Construction and Engineering

1
Construction and Engineering The Roll-Up Rage
AftermathConstruction and Engineering Industry
Reporter - August 2004

• Introduction to the Brereton Construction and
  Engineering Industry Reporter
• The Brereton Industry Reporter is a quarterly
  journal designed to assist management and
  investors in the construction and engineering
  trades. The journal attempts to address and
  explain current and anticipated market
  influences, investor sentiment and the valuation
  implications of the economic environment
  including private company acquisition activity.
  By introducing quarterly data and highlighting
  critical market issues, we hope that the Brereton
  Industry Reporter can help management and
  investors gain effective insight into the
  valuation and organization of their business.
• Table of Contents
• I. Executive SummaryII. Specialty
  Contractors An Overview of the Independents
• III. Public Sector Growth OpportunitiesIV.
  Mergers and Acquisition ReviewV. Public
  Company Review
• Executive Summary
• In the present era of competition and technology
  driven business, companies are increasingly
  leveraging collaboration as a strategic tool for
  business growth. To succeed as any type of
  contractor in this low margin and high volume
  environment, you need to continuously design and
  build sophisticated products to beat the
  competition. This demands working across
  enterprise boundaries with speed, accuracy,
  innovation, and efficiency.
• Among the many trends confronting the
  construction and engineering industries, several
  issues and challenges have emerged as key
  determinants of success. In this issue we will
  focus on the specialty contractor market and
  opportunities for growth through public sector
  work.

Specialty Contractors An Overview of the
Independents In boom of the late 90s, the
consolidation frenzy among specialty contractors
had reached a peak. Companies focused in the
specialty trades, including electrical,
mechanical, masonry, concrete, utility, roofing,
asbestos and many other sub-sectors, were
targeted for acquisition as part of a wave of
consolidations or roll-ups that swept the
industry in 1998 alone, for example, over 300
specialty contractors were acquired. Roll-ups
were driven by, among other things, market
fragmentation, the availability of debt equity
capital and the opportunity for valuation
arbitrage (purchasing targets at multiples lower
than the acquirers). The ensuing five years
have brought a number of changes to the companies
that drove the roll-up strategy, to the other
companies in the sector and to the end-markets in
which the companies perform their services.
Engineering News-Records October 2003 survey of
the contracting industry indicates that this
market generated revenues in 2002 of
approximately 48.4 billion, down from 2001
revenues of 54.9 billion and up from 1998s
37.9 billion. The decline from 2001 to 2002
resulted from a slowdown in overall business
capital expenditures, stemming from the general
economic contraction as well as specific events
such as the September 11th attacks and the
build-up to the Iraq war. In addition, companies
with undercapitalized or overleveraged balance
sheets were significantly impacted as the bonding
market contracted drastically.(Continued on Page
2)
Construction and Engineering MA Deal Volume
We would like to invite your insight on these or
other industry related topics. Our contact
information is on the back cover.
Source Capital IQ MA Database. Deals between
10 and 250 million.2004 Estimated from 125
deals as of 7/31/04.
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Construction and Engineering Industry Reporter
- August 2004
Specialty Contractors An Overview of the
Independents (Continued) Again, using ENR
Magazines classifications, building represents
the bulk of activity, while the specialty markets
are evenly distributed. Market Analysis Sp
ecialties While all of the trades have
been impacted by the U.S. economic contraction,
some end-markets declined more precipitously than
others.

• MA in the Specialty Contractor Market
• Today, buyers and sellers of specialty
  contractors approach MA differently than they
  did five years ago. In particular
• Few, if any, companies believe that a quick
  roll-up to go-public strategy is feasible
• While 12 EC companies went public from 1997 to
  2000, no EC company has gone public since 2000
• Private equity funds investing in the sector
  appear to be purchasing companies with reasonable
  amounts of leverage and pursuing a more patient
  buy and hold strategy once theyve acquired the
  companies
• Buyers are focused on expanding into particular
  geographies or end-markets, not just acquiring
  loosely related companies for the sake of growth.
  Particularly favored sub-sectors include
• Advanced technology Education Healthcare
  Homeland security Water/wastewater expertise
• Few companies in todays market are taking on
  significant amounts of leverage
• In many industries, lenders are increasingly
  raising the multiples at which they are willing
  to lend against EBITDA
• In the contracting space, however, the lack of a
  significant asset base and the uncertainty of the
  percent of completion method of accounting cause
  many lenders to avoid the space or to cap the
  amount of leverage any company can carry
• The median leverage of the specialty contractor
  tracked in this article is 2.2x Debt/EBITDA,
  which conforms favorably with the overall market
• Companies are acquiring larger, fewer targets
  rather than a large volume of small companies
• The transaction costs of accomplishing multiple
  acquisitions (including the time and expense
  involved in finding targets, conducting due
  diligence, executing the transaction documents
  and paying the professional fees) and the
  difficulties of the blocking and tackling of
  integration and establishing a cohesive
  management structure raise significant hurdles to
  acquiring many companies as part of one
  transaction
• Conclusion
• Companies throughout the contracting sector
  always struggle with finding the means to grow
  consistently through organic growth alone. For
  these companies, mergers acquisitions have
  provided an alternative, faster means of
  achieving their revenue and value growth
  strategies but these transactions almost always
  involve a higher level of risk. MA in the
  specialty contractor sector, in particular, has
  been associated since the late 1990s with
  roll-ups, leverage, difficult end-markets and
  unfulfilled promise. However, in 2004, improving
  economic conditions, smarter acquisition
  strategies and stronger balance sheets indicate
  that MA in the specialty contractor service is
  worth considering.

