A whole heap of beans

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Christopher Gasson tries to make sense of AECOM’s decision to cut Earth Tech back to its roots.

AECOM’s acquisition of Earth Tech and its subsequent sale of the operations business and its equity interests in water projects is interesting. It seems to suggest a change in direction in the way people in
the engineering sector are thinking.

Over the past few years, the main strategy that engineering firms have been pursuing in the water sector might be described as “climbing the value chain”. You start at the bottom with a plain vanilla architectural engineer, making a dime by renting its people out by the hour, then
you move into procurement and construction and hope to squeeze a little extra margin from packaging design and build together. Then you add operations and start to look at how you can make a margin from the trade off between capital and operating costs. Finally you add finance, and you are in a situation where you can use your expertise to optimise the design, construction, financing and operation of a plant.

There is earnings growth to be had all along the way. Moving from the simple architectural engineer’s business into the design-build (or engineering, procurement and construction) market might bring slimmer profit margins, but it brings with it a much larger slice of the market. It also brings a much larger slice of the client’s budget, and, for an American firm, it also opens the possibility of international expansion (because outside the US, the EPC model predominates). Moving into operations brings another chunk of the client’s budget, with a better profit margin than would be expected from EPC alone. Add finance, and you have total control of the client’s budget, as well as the opportunity to squeeze a margin out of every aspect of the full lifecycle cost of a project. Typically, an engineering firm which is not involved in operations or finance will make a margin of between 2% and 5%. An operator might get up to 8%, while a developer which also acts as EPC contractor and operator might expect 12%.

Under Tyco’s ownership, Earth Tech followed this pattern of development,expanding into operations and project development. It has positioned itself to be able to offer the full range of project procurement
services, from design, through construction and procurement, to operations and finance. By selling off Earth Tech’s operations and project development interests, AECOM seems to be saying that it is not interested in climbing the beanstalk to find the goose that lays golden eggs in project development at the top. Instead, it just wants to grow beans as a plain architectural engineer in the water sector.

That decision would not have been made if, in fact, Earth Tech had found the goose that lays golden eggs in its diversification outside engineering consultancy. Instead one has to conclude that the Long Beach-based company was sub-scale in both operations and project development, and probably loss-making. United Water has bought the US contract operations business and should make a bigger profit because it can integrate the business into its existing overhead. The projects in which Earth Tech has an equity interest are being sold piecemeal to larger developers (such as Mitsui and Suez’s Chinese joint venture Sino-French Development). AECOM will be “a pretty pure consulting engineering firm”, according to chief strategy officer Glenn Robson (see story p9).

This may not be such a bad move, as long as AECOM didn’t pay too much for the business. The purchase price was USD 510 million for USD 1.3 billion of revenues, which sounds like a much better deal than swapping Milky White the cow for five magic beans.

Earth Tech is unlikely to be the only company to have struggled with the profitability of its international expansion and diversification into operations and project development. I suspect that over the next eighteen months, we will see one or two other firms abandon the search for golden eggs and go back to farming beans.