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.
Target price of $43/share, or 9x 2021 normalized EBITDA, 30% upside from current price of $33.50. Sensitively shown below.
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:
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
oPrimarily consists of the United States and Canada
oConsists of EMEA and APAC regions.
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.
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:
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.
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.