated by ACM’s cash proceeds from the management services was completed subsequent to the fiscal Q1’20 close on 12/31/2019. 

Absent a deal, ACM is a more focused and profitable enterprise as it experienced a substantial reduction in G&A extraction from lower-returning businesses and a planned exit of more than 30 countries (more than 50% complete). The company’s current low leverage (1x 2019 EBITDA or <1x 2020 E EBITDA), valuation of 7x 2020 EBITDA (or 10x assuming a 20% drop in EBITDA due to the corona crisis) and with 56% exposure to government spending boosted by the recent US Infrastructure Act passage compare favorable to peers (WSP, Parsons, Tetra Tech, Stantec, and Jacobs all trade for 9x+ forward EBITDA) as well as the company’s historic valuation. 

Valuation

Target price of $43/share, or 9x 2021 normalized EBITDA, 30% upside from current price of $33.50. Sensitively shown below. 

Company Details

Business Transformation 

In June 2019 activist investor Starboard Value accumulated a top five stake in ACM of 3.77% with little-to-no management engagement. Starboard’s letter focused on the underperformance of the company rather than compensation issues with the CEO, unlike the last activist (Engine Capital) attack that resulted in 43% of shareholders voting against the company’s compensation.

In November 2019, ACM and Starboard prevented a proxy war with an agreement. ACM appointed three new independent directors recommended by Starboard, including Starboard managing member Peter A. Feld and ACM’s Chairman and Chief Executive Michael S. Burke announced his plans to retire. 

On January 31, 2020 ACM completed the sale of its Management Services (MS) to American Securities LLC and Lindsay Goldberg LLC for $2.405 billion (includes contingent consideration of $150 million). 

Additionally, ACM concluded that its self-perform at-risk construction businesses was to be held for sale beginning Q1’20 and is now classified as discontinued operations. 

In FY2019 ACM made the decision to simplify AECOM Capital. AECOM Capital was a business where it was deploying capital from the company’s own balance sheet. ACM decided to go out and raise third-party funds. In September ACM closed on its first fund with external money of $500 million with partner Canyon Partners. 

In terms of streamlining the existing business, ACM made a decision to exit 30 countries starting in FY2019 (50% complete). These are countries where there wasn’t a long-term opportunity for growth, had a high risk profile, an insufficient a return on invested capital or a corruption index requiring excess management attention. ACM also de-risked and simplified its business by selling oil and gas assets during 2019. Cost cutting resulted in an already executed $225 million of G&A reduction to align ACM’s cost structure and simplify the business..

The improvement plan resulted in higher margins during the year as noted below:

Segments

ACM previously reported its business through four segments prior to Q1’20 (12/31/20): Design and Consulting Services (DCS), Construction Services (CS), Management Services (MS), and AECOM Capital (ACAP).

•Design and Consulting Services (DCS)

oPlanning, consulting, architectural and engineering design services to commercial and government clients worldwide in major end markets such as transportation, facilities, environmental, energy, water and government.

oDCS revenue is primarily fees from services provided, as opposed to pass-through costs from subcontractors.

•Construction Services (CS)

oConstruction services, including building construction and energy, infrastructure and industrial construction, primarily in the Americas.

oCS provides construction services, including building construction and energy, infrastructure and industrial construction, primarily in the Americas. CS revenue typically includes a significant amount of pass-through costs from subcontractors.

oAt-Risk Construction Services was included in discontinued operations in Q1’20 (12/31/20).

•Management Services (MS)

oProgram and facilities management and maintenance, training, logistics, consulting, technical assistance, and systems integration and information technology services, primarily for agencies of the U.S. government and other national governments around the world.

oIncluded in discontinued operations in Q1’20 (12/31/20), sale closed on 2/3/20. 

•AECOM Capital (ACAP)

oInvestments primarily in real estate projects.

oACAP segment primarily invests in real estate projects. ACAP typically partners with investors and experienced developers as co-general partners. In addition, ACAP may, but is not required to, enter into contracts with our other AECOM affiliates to provide design, engineering, construction management, development and operations and maintenance services for ACAP funded projects.

ACM’s new reporting segments as of Q1’20 (12/31/19) consist of the 

•Americas segment

oPrimarily consists of the United States and Canada 

•International segment

oConsists of EMEA and APAC regions. 

•AECOM Capital

oNo change.

The company also refers to net service revenue or NSR, which is defined as revenue excluding subcontractor and other direct costs. ACM’s discussion of margins will be made on an NSR basis unless otherwise noted. Organic NSR growth is presented on a year-over-year and constant currency basis and reflects continuing operations.

Financial Review 

ACM reports its annual results of operations based on 52 or 53-week periods ending on the Friday nearest September 30.