We would like to invite your insight on these or
other industry related topics. Our contact
information is on the back cover.
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Construction and Engineering Industry Reporter
- August 2004
Public Sector Growth Opportunities Many
engineering and construction companies have
actively diversified into less cyclical
businesses to decrease exposure to under
performing industries and create more even
revenue streams. Many markets once rife with
activity, such as industrial, commercial and
power, have recently stalled for various reasons.
Construction firms have instead begun to favor
more stable sources of growth, namely the federal
services market and work associated with federal
regulatory changes. Growth drivers for public
sector projects include growing populations,
aging infrastructure, increased public funding,
environmental regulations, privatization of
infrastructure and homeland security. In this
section we will provide an overview of the
federal services market and reasons for its
growing prominence in the revenue mix of
contractor companies. The Federal Services
Market Despite the widely known federal budget
deficit issues, the federal services market,
consisting of projects for the federal government
and agencies and state local governments, is
one of the most robust sectors today for the
construction industry. The annual budget for
public sector work is about 200 billion, 25 of
the 800 billion domestic construction
industry. In 2003 and 2004, increased federal
spending on defense and homeland security has
generated the most revenue growth. Forecasts
indicate that these budgets will continue to grow
over the next few years. The public sector has
historically been one of the most stable clients,
but recent increases in the spending of these
departments have led to the rapidly growing
government portion of construction companies'
businesses. The Department of Defense ("DoD")
and the Department of Homeland Security ("DHS")
are expected to continue spending at record
levels fueled by residual effects from the Iraq
war, opportunities to outsource federal jobs to
civilians, and continued concerns about homeland
safety. The Department of Energy ("DoE") will
also be a significant contributor of funds to the
industry.

• Agency WorkDoD contracts include the building of
  missile sites, outsourcing of base operations,
  maintenance of space facilities and building
  nuclear and biological detection and protection
  systems. The DoD's forecasted 2004 budget is
  about 380 billion.
• DHS contracts include the review of
  transportation infrastructure, review of
  emergency response centers, building facilities
  for natural disasters, and FEMA work for disaster
  recovery. The DHS 2003 budget was 33.4 billion,
  with an additional 6.7 billion in supplemental
  funding recently approved. The department's 2004
  spending levels are forecasted to increase to
  approximately 41 billion.

We would like to invite your insight on these or
other industry related topics. Our contact
information is on the back cover.
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Construction and Engineering Industry Reporter
- August 2004

• Public Sector Growth Opportunities (Continued)
• Federal Outsourcing (Continued)
• The Federal Activities Inventory Reform Act
  (FAIR) of 1998 states government intention to
  outsource an additional 125,000 non-DoD and DoD
  civil service jobs by end of 2004 and a total of
  850,000 over the next 8-10 years.
• The proposed Defense Transformation Act for the
  21st Century of 2003, authorizing the use of
  civilians for non-combat military jobs, could
  convert another 320,000 military positions.
• The Environment
• Regulatory provisions also generate significant
  opportunities in the environmental and water
  sectors
• The Environmental Protection Agency ("EPA") has
  mandated the compliance of sulfur levels in
  diesel by mid-2006, with more stringent standards
  to come by 2010.
• Sulfer compliance represents a 17 billion market
  opportunity for CE companies, according to
  estimates from the National Petroleum Council.
• Although the latest information is not yet
  available, ConocoPhillips and ExxonMobil, the two
  largest U.S. refiners, expected their clean fuels
  capital expenditures to more than double in 2003
  over 2002. Their total clean fuels investment is
  projected to reach 4.5 billion in total.
• New Maximum Achievable Control Technology
  ("MACT") standards set the emissions levels for
  specific sources of pollution, such as oil
  refineries, chemical plants and steel mills.
• The EPA has issued more than 50 MACT standards
  over the past 13 years. In August 2003, 13 new
  MACT standards were issued for iron and steel
  foundries, combustion turbines, metal parts and
  products, and coating companies.
• Estimated annual costs (excluding initial
  capital costs) are 350 million. These EPA
  estimates tend to be much lower than reality.
• Transportation
• Transportation Equity Act for the 21st Century
  ("TEA-21") authorizes the federal surface
  transportation programs for highways, highway
  safety and transit.
• This infrastructure project will provide 218
  billion of funding.
• Between 1998 and 2003, 170 billon of these
  funds were utilized for highway and transit state
  matching funds.

