The proposed all-share merger between civil engineer Costain (COST) and road maintenance group May Gurney (MAYG:AIM) has brought renewed takeover interest to the construction and support services sectors. As for the deal itself, Costain most certainly has the upper hand with its staff taking all the senior positions on the board, implying that it is more of a takeover than a merger. May Gurney is up 32% to 243.5p amd Costain up 0.3% to 303.75p.
The rationale behind the transaction is that the combined entity should be able to bid on larger contracts. They have complementary skills in servicing the infrastructure market including rail, water, waste and power.
The combined order book is £3.9 billion and combined revenues of £1.6 billion per year. The new business will be renamed Costain May Gurney.
Costain reckons its can achieve £10 million annual cost synergies, mainly through consolidating the corporate functions and shares services. Costain believes the merger will be 'double-digit earnings enhancing' in 2014.
It does look like a deal heavily skewed in Costain's favour. Its chief executive officer (CEO) Andrew Wyllie, finance director Tony Bickerstaff and chairman David Allvey all get to keep their existing roles in the enlarged business. May Gurney chairman Margaret Ford is demoted to deputy chairman; her colleague, chief executive William MacDiarmid is left with a mere non-executive director position. Perhaps not what he was expecting when taking the CEO role at May Gurney only six months ago.
Liberum Capital reckons the deal will improve Costain's earnings by between 28% and 33%. It sees the £10 million synergies as 'relatively cautious'. It says the transaction adds significant risk, particularly because Costain does not have a track record of executing a large deal, but says the economics 'look attractive'.
Costain has bucked the weak UK construction industry by growing its earnings through a focus on the infrastructure market which is enjoying much stronger market conditions. May Gurney suffered a profit warning in September 2012 which cost the previous CEO, Philip Fellowes-Prynne, his job. It suffered operational issues within several contracts.
This is the second time in the past few years that Costain has tried to expand the support services side of its business. It tried to buy infrastructure consultant Mouchel in 2011 but had its offer rejected; in hindsight a good result given that Mouchel went into administration a year later.
Costain was valued at £201 million on the eve of the announcement versus a £129 million market cap for May Gurney. Today's deal values May Gurney at £177 million.
The operational problems experienced by May Gurney are reflected in a weak share price rating. The shares last night traded on 7.6 times prospective earnings for 2013. In comparison, Costain was on a PE (price to earnings) ratio of 11.7 times 2013 estimates.