In terms of Q1’20:

•The company’s adjusted EBITDA increased by 27% in the first quarter, and ACM reiterated guidance for 12% EBITDA growth at the midpoint of 2020 guidance range. 

•The adjusted operating margin in the Professional Services business increased by 230 basis points to 11.7%, building on the 200 basis point increase in 2019 consistent with expectations for all of 2020.

•The company continues to win new business:

oACM had a $3.3 billion of wins in the quarter.

oBacklog increased by 2% to $37 billion (near-record levels). 

oAfter Q1’20, ACM’s momentum continued with several large pursuits moving into the award phase and had expected its backlog to reach a new record in the second quarter.

•In terms of ACM’s new business segments:

oAmericas:

• Revenue declined by 4%, however NSR increased by 2% on an organic basis driven by strength in transportation, water and environment markets, and double-digit growth in construction management.

• The Americas business had a 16.6% adjusted operating margin, which marked a 220 basis point improvement over the prior year and was ahead of expectations.

• Contracted backlog increased by 27% to a new record in the quarter, driven by:

• •State tax revenues increasing by mid-single digits in 2019 and 5 states implemented gas tax increases in the last year, which are key funding sources for public infrastructure investment.

• •Many states and large metros are proposing plans for substantial infrastructure investment.

• •In ACM’s largest U.S. market, New York, Governor Cuomo recently unveiled a $275 billion infrastructure plan, which would be the largest statewide plan in U.S. history and would support the MTA's more than $50 billion capital spending plan. 

• •The recently proposed changes to the National Environmental Policy Act demonstrate a political focus on accelerating infrastructure investment. The Federal Highway Administration has an approximately $10 billion backlog of projects that have been undergoing environmental assessment for more than a year that would move forward much more quickly under the proposed NEPA change.

• •The pipeline in the construction management business remains strong. 

oInternational business:

• While revenue declined slightly, organic NSR was effectively unchanged. 

• Adjusted operating margin for the first quarter was 4.7%, a 210 point basis increase over the prior year, with strong performance in Australia and results in the U.K.

• Trends across our international markets are mixed. 

• •U.K. (ACM’s largest international market) the new government has indicated support for an additional $100 billion of infrastructure investment in its first budge. ACM has been successful in winning more than 250 frameworks, including key positions for Highways England and Network Rail.

• •Australia increased during the quarter as large infrastructure projects continue to progress.

• •Hong Kong, ACM had forecasted a 20% revenue decline for the year, however performance was better than expected. 

• •The Middle East, ACM has been focused on aligning its portfolio and cost structure, and we expect further margin improvement as the year progresses.

2008 Great Recession Comparison 

ACM IPO’ed in 2007 and prior to Q1'15 AMC reported segments under professional technical services and management support services (the MS division recently sold). 

Looking through the 2008/2009 results and earnings transcripts, in 2008/2009 ACM’s business grew due to:

•70% of ACM’s work is funded by government agencies around the world (30% private-sector work).

•Margins improved in the Great Recession, partly aided by a three years margin improvement plan the company began in 2006.

•The company had a strong balance sheet position with leverage well below its targeted 1.5x – 2x EBITDA (9/30/19 FYE’19 net cash). 

•Funding for infrastructure projects were strong in key markets, driven by the stimulus packages.

A side by side comparison: 

2020 Infrastructure Spending Plan

Public infrastructure spending typically involves transportation, water, energy and telecom. Transportation circles around road, bridges, and airports that are managed by state, local, or third parties compared to the federal government.

The $2 trillion amount given in press releases and tweets is a reference to President Trump and Congressional Democrats April 2019 conversation about a $2 trillion dollar bill and isn’t definitive as of today.

Where does the $2 trillion come from? 

•$1 Trillion almost in reauthorizations. 

o~$800bn in reauthorizations (~$600bn in 10 year Highway Trust fund reauthorization + ~$155bn in FTA Reauthorization). 

o$200bn in “emergency/stimulus” funding. Rough size of funding request in the president’s budget for infrastructure the last several years.

•Additional $1 Trillion 

oTrump’s 2017 proposal implies levering federal dollars 5x -6.5x – for an additional $1 - $1.3 trillion. 

•Trump has also said he wants to include infrastructure spending in the next potential aid package.

What’s the real spending?

•Worst case

o$1 Trillion in reauthorizations.

oPublicity gives momentum for the Surface Transportation (FAST) reauthorization needed before the 9/20 expiration (further direct funding of $200bn+).

Risk Factors

Corona

• A shutdown of providing services despite the government stimulus is a key risk.

Private Sector Spending

• ACM still derives a substantial amount of proceeds from outside the governmental sector, a key risk in the upcoming recession. 

Financials

• Asset sales and movement of business to discontinued operations challenges a historic financial analysis. 

