Months of secret talks between Costain and May Gurney have come to a head with a proposed merger, but with Kier showing interest in a rival bid, what will May Gurney’s board be considering when evaluating any proposed new offers?
Costain’s bid would see the infrastructure firm acquire the entire share capital of the support services group for £178m.
News of a proposed £1.6bn turnover company called Costain May Gurney sent the latter’s share price – which fell 40 per cent after a profit warning last year – up 30 per cent, to 241p last week.
But just hours after Costain’s bid was made public, it emerged that May Gurney had repeatedly knocked back approaches by Kier, while giving Costain exclusive access since November.
Kier is carrying out due diligence on May Gurney, which could continue for another week before it makes a decision on whether to start a bidding war.
In the blue corner – Costain
Costain would take a 53 per cent stake in the new group, with May Gurney shareholders set for 0.8275 of a new Costain share, or about 252p per share.
Costain’s chief executive Andrew Wyllie and finance director Tony Bickerstaff would run the proposed new firm, with a potential 28-33 per cent earnings per share enhancement for their company.
It would take May Gurney, which made a loss in its last half-year and has £77m of debt, to a “modest” group debt position.
A consolidating market and demands from major clients for fewer suppliers offering end-to-end services means Costain has long-talked of plans to bolster support services.
But Kier’s intervention immediately sparked comparisons with Costain’s failed bid to buy consultancy Mouchel in 2011, when Interserve emerged as a rival bidder. Mouchel rejected all offers and the firm eventually dipped into administration, but continues as a private company.
It is perhaps why Costain’s approach this time has been such a collaborative one.
Mr Bickerstaff tells CN a lot of work has been done in recent months to establish the right structure and integration plan, which he says is “pretty well advanced”. Documents detailing the deal to the Stock Exchange said the merger would result in the loss of “fewer than 150” jobs out of the 11,000-strong combined staff.
But could combining its infrastructure skills with May Gurney’s services in areas such as rail, water, energy and roads, also enhance Costain as a target for foreign firms?
William Shirley, of Liberum Capital, says: “Once it’s integrated the combined group could be very attractive, and the two largest shareholders in Costain will have been diluted which might make a deal more straightforward.”
The Costain May Gurney deal is subject to shareholder votes in early May.
In the red corner - Kier
May Gurney could be at least 30 per cent EPS enhancing for Kier, and enable it to bolster local authority relationships.
Analysts say synergies would be higher due to Kier’s regional network, maintenance skills and a potential willingness to close May Gurney’s existing head office in Norfolk, which Costain’s chairman David Allvey describes as being of “strategic significance”.
A Kier bid, likely to be almost all equity, could be in the region of £3 per share.
But as Kier has not historically been an acquisitive company, there are also overpayment and integration risks and the £2bn contractor is currently restructuring its local office network.
Analyst Stephen Rawlinson, from Whitman Howard, says Kier could offer better upside for May Gurney shareholders while the Costain offer arguably undervalues their share in the new firm.
“We are not saying that Costain cannot and will not manage May Gurney well, but it will take a lot longer for the cultures of the two operations to gel and potentially be more expensive than a Kier integration,” he says.
Andy Brown, analyst at Panmure Gordon, says while more overlap between the Kier and May Gurney businesses could mean more savings and gains for shareholders initially, it could also mean slightly limited growth.
It could go one of five ways – Liberum Capital
Costain/May Gurney: existing terms – If the deal happens in its current form, Costain is the cheapest way into Costain May Gurney PLC (8 per cent cheaper than through May Gurney). Once the deal is complete we would expect the combined group to re-rate.
Costain/May Gurney: raised bid – We would expect a counter bid from Kier to trigger a higher bid from Costain.
Kier/May Gurney: raised bid – A Kier bid would have to be at a higher level given the apparent preference of the May Gurney board for a Costain deal.
ANOther/May Gurney: raised bid – The possibility of another bid cannot be ignored. Carillion’s share price fall perhaps indicates that the market believes a Carillion bid is possible (we view it as possible but unlikely)
Deal falls through – Both Kier and Costain have made it clear they are keen to do a strategic deal. Costain has already seen Mouchel fall away. We believe this scenario is unlikely.
It’s good to talk
Analysts were left “surprised and uneasy” by the exclusivity of the Costain and May Gurney talks.
Mr Rawlinson says there is “there is no way of knowing” if the valuation is right without competitors in the mix.
Mr Shirley adds it may have been about keeping disruption to a minimum. “Once you get the uncertainty of a bid, people start leaving and it becomes very difficult to win new contracts,” he says.
Analysts have mooted the likes of May Gurney and Mears as targets before now as more growth is expected within industry from outsourcing, with firms such as Balfour Beatty and Carillion expected to dig deeper into the services space, along with Ferrovial, Interserve and potentially Skanska.
Construction News understands neither Skanska, which has just acquired the Atkins highways business, nor Carillion – which continues to integrate energy services firm Eaga - are looking at May Gurney.
Interserve is focused on acquisitions that enable the company to enter new markets, not on bulking up existing services.
Competitors look on ‘with amusement’
“We’re watching with some amusement at the moment,” says a director at one major contractor.
“My initial reaction was I didn’t think it would just simply go at the price Costain was offering, I thought somebody else may come in – and Kier has been sniffing around May Gurney for ages.”
Another director at a major firm says: “I think it’s good for the industry; Amey and Enterprise; Skanska and Atkins highways and now Costain/May Gurney/Kier.
“Costain need to do something otherwise they’ll just stagnate. Wyllie has got ambitions to grow and be a big infrastructure player.”
Not long after the merger news came the announcement that May Gurney had lost out on a contract worth around £390m in its home county of Norfolk.
The council says the decision was not linked to May Gurney’s recent financial performance and came before the merger news. It was simply that three other bids had won better scores. Nevertheless, it is a big loss for May Gurney and one they are appealing.
Industry sources question what effect it will have on the May Gurney price.
Mr Shirley adds: “It’s clearly unhelpful. Would it lead to Costain withdrawing their offer? No I don’t think so. Might it influence the amount they might increase their offer by? Yes it might.”
But that contract loss should arguably not overshadow other lucrative deals.
A partnership between May Gurney and WSP was recently announced preferred bidder for Suffolk County Council’s £200m Highways Services Contract. Other major clients include Network Rail, British Waterways and a string of local authorities, with services ranging from bin collections to railway maintenance.
What is it about May Gurney?
May Gurney’s strength has perhaps been undermined most recently with a profit warning in September last year, problem contracts, a loss in the half-year and the shock departure of chief executive Philip Fellowes-Prynne.
But the company is also seen as having a strong board, a track record of good cash conversion and a strong balance sheet and a strong presence in roads and utilities.
Public sector work made up 58 per cent of group revenues from April to September 2012, with the rest in regulated sectors.
May Gurney’s long term contracts mean good visibility in terms of revenue and earnings and more than 95 per cent of its business consists of long-term contracts that deliver front-line services for clients.
Liberum Capital predicts margin recovery by 2015 in public sector, from 3 per cent up to 4.7 per cent, notably in highways, from 3.5 to 4 per cent and utilities to climb to 5 per cent. And at group from 3.6 per cent to 4.7 per cent.
Liberum expects any counter bid from Kier to trigger a higher bid from Costain. It says a Kier bid would “have to be at a higher level” than Costain’s, given the “apparent preference of the May Gurney board for a Costain merger. It also says the possibility of another bid cannot be ignored, pointing to Carillion’s share price fall on 27 March as a possible indication the market believes a bid from the contractor is possible. Liberum also believes it is “unlikely” that Costain’s bid will collapse as it did with Mouchel.