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OUTSOURCED UTILITY SERVICES A combination of unique secular trends is providing stability and controlled growth in a time of uncertainty.

Except for severely distressed situations and / or forced liquidations, COVID-19 has caused middle market M&A activity to slow dramatically. Although this is the case more broadly, certain sectors continue to demonstrate resiliency in a time of economic uncertainty.

In outsourced utility services, resiliency is stemming from a combination of unique secular attributes including ESG, increased investment in renewables, and aging transmission / distribution infrastructure. These dynamics are leading to rising construction as well as ongoing repair and maintenance demand and expanding test and measurement services providing stability and controlled growth within the sector. Furthermore, adoption of technological innovation is transforming the industry and paving the road for further disruption through digitalization, data analytics, artificial intelligence, and related technologies.

Renewable Energy Development

Renewables are reshaping America’s energy sector.

Worldwide, $3 trillion was invested into the renewable energy sector over the past decade with a majority of the capital deployed in wind and solar power generation. In the US, plunging renewable energy costs may enable up to 90% renewable electricity production by 2035 with many of the largest utilities and energy producers pledging to shift to green energy by the middle of the century.

ESG – Both the public and private markets’ attention has shifted to Environmental, Social, and Governance (“ESG”) initiatives. Major utilities are committing to aggressive green energy plans and private equity firms are actively raising ESG funds related to renewable energy generation, green technology, and other carbon elimination methods.

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State regulations and carbon incentives – States continue to implement stringent regulations supported by carbon emission incentive programs in an attempt to cut CO2 emissions. Established in 2005, the Regional Greenhouse Gas Initiative was the first mandatory carbon cap-and-trade program in the United States to limit CO2 emissions within the power sector. Since then, many states have implemented cap-and-trade programs for carbon emissions, and because emission allowances decrease annually, participating companies are incentivized to shift to clean or renewable sources.

Aging Infrastructure

The backbone of America’s utility infrastructure is rapidly aging.

The backbone of America’s utility sector, transmission and distribution infrastructure, is on the brink of exceeding its useful life. With a majority of the system over 25 years old, the industry is committing substantial capital to rebuilding, inspecting, and maintaining legacy infrastructure thereby creating a surplus of demand for outsourced utility service providers.

Electric utilities: The grid – Most of America’s electrical grid infrastructure was constructed in the 1950’s and 1960’s. At a total replacement cost of $4.8 trillion, with over 70% of transmission lines and power transformers greater than 25 years old and 60% of circuit breakers over 30 years old, electric utilities are investing between $30bn and $50bn annually to update systems and maintain reliability.

Gas utilities: Pipelines – With approximately 50% of gas distribution infrastructure constructed prior to 1990 and a quarter of gas distribution lines over 50 years old, investment in constructing and maintaining America’s natural gas system has tripled over the last decade from $5bn to $15bn per year.

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Technology Adoption

Technology adoption in the utilities sector is on the rise, similar to other legacy industries.

Like other energy and industrial sectors, utilities are welcoming technology into their legacy system. Coupled with new infrastructure buildout and maintenance, considerable efforts are being made to modernize and digitize transmission and distribution infrastructure. The following trends are competing for industry capital as innovation sweeps through the sector:

  • Software development: The first wave of growth in the utility sector is happening through the addition of physical assets on the ground, however the next wave will come through the development of digital products that help optimize the power flow from generators to their customers. Many emerging technologies related to asset management and test and inspection are utilizing big data and artificial intelligence to maintain efficiency throughout the grid.
  • Smart grid buildout: Utilities and outsourced utility providers are focused on upgrading the grid to better connect utility companies to consumers. Investment in two way communication between utility providers and consumers through means such as advanced metering infrastructure, smart appliances, sensors, and other data transmitting infrastructure is resulting in better integration of renewable energy sources and reducing the risk of supply chain congestion and outages.
  • Distributed energy resources: Hospitals, datacenters, and other mission-critical facilities are investing in distributed energy resources to gain independence from the grid, increase resiliency, and mitigate risk of power failure. This push to generate energy at the residential, commercial, and industrial level is driving up demand for downstream microgrid, residential solar, electric vehicle, and storage infrastructure and related services.
Financially Resilient Customer Base

A financially resilient sector rooted in strong industry fundamentals is encouraging M&A, private equity investment, and other corporate finance activity.

