ARCADIS: Buying a UK presence and global exposure

While warning for weaker-than-expected EPS growth over FY11, Arcadis announced the acquisition of UK Project management consultant ECHarris for an undisclosed sum. EC Harris ended FY11 with € 254m in net revenues and an underlying EBITA margin of almost 7%. While the deal increases Arcadis’s exposure to Asia and the Middle East, we remain somewhat concerned by the high UK public exposure.
EC Harris merger:
The acquisition of EC Harris significantly strengthens Arcadis’s position in Project Management in both Asia (18% of rev) and the Middle East (14%). But the deal will likely dilute margins over the short term (7% margin vs. 10% at Arcadis), while also carrying the risk that the UK market will decline further. We estimate that 1/3rd of EC Harris revenues could contract, mainly due to the exposure to UK Public, Water and Highways. We are confident though that the high-end project and property management activities of EC Harris show decent growth prospects through the cycle, especially for Arcadis’s MNC clients. By becoming one of the UK’s top 10 engineers, Arcadis also strengthens its position in Europe’s 2nd largest economy. This shouldallow the Dutch engineer to tender for larger contracts across the UK.
We forecast the deal to be almost 5% EPS accretive over 2012, assuming no growth or synergies, while we forecast a short term ROIC of ~8.5%. Based on cross-selling synergies, the actual returns could end up higher, but the current environment requires caution.
3Q11 Trading Update:
Arcadis sees 3Q11 revenues down 2-3% y/y (-3% kbcs) with 3% organic growth (was +3.5% kbcs). Underlying EBITA is now seen as flat y/y and EBITA is predicted ~10% lower than last year (was -8% kbcs). This would indicate 3Q11 EBITA of € 31.6m, and underlying EBITA of ~€ 35.1m. Management also reduced its guidance for 0-5% growth in FY11 net income from operations to flat net income vs. FY10. The blame is laid mainly on Poland, higher financing charges and higher taxes. We were banking on 3.9% growth and have subsequently cut our forecasts to flat growth y/y.
Slight adjustment to our forecasts:
The somewhat weaker 3Q11 trading update and the EC Harris acquisition have prompted us to adjust our numbers. This results in a 6.7% cut in our FY11 EPS (based on net income from operations). Our FY12 EPS is upped by 2.5% and our FY13 numbers by 1.6%.
Conclusion:
Our TP of € 16.0 (down from 16.5) is based on our DCF model. Our rating is Accumulate. There could be additional upside from new add-on acquisitions (we estimate Arcadis has up to € 250-300m to spend), which we expect soon, probably in both Asia and Brazil.