LUMINA M&A Outlook 2019 – Construction and Contracting  

Despite a challenging 2018 for the construction and contracting sector, we have seen some encouraging early signs going into 2019. The UAE government’s recent announcement tripling the size of the Dubai International Financial Centre, and the recent approval of the infrastructure spending budget in the run up to Dubai Expo 2020 bodes well for the near-term future of dependent sectors. This will undoubtedly create long-term value for shareholders of the companies that benefit from this momentum.

But what if shareholders are seeking an exit today? Typically the last few years of repressed earnings, and a ballooning balance sheet may not be conducive to a straight M&A transaction. Under these circumstances, we often find that an “earnings based” pricing is less than the working capital tied up in the balance sheet. Even in the instance where a successful sale is consummated, most buyers tend to discount trapped working capital to a large extent (often nil). This steep discount, together with deferred or contingent payments and retentions against warranties, often results in the sellers’ cash proceeds being less than the inherent value in the balance sheet (“Buyer Reluctance”).So what alternative exits may be possible in the above scenario? Two key themes emerge:

Management buy-outs (“MBO’s”) are becoming increasingly popular, with vendors being amenable to deferred payments over a few years, in return for some upside mechanisms and comfort that the company will continue its legacy under the stewardship of a trusted management team (often a important in cases of succession planning). A combination of debt financing and a vendor loan note, structured over a reasonable period, can be a quick and relatively simple way to achieve retirement goals and a motivate the new management teams’ ambitions.

In cases where an MBO isn’t a viable option, an often-overlooked option is a Balance Sheet Cash Release (“BSCR”). For well managed companies with low/moderate leverage, this can result in a higher amount of exit proceeds being released than in a typical M&A sales process (see “Buyer Reluctance” above).  BSCR entails the release of trapped cash from performance bonds, receivables, guarantees and the like, through a managed process of contract completion and other unwinding of financial positions in the capital structure. This often necessitates the appointment of a temporary experienced “caretaker” CEO with the financial and operational skills necessary for the task. The “caretaker” CEO often works in conjunction with the appointed financial adviser in implementing this balance sheet exit on behalf of the shareholders/owners wishing to exit.