Sector Dynamics

Communications - In an environment where communications service providers are faced with an overwhelming supply of work, pressure for 5G deployment is accelerating. Emerging social trends and technologies alike are reliant on 5G and the current US communications infrastructure landscape is struggling to keep up with the growth. Over the next five to ten years, substantial capex dollars from communication majors such as AT&T, Verizon, Dish, and US Cellular will funnel into widespread fiber and 5G buildout.

It is estimated that only 15% of the current population has fiber coverage, but with an estimated 50% of US workers working remote in Q1 2021 and data requirements at all-time highs, it is becoming increasingly clear that fiber to the home and 5G buildout are essential across urban, suburban, and rural America.

Similarly, as the world transitions to a cleaner and smarter paradigm, the growing numbers of electric vehicles, internet of things devices, and similar technologies are more reliant than ever on fiber and 5G availability.

In order to fully support these trends and expand fiber penetration to 90% of the nation, an estimated $70bn of capital will be deployed into the initial buildout. Once the fiber backbone is installed, existing towers will require upgrading and up to 1 million small cells will be installed to support 5G.

In short, the 5G train is coming in at full speed ahead and is creating a massive opportunity for outsourced service providers to expand wallet share, increase pricing, and capture margin expansion.

Electric and Gas - On the other side of the spectrum, maintenance, replacement, and upgrade of existing electric and gas infrastructure as well as investing in renewable power generation assets remain a top priority for asset owners.

As the nation works to upgrade outdated electric transmission and distribution infrastructure, focus is shifting to modernizing the grid to make it harder, smarter, and more resilient. Deployment of new types of infrastructure, technologies, equipment, and controls that work together to deliver electricity more reliably and efficiently are rising to the top of utility budgets and outsourced providers are being called upon to execute the initiatives.

With a high degree of fundamental overlap between communication, electric, and gas infrastructure, this balance of rapid new build, upgrade, maintenance, repair, and replacement is favoring outsourced service providers in every part of the value chain.

Investor Viewpoint: News Cycle

Recent events have highlighted the state of the nation’s utility and communications infrastructure and the vast, long term investment required to upgrade and expand the network.

• California Wildfires, Summer 2020: Disastrous wildfires sparked partly from antiquated utility infrastructure resulted in California utilities pledging to spend $13 billion to cut wildfire risk.
• Texas Freeze, Winter 2021: A once in a generation freeze of Texas and the resulting power outages for millions exposed the state’s vulnerable energy infrastructure.
• Infrastructure Bill, Spring 2021: The Biden Administration recently announced a $2 trillion infrastructure spending bill with ~$300 billion dedicated to utility and communication upgrade and expansion.
• Pacific Northwest Heatwave, Summer 2021: Unusually high temperatures in the Pacific Northwest drove up energy usage and forced utilities to take drastic steps to prevent overloading the substantially strained electric grid.
• Renewable Energy, Ongoing: ESG investment mandates, zero carbon pledges, and rejoining the Paris Agreement are resulting in record US investment in renewable energy projects estimated at ~$40bn between '20 – '22.

Value Drivers

Through Industria’s conversations with buyers as well as keeping a tight pulse on the industry as a whole, we have witnessed four main categories driving valuations in the sector:

• Revenue composition: Buyers are paying close attention to revenue categorization and ascribing larger EV / EBITDA multiples to businesses with a higher degree of repair, maintenance, upgrade, and other recurring work.
• Growth & capex: Both organic and inorganic growth are considered. For platform companies formed through M&A, increased importance is placed on integration capabilities and acquisition pipelines, and for organic growth, buyers are scrutinizing capex to EBITDA ratios and timelines. In general, buyers prefer lower capex businesses but are expecting management teams to have strong conviction around maintenance, replacement, and growth capex requirements.
• Diversity & scale: In most sectors, increased scale yields increased value, but for communications and utility service businesses, buyers are placing increased importance on businesses capturing a wider portion of the value chain with a preference towards white-collar service offerings (permitting, design, engineering, testing, etc.) and self-performing operations.
• Administrative: A well rounded management team is essential, but a polished back office is key to having buyers view an organization as a cohesive and mature business ready for integration on day one.

Best in class communications and utility service providers that achieve double digit EBITDA multiple valuations have many of the following characteristics:

Case Study: Primoris Services Corporation’s acquisition of Future Infrastructure Holdings

Primoris’s acquisition of Future Infrastructure from private equity firm Tower Arch Capital demonstrates buyers’ willingness to pay a premium for top tier businesses.

Future Infrastructure provides maintenance, repair, upgrade, and installation services to communications, gas, pipeline, and civil infrastructure throughout the southern and western regions of the United States.

In a push to expand communications services to support the buildout of fiber and 5G infrastructure, Primoris viewed Future as an ideal target to establish a strong presence in the communications market.

Valued at 9.4x EV / LTM EBITDA, Future demonstrates many of the attractive characteristics buyers are focusing on, including a high degree of communications exposure, 93% recurring and reoccurring revenue, large quantities of small ticket, MSA oriented revenue, and low maintenance capex requirements.

Because of these characteristics, Primoris indicated “this is one we felt like was worth stretching for a little bit in order to really get us into this space in a meaningful way.”

M&A Update

As the world recovers, M&A activity is rebounding with vigor as both buyers and sellers look to capitalize on strong macroeconomic conditions supported by widespread capital availability.

• Deal value and volume: In the first quarter of 2021, total global M&A was valued at $1.2 trillion, representing the strongest opening quarter on record, and doubling year over year. In the US, deal value increased 163% year over year while deal volume remained relatively stable.
• Dry powder: Private equity funds and nonbank specialty lenders are eager to deploy dry powder and willing to stretch on valuation when there is conviction around a particular opportunity.
• Capital availability: Public and private debt and equity capital remain readily accessible to strategic buyers further driving up valuations and deal flow.
• Regulatory & tax impact: The enforcement of tighter compliance with regulations coupled with expected tax increases from the new administration are leading more business owners to evaluate exit opportunities to decrease risk and diversify holdings.

As a result of a booming sector and robust capital availability, merger and acquisition activity in the communications and utility services space is accelerating with new deals regularly announced each week. Ranging from local service providers to nationwide platforms, public, private, and financial constituents are growing their footprint and service offerings via M&A.

In addition to the business fundamentals discussed in last week’s piece, private equity firms are valuing platform investments at a premium to add on acquisitions (or tuck ins for strategic buyers). The graphic below illustrates the range of sector valuations and the correlation between size, type (platform or add on), and value.

We hope you found this insightful. Please feel free to contact anyone on the Industria team – we would welcome the opportunity to discuss our viewpoints. Don’t wait. Let’s start the conversation.