In the last several years, outsourced utility service providers have benefited from a stable customer base, low levels of leverage, and high levels of liquidity in pursuit of industry consolidation amid a fragmented market. Larger public and private equity backed players are acquiring local suppliers, increasing capabilities, and gaining market share. However, as consolidation slows, another wave of fragmentation will occur as new technology emerges and again, utilities and their service providers will compete to bring capabilities in house and optimize efficiency.

Customer stability – A positive outlook from the utility industry provides visibility and stability in the outsourced utility service providers’ customer base. Throughout the COVID-19 pandemic, utility companies have generally maintained original 2020 capex budgets where approximately half the capital is dedicated to transmission and distribution infrastructure.

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This positive sentiment has resulted in minimal operational disruptions and stable cash flow for outsourced utility service providers throughout the pandemic.

Industry frontrunners – A consolidated group of public companies has captured a majority of market share within the outsourced utility services space. Due to a high degree of resiliency stemming from a dependable customer base and the favorable industry dynamics mentioned in this piece, these industry leaders continue to demonstrate strong leverage and liquidity figures and forward valuations, a positive outlook in a recessionary environment.

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M&A and the capital markets – Compared to many other industries, there has been a considerable amount of growth investment in the sector throughout 2020. Centered in the public and private equity arena, M&A activity is focused on expanding construction, maintenance, and inspection capabilities, acquiring technology platforms, growing geographic footprint, and gaining market share. Debt raises and equity investments are concentrated on supporting emerging technologies and ESG initiatives (such as renewable energy buildout), and relative to other industries, there has been very little bankruptcy activity in the space.

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Implications for the Middle Market

Outsourced electric utility service providers are the benefactors of the above secular trends, but what are the implications for the middle market?

A majority of market share within the outsourced utility services space is centered around a handful of public players. However, outside this arena, the space is highly fragmented and many regional, niche, and emerging companies are competing for the remaining market share. Below are our thoughts on how the trends mentioned in this piece will shake out for middle market subsegments within the industry:

Construction: Investment in renewable energy will drive demand for transmission infrastructure to connect the newly sourced power to the grid, however many of these projects will likely be awarded to larger public players. Increased opportunity exists for middle market companies located in regions where renewable energy is produced (such as the West, Midwest, and Northeast). Additionally, innovations in smart and micro grids as well as distribution infrastructure buildout will provide supplementary opportunities for middle market utility construction companies.

Maintenance & repair: Although many construction projects may be awarded to larger industry players, regional electrical contractors can capitalize on repair and maintenance opportunities presented by the nations aging infrastructure. These companies are more likely to be insulated from economic uncertainty due to a high degree of recurring revenue.

Engineering & consulting: Opportunity exists for engineering and consulting companies throughout the supply chain. Upstream, as more renewable energy capacity is coming online, utilities are enlisting engineering firms as connection to the grid remains a top priority. Downstream, as many regions transition to “smart cities”, consulting companies will be an essential partner for both utilities and municipalities to ensure seamless technology implementation.

Test & inspection: Most utilities need to be inspected every five years and many utility companies are turning to outsourced test and inspection providers. Most inspections take place on foot leading to longer timelines and increased human error. Companies that adopt higher levels of technology such as the use of drones for aerial inspections of electric utilities or augmented reality for insight into underground utilities will more likely be able to usher their services into the next generation of infrastructure buildout.

Emerging technology: As new infrastructure gets built, the industry will be presented with an inflection point, focus will shift to creating efficiency, capturing data, and digitally connecting the power generator to the end user. As demonstrated in other legacy industries, companies with technologies that focus on data analytics, AI, and machine learning will emerge as the winners in the next wave of innovation in the sector. Furthermore, these companies will drive future sector consolidation as utilities seek to rely less on outsourced services and bring technology in-house.

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How can Industria help?

Industria Partners believes in Full Cycle Strategic Advisory, meaning we consider our team as strategic advisors, first and foremost, in our approach to finding and creating solutions to our client's challenges at every point in the business cycle. We work with business owners, borrowers, financial sponsors, and lenders on the following projects:

  • Sell-side and buy-side M&A advisory
  • Growth capital planning / raising
  • Distressed and restructuring advisory
  • ESOP advisory
  • Capital stack optimization
  • Outsourced CFO services focused on strategic capital decisions
We hope you found this piece insightful – please feel free to contact anyone on the Industria team – we would welcome the opportunity to discuss our viewpoint.

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Credits:

Created with images by Fré Sonneveld - "Power Line Grids" • Mariana Proença - "untitled image" • Adi Rahman - "electricity" • NASA - "untitled image" • Anil Kumar Shrestha - "untitled image" • Omar Ram - "untitled image"