• Public Sector MA OpportunitiesBecause entering
  a new industry segment through organic growth
  takes time and may lead to unanticipated results,
  Construction and Engineering firms have been
  using acquisitions as a means of expanding their
  presence in or accessing the public sector and
  other public sector activity. Because of the
  continued difference in margins (as illustrated
  below), publicly held government service (GS)
  companies have typically traded at higher
  multiples than their open market (OM)
  counterparts. In 2003, the median margin for OM
  firms was around 3.6, while the median margin
  for GS firms was closer to 9.4. From a
  transaction multiples perspective, in 2003, the
  median EV/EBITDA multiple for GS firms has
  increased to 8.9x and the multiple for OM firms
  has decreased to 7.4x.
• Conclusions

Note GS companies include Affiliated Comp
Services, American Management Systems, Anteon
International, Bearingpoint CACI International,
CDI Corp., Computer, Sciences Corp., DigitalNet
Holdings, Dynamics Research, Electronic Data
Systems, GTSI Corp., Halifax Corp., Keane Inc.,
ManTech International, Maximus Inc., MTC
Technologies, PEC Solutions, Perot Systems, SI
International, SRA International, Tier
Technologies, Titan Corp., Tyler Technologies and
VSE Corp.
We would like to invite your insight on these or
other industry related topics. Our contact
information is on the back cover.
Page 3
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Construction and Engineering Industry Reporter
- August 2004
Merger and Acquisitions Review The worldwide
construction and engineering market rebounded in
2003 and early 2004, as the general economy
experienced a broad-based recovery. As seen on
page one, 2003 and the first half of 2004 has
been a very active time for construction and
engineering firms in terms of mergers and
acquisitions (MA) activity. However, it should
be noted that while there are more deals getting
done, they are generally smaller
transactions. Factors Affecting
Activity There are several factors that may
assist in the resurgence of deal activity within
the sector. Some of these factors
include Rebounding Credit Market The credit
markets remain tight, but they appear to have
bottomed out, as average total debt/EBITDA
leverage ratios in transactions rose to 4.0x in
2003. Acquisition financing continues to be
predominantly through asset-backed loans as a
majority of the debt component, however recently
lenders are showing increasing support for cash
flow lending, which should help stimulate deal
activity.
Increased Activity from Private Equity
Groups Despite a decline in fundraising in 2003,
analysts confirm that there is no shortage of
capital in the hands of private equity groups,
who still have an estimated 100 billion, raised
during the golden fundraising years of 19982001,
to invest. In fact, the abundance of uncommitted
capital has become an issue for private equity
firms, many of which are behind their forecast
investment pace. As a result, they are scrambling
to make investments in quality companies.
Private Equity Groups are actively looking for
attractive construction and engineering companies
with stable cash flows to invest in. This is
exemplified by the recent barrage of deal
activity. Increase in Offer
Multiples Not only have the number of
middle-market deals increased, but offer
multiples have risen as well. In 2003, the
International Mergers and Acquisition Partners
(IMAP) reported a jump of over 20 in EBIT
multiples.

1. Multiples of Earnings Before Interest and Taxes
   (EBIT) were used in the comparisons above. EBIT
   was calculated using trailing 12 months earnings
   before interest and taxes, adjusted for
   non-recurring expenses and discretionary owner
   distributions including compensation in excess of
   market rates. Seller notes, etc., were discounted
   present values.

Source Loan Pricing Corporation (A Reuters
Company)Transaction gt100 millionBorrower
Revenues gt500 million
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Construction and Engineering Industry Reporter
- August 2004
Merger and Acquisitions Review (Continued) Recent
activity reflects the strong interest from both
strategic and financial buyers. It should be
noted that in the last twelve months, publicly
traded construction and engineering firms have
seen an approximate 20 increase in valuation,
providing a more effective acquisition
currency.
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Construction and Engineering Industry Reporter
- August 2004
Public Company Review While public company
performance does not always translate perfectly
into private company, middle-market trends, we
have found it to be a useful reference for
general trends. This page used the following
public entities as a guide
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Brereton and Company is a boutique investment
bank dedicated to maximizing the value and
liquidity of closely held businesses.

• Strategic and Financial advisors to businesses
  seeking value Maximization
• Hands-on attention from experienced senior
  dealmakers who stay with your deal to closing
• Founded in 1995 drawing from prior investment
  banking experience
• Empathetic professionals who have acquired,
  operated and divested businesses for their own
  account
• Broad industry experience in middle market
  Mergers Acquisitions
• Strategic planning framework for evaluation of
  financial alternatives
• Structured timelines and processes for multiple
  bidder-based value maximization

Attention
Expertise
Process

• If you are
• Undercapitalized and experiencing explosive
  demand for your product
• Facing a difficult transition after many years at
  the helm
• Unsure about how to best maximize the value of
  your business for your heirs
• Ready to harvest your business investment to
  diversify your net worth
• Please give us a call. Our initial discussions
  and analysis are strictly confidential and
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Brereton and Company, Inc.1075 N. Tenth Street,
Suite 110San Jose, CA 95112www.brereton.net
Brandt Brereton, Managing Director E-Mail
brereton_at_brereton.netTelephone [phone]
Facsimile [phone]
Member International Network of Mergers and
Acquisitions Partners (www.imap.com)
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