Opportunity knocks as the strain on the UK building industry continues

On the surface, the construction sector in the UK looks to be among those that are recovering best from the COVID-19 pandemic. Companies have seemingly sussed out how to operate within the confines of social distancing restrictions and business appears to be growing again despite the ongoing pandemic.

Figures for February show that activity in the sector is up, with the IHS Markit/CIPS UK Construction PMI rising from 49.2 to 53.3, well over the growth threshold of 50 and the biggest rise in activity since September last year.

Meanwhile, the spring budget brought with it a raft of stimuli, from the super-deduction tax break to the £12bn apprenticeship fund, that will be of direct benefit to the construction sector.

However, beneath the surface a triple threat of factors means that this fledgling recovery may be standing on far shakier foundations than it seems – and that could spell valuable acquisition opportunities for those with the cash to do deals.

Reverse charge VAT

For small sub-contracting firms, one of the key sources of cash flow that keeps them in operation from month to month is the VAT they charge on goods or services rendered. However, at the beginning of March some long-delayed and highly controversial rule changes were brought in which means that this valuable source of cash disappeared overnight.

In an effort to tackle “missing trader fraud” (seen as rife within the construction industry,) the Treasury has introduced reverse VAT charge for the construction and building sector within the UK. What this means is that all VAT-registered construction companies must now pay VAT directly to HMRC, rather than the firm that is supplying them.

Sub-contractors often work within a supply chain of contractors rather than serving an end-client, meaning that this is a massively damaging rule change with a sting in the tail. Not only can they no longer charge VAT on services or goods rendered, they still have to pay VAT on goods or services they engage.

With many small firms still recovering from the months of trading lost to and interrupted by COVID-19 and adjusting to the post-Brexit economy, this change comes at the worst time possible and could prove to be unsustainable for many.

Furthermore, with so many firms in the construction sector suffering from a major depletion of cash reserves, the new rules could mean that many will be forced into administration or insolvency over the coming months and will be desperate to borrow funds or sell equity before they collapse completely.

These solvency problems could also impact the bottom lines of bigger companies further up the supply chain, perhaps reigniting the issue that arose last year of defaulted invoices having a severely damaging impact on creditors.

Brexit

Following the uncertainty that plagued the run-up to Brexit and the subsequent transition period, the post-Brexit world comes with a whole new set of challenges. For construction companies, the limitations of the UK’s post-Brexit trade deal with the EU means that significant issues have arisen.

Firstly, delays and queues that have been clogging up vital UK ports for months, now exacerbated by more stringent checks, could severely impede the import of raw materials which many construction companies rely on.

These issues are likely to result in once-cheap imported materials now becoming far more costly and time-consuming to get into the UK, severely impacting cash flow and causing potentially damaging delays to projects. Meanwhile, domestic suppliers will now have the leverage to charge a premium for supplying materials quickly.

However, perhaps the most damaging impact of Brexit for construction companies are new rules governing skilled labour. With free movement now a thing of the past, the UK has moved to a points-based immigration system for EU and non-EU citizens.

Unfortunately for construction companies, many of which rely on cheap unskilled labour from the continent, these rules contain minimum skills thresholds and labourer roles are not considered skilled enough to be eligible for sponsorship. This could mean construction firms see their payrolls increase as they are forced to turn to more expensive UK labour to fill unskilled rolls.

Furthermore, while the UK has lowered the skills threshold, meaning that more roles can be sponsored, the potentially prohibitive cost of sponsorship must now be factored into the budgeting of any construction firm that wishes to employ skilled workers from the EU.

Zombie companies

Government support schemes and courts that are running at a fraction of capacity have meant that many inviable firms are continuing to survive, with administrations and insolvencies at record lows despite the damage caused by COVID-19.

This is particularly evident in the construction sector. According to Begbies Traynor, there were over 80,000 UK construction companies in “significant financial distress” in Q4 2020. The concern is that a winding down or reduction of government support could mean that the true impact of COVID-19 on construction firms is revealed in a dramatic wave of collapses.

The construction sector has been the biggest beneficiary of government support, meaning that thousands of construction firms that have taken on government facilities such as CBILS loans will be moving into an uncertain post-COVID trading period saddled with considerable piles of new debt.

On top of this, while companies undoubtedly needed the financing for survival, concerns have begun to arise about how some of them used government support. Many firms are reported to have used the financing for down payments on costly equipment and are now facing a situation where they must begin to make monthly payments on these investments, whilst also thinking about servicing the debts they’ve accrued.

These new debts will also sit alongside substantial liabilities racked up during the pandemic, things like deferred payments to landlords, invoices with increased terms for suppliers and other creditors and VAT deferments.

A coming wave

These factors seem to form a deadly cocktail for construction companies and are likely to be particularly damaging given that the industry recovery from COVID-19 is only just beginning to gain pace and work remains relatively scarce.

This means that companies are faced with mounting overheads, restricted cashflow, workforce and materials shortages as well as a monumental struggle to win the contracts they need to generate the revenue to keep up with this. What’s more, this desperation means that the prices of contracts are being driven down and the value of work diminished.

Under this kind of strain, many construction companies will be forced into administration and insolvency. This creates intriguing possibilities for acquisitive parties, particularly with the UK set to embark on ambitious infrastructure spending once the pandemic is over.

What are the main acquisition opportunities?

High-potential firms in distress
The most obvious opportunities for acquisitive parties to do deals in the construction sector will be distressed companies. As per the Begbies Traynor figures, there were huge numbers of construction companies in financial peril at the end of 2020. This will only have increased in the time since, with the end of the Brexit transition period and the implementation of reverse charge VAT, and that’s without even mentioning the eventual end of government financial support.

Many companies are going to fall into administration that were perfectly successful and viable prior to the pandemic and could easily recover quickly in the post-COVID economy. Such companies represent incredibly attractive opportunities, having shed considerable liabilities and debt by entering administration, and could be extremely worthwhile investments.



Distressed assets
With many companies sure to close for good, buyers may be in a position to pounce on hard assets, from plant and equipment to less tangible but equally valuable assets