Morningstar | Aecom Announces Spin-Off of Management Services Segment; Raising FVE
We modestly increase our fair value estimate for Aecom to $37 from $36 after the no-moat engineering and construction firm announced plans to spin off its management services segment to form a stand-alone government services company. Management expects the spin-off to be completed in the second half of fiscal 2020. Our fair value increase is due to slightly more optimistic assumptions about operating margins in the management services segment, which we bumped by 50 basis points to 7% from 6.5% at midcycle, as well as time value of money since our last update. The market reacted favorably to the news, as the share price rose by nearly 5.5% to around $35 on June 17, making the stock fairly valued at current levels.We view the move as well timed, as the management services segment has been a bright spot in Aecom’s portfolio, and valuation multiples for government services firms have been steadily drifting higher. Furthermore, we believe the new business has the potential to build an economic moat based primarily on switching costs. The segment currently derives roughly three fourths of its sales from contracts with the Departments of Defense and Energy, which are often long term (some longer than 10 years) and generate relatively stable cash flow. Aecom also has a large base of employees with security clearances for government contracts, which acts as a barrier to entry for competitors.
Also, management has taken meaningful steps to lower the risk profile of Aecom’s remaining portfolio. The company is exiting more than 30 countries and several businesses, including fixed-price combined-cycle gas power plant construction, at-risk oil and gas construction, and international at-risk construction projects. We expect these moves, coupled with recently implemented cost-reduction initiatives, to lower the volatility and boost the operating margins of the remaining company.
AECOM designs, builds, finances and operates infrastructure assets for governments, businesses and organizations. The company provides: planning, consulting, architectural and engineering design services to commercial and government clients in transportation, facilities, environmental, energy, water and government markets; construction services, including building construction and energy, infrastructure and industrial construction; as well as program and facilities management and maintenance, training, logistics, consulting, technical assistance, and systems integration and information technology services, for agencies of the United States government and for other national governments.
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