Engineering and construction: US Deals 2023 outlook

E&C deals expected to return to growth in second half of 2023 if near-term M&A headwinds subside 

M&A activity slowed in 2022, primarily due to emerging economic and geopolitical challenges. Looking ahead, however, deal activity could rebound in the latter half of 2023 if near-term economic headwinds subside and markets grow from a new base. Tailwinds associated with balance sheet strength (both corporate and private equity), lower valuation multiples and upcoming tax changes that will disincentivize allocating capital to share buybacks could also drive deal-activity growth. 

While transaction volumes declined relative to record highs in 2021, deal activity was still in line with pre-pandemic levels and historically strong. Deal values declined in the last four quarters due to fewer billion-dollar-plus deals, with companies increasingly cautious of antitrust concerns and government approvals for megamergers.  

The decline in engineering and construction (E&C) transaction volumes was in part due to a pullback in local strategic investor deals in North America.

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Engineering and construction deals 2023 outlook

Despite slowing economic activity and concerns that tighter Federal Reserve policy might trigger a recession in the first half of 2023, the medium-term deals outlook for the sector is one of cautious optimism. Underlying confidence is fueled by significant amounts of undeployed private equity capital and cash-rich corporates, buoyed by recently passed legislation — new federal spending associated with the Infrastructure Investment and Jobs Act and expanded tax incentives for decarbonization included in the Inflation Reduction Act. 

The short-term outlook for the residential sector, which experienced record high building permits and starts in 2021, appears challenging. Housing starts are expected to decline in the 4% to 5% range in 2023. However, given that homeowners have significant equity, interest rates remain historically low, and there is still a substantial housing gap due to underbuilding in the decade following the 2008 recession, the long-term outlook for this segment remains positive.

The nonresidential segment struggled for much of 2021, with spending significantly below pre-pandemic levels. Following a rebound in 2022, the outlook for this segment is stable, though this varies by segment. Transport, health, manufacturing and education are expected to benefit from spending associated with the Infrastructure Investment and Jobs Act, while construction spending on offices, retail and hotels — impacted by continued remote working and reduced business travel post pandemic — is expected to be muted.

Value creation through strategic portfolio review and divestitures

Divestitures come with significant investments in cost and time and operational complexities such as entanglements and tax implications. As a result, companies across all industries are typically more reluctant to embrace them than acquisitions. However, divestitures are an equally critical part of strategic repositioning and are key to driving higher shareholder returns.

An upcoming PwC study on divestitures found that companies that make timely and objective divestitures decisions and strategically manage their portfolios are at an advantage in this dynamic business environment. The length of time between the identification of non-core divestible assets and making the decision to divest can have a direct impact on value creation.

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“The medium- to long-term outlook for E&C sector deal activity remains optimistic due to tailwinds associated with recent legislation (Infrastructure Investment and Jobs Act and Inflation Reduction Act) and capital availability from private equity and strategic corporate acquirers, despite near-term macroeconomic and geopolitical challenges, rising interest rates and continued supply-side cost pressures.”

— Danny Bitar, US engineering and construction deals leader

Key deal drivers

Capital discipline and conviction

Competition for assets and an increasing cost of capital means buyers will be required to exercise greater capital discipline in the near term, despite the significant dry powder available to private equity and healthy balance sheets of corporates. Inflationary pressures, driven by supply constraints, required the Federal Reserve to respond with the most aggressive pace of monetary policy tightening in over 40 years. 

This higher cost of capital and inflationary environment requires companies to apply a more discerning approach to M&A activities, with growth alone no longer an adequate strategic objective. In this rapidly evolving landscape, E&C companies that reassess their portfolios against core business strategies and find the appropriate balance of acquisitions and divestitures will be best positioned to differentiate and drive higher returns on capital. 

We expect 2023 to provide a unique opportunity for E&C investors with high conviction in the sector (both corporate and private equity). Financial buyers with less expertise are likely to remain on the sidelines as they worry about cyclical risk which could reduce competition for available deals. High-conviction investors investing in construction in the medium- to long-term or in secular penetration themes (e.g., products that improve building energy efficiency) will likely have an opportunity to buy at lower multiples and increase value creation. For this reason, we expect corporations to expand their share of M&A for the first time in years.

Navigating uncertainty

Top of mind for E&C executives is inflation. Despite an overall moderation in prices from pandemic highs, input costs are still higher than pre-pandemic levels. New challenges, such as geopolitical destabilization ushered in by the war in Ukraine and tensions between the US and China, continue to pressure input prices and already slim margins. 

Geopolitical instability increasingly led E&C companies to focus on portfolio realignment, with continued divestments of underperforming and non-core regions and reallocation of surplus cash into local, mature markets such as North America and Europe.

Investments in purpose

Environmental, social and governance (ESG) will continue to be an increasingly important lens for investors in the E&C sector, as companies focus on sustainability factors beyond typical due diligence and value drivers. In addition, stakeholder-led emphasis on ESG is being driven by expanding regulatory reporting requirements. 

Because the E&C industry is fragmented and lacks visibility in supply chains and subcontractor processes, it is more challenging for it to commit to green construction. However, with customers placing greater emphasis on decarbonizing construction, companies that support initiatives promoting sustainable design, development and construction practices  — such as responsible sourcing, offsite construction and lower carbon technologies — will attract higher valuation multiples.

Increasing resilience and security

Several factors continue to drive up input costs, which are eroding margins and impacting project timelines across the sector. The persistence of global supply chain disruptions and sourcing challenges are affecting project profitability. These challenges are being further exacerbated by wage inflation and labor shortages, with the available E&C workforce shrinking, as an aging cohort of skilled workers either retire or move into other professions offering competitive salaries. 

These ongoing disruptions increase the urgency for greater innovation, with companies expected to fine-tune their business models by leveraging technologies and focusing on solutions geared towards supply chain management. Developing strategies to mitigate these risks, restructuring and ensuring consistency of operations will be a key factor for companies in preserving value.

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Danny Bitar

Danny Bitar

Engineering and Construction Deals Leader, PwC US

Michelle Ritchie

Michelle Ritchie

Global Industrial Manufacturing and Automotive Deals Leader, PwC US

Michael Sobolewski

Michael Sobolewski

Partner, Trust Solutions, PwC US

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