Key Sources

Infrastructure - The White House

https://www.whitehouse.gov/wp-content/uploads/2019/03/FY20-Fact-Sheet_Infrastructure_FINAL.pdf

The Administration’s Plan: Invest at Least $1 Trillion in Infrastructure

SURFACE TRANSPORTATION REAUTHORIZATION

https://www.railpassengers.org/happening-now/current-campaigns/reauthorization/

4/7/2020 

Trump Asks Congress for $250 Billion More for Small Business Loan Program

https://www.barrons.com/articles/coronavirus-news-51586267097

4/6/20

AECOM cuts executive and board pay by 20%, CEO Burke remains for now

https://www.sec.gov/Archives/edgar/data/868857/000110465920042717/tm2014929d1_ex99-1.htm

https://blinks.bloomberg.com/news/stories/Q8DFZNMB2SJY

3/31/20

Trump, Pelosi see ‘Phase 4’ coronavirus package that includes infrastructure spending

https://www.marketwatch.com/story/pelosi-sees-phase-4-coronavirus-package-including-additional-payments-to-americans-infrastructure-spending-2020-03-30

3/24/2020

https://thefly.com/landingPageNews.php?id=3059304

Aecom merger talks 'have fallen apart,' Dealreporter says WSP Global's talks with rival Aecom about a potential merger are said to have fallen apart, two sources told Dealreporter, the news service said, according to Fly contacts.

3/4/2020

WSP Global Is Said to Progress in Discussions to Buy Aecom 

https://blinks.bloomberg.com/news/stories/Q6OCWFT0AFB6

Canada’s WSP Global Inc. is moving ahead with talks to acquire rival engineering services firm Aecom, people familiar with the matter said. A deal could be announced as soon as next week, the people said, asking not to be identified because the matter is private. The market volatility has added uncertainty to the negotiations, and discussions could drag on further or fall apart, according to the people. Shares of Aecom rose 7.7% to $51.33 at 10:14 a.m. in New York trading Wednesday, giving the company a market capitalization of about $8.1 billion. WSP Global shares fell less than 1% to C$88.48 in Toronto, valuing it at about C$9.4 billion ($7 billion).

WSP Global Brief: Down Near 1% on a Report It Is Moving Ahead With Move To Buy Rival Aecom, With Deal Possible Next Week.

https://blinks.bloomberg.com/news/stories/Q6OC4ZBP8R2F

2/19/2020

BAIRD SEES POSSIBLE DEAL WITH WSP GLOBAL AT $60+/SHARE

https://blinks.bloomberg.com/news/stories/Q5YR9ST0AFBK

1/16/2020

WSP Global declined to comment on Bloomberg’s reportearlier this week that it has approached rival engineering 

services firm Aecom about a possible deal.

https://blinks.bloomberg.com/news/stories/Q47S62T0G1L1

01/13/2020

WSP Global Inc proposed to acquire AECOM for USD 7,400.00M. The transaction was proposed on 01/13/2020.

https://blinks.bloomberg.com/news/stories/Q7POONT0AFB9

Market Chatter: WSP Global Said to Show Interest in Acquiring AECOM

https://blinks.bloomberg.com/news/stories/Q43ABSBP8R29

Aecom Shares Rise Premarket on Report of WSP Global Interest >ACM

https://blinks.bloomberg.com/news/stories/Q43KN20799MO

AECOM MAY BE WORTH $54-$59/SHARE IN TAKEOUT, DEUTSCHE BANK SAYS

https://blinks.bloomberg.com/news/stories/Q43IHQT0AFB4

Amentum Services (Management Services division) Sale

Announcement: 10/14/19

https://blinks.bloomberg.com/news/stories/Q54JYCMEQTXC

Completion: 02/03/20

https://blinks.bloomberg.com/news/stories/PZD2BOMEWG74

AECOM sold Amentum Services Inc to a consortium led by American Securities LLC for USD 2,255.00M. The transaction was announced on 10/14/2019 and completed on 02/03/2020.

Aecom enters governance agreement with activist investor Starboard Value 

11/22/2019

• Aecom and Starboard have entered a governance agreement, providing for appointment of three new independent directors recommended by Starboard Value

• Michael S. Burke, chairman and CEO, has also notified the board that he intends to retire

o The board will initiate a CEO succession process with Burke continuing in both roles until a successor is found by or prior to the 2020 AGM; after successor named, chairman and CEO roles will be separated

• Size of board is expanding to 11 members initially, with Peter Feld & Robert Card joining board immediately, Jacqueline Hinman joining by Dec. 16

o Directors James Fordyce & Linda Griego, who have served on the board since 2006 & 2005, respectively, have retired

o Also, one current director won’t stand for re-election at 2020 AGM expected to be held in March, ultimately reducing size of board to 10 members

o Current director Steven Kandarian will serve as Board’s Lead Independent Director

• Terms of governance agreement with Starboard also include committee appointments, committee leadership roles, formation of a CEO search committee

• Starboard has agreed to customary standstill provisions & voting commitments

• Also in connection with today’s announcement, Aecom shareholder Engine Capital has committed to vote shares in support of all of Aecom’s director nominees at 2020 AGM

Starboard Takes Stake in Aecom, Calls for Potential Sale

6/20/2019

https://blinks.bloomberg.com/news/stories/PTEZ4M6VDKHS

Activist investor Starboard Value disclosed a stake in Aecom and is urging the infrastructure firm to explore alternatives to its proposed plan to spin off its management services business, including a possible sale of the entire company. The New York-based hedge fund, which said it owns a 4% stake in Aecom, wrote in a letter Thursday it believes the company is undervalued. That’s partly because it has failed to effectively integrate a series of acquisitions, leaving business segments lagging peers.

Letter

https://blinks.bloomberg.com/news/stories/PTEAM33MSFLS

http://www.prnewswire.com/news-releases/starboard-delivers-letter-to-aecom-ceo-and-board-of-directors-300871991.html

ACM Transcript Highlights

Nov. 12. 2009 / 4:00PM, ACM - Q4 2009 AECOM Earnings Conference Call

Fiscal year 2009 was a solid year for AECOM overall. Despite the global recession, we executed well. AECOM has a long history of adapting to changing market conditions, and 2009 was no exception…In the fourth quarter, as signs of economic recovery became more evident, many of our customers began to reactivate programs that were previously delayed or on hold. We are beginning the year with record backlog of $9.5 billion and a diversified pipeline of new opportunities, including stimulus-funded projects in the United States and around the world…Three years ago, we embarked on a margin improvement initiative that is now producing the intended results. Over the past three years, we have improved our EBITDA margin by 258 basis points….AECOM's business around the world reflects the uneven recovery of the global economy. In general, most of our markets are doing well, such as our transportation and federal governments markets in the United States as well as our global markets in Asia, the Middle East and Canada. 

Sep. 17. 2009 / 2:00PM, ACM - AECOM at D.A. Davidson Engineering & Construction, Construction Products Conference

About 70% of our work is funded by government agencies around the world, so 30% of our work is private-sector work....Our sense is that many of our clients, especially here in the US that were positioning themselves for the US stimulus package, took a pause as they were trying to identify how best to capture those US stimulus monies, so there was a slight slowing in the procurement cycle through the summer, and we expect that to pick up later in this calendar year as the monies start coming out....Moving onto margin improvements. Over the past two fiscal years, from '06 to '08, we've experienced a 184 basis point improvement in our EBITDA margins. This is EBITDA over our net service revenues. In the -- through the first three quarters of this year, we increased our EBITDA margins by 58 basis points. We have been on a pretty healthy growth curve on the EBITDA margins….Fortunately only 10% of our revenues were in the private sector facilities market, and just not a lot of tall buildings being built right now. So that was a tough market. But we had plenty of other diversified areas that helped us offset that.

Aug. 06. 2009 / 3:00PM, ACM - Q3 2009 AECOM Earnings Conference Call

On a constant currency basis, our PTS net service revenue grew organically at 1%. As we have previously discussed, we have experienced an overall weakness in our private sector buildings market, as well as in our U.K. and Dubai operations. This week, this was offset by strong performance in our U.S. transportation market, in our Middle East operations, particularly Abu Dhabi and Qatar, in North Africa, and across our entire infrastructure practice in Hong Kong and China.

Our balance sheet remains strong. We closed the quarter with $275 million in cash and cash equivalents, and debt of $241 million. This net cash position places us well below our target leverage range of 1.5 to 2 times EBITDA.

Funding for infrastructure projects in most of our key markets remains strong. In the United States, although budget issues at the state and local levels have pressured government spending, the stimulus packages have begun to take hold, and have helped sustain infrastructure spending. This has been the case in the United States, as well as many other of our key global geographic markets. In the United States, we don't expect that stimulus spending will begin to contribute materially to our revenue until mid fiscal year 2010, continuing through fiscal 2012. In other key markets outside the United States, such as in Hong Kong, regions of the Middle East, Australia and Canada, stimulus spending has begun.

A little overview of our markets, overall our markets remain strong. Again, the markets being transportation, facilities, environment and power and energy. The one soft spot that we did see and we experienced over these past six months is our private facility market. And we've seen that go soft in those markets primarily in the United States, UK and in Dubai. The good news is that they won't -- they were only a small piece of our overall market.

Catalyst

Earnings on 5/5/20 with pro-forma balance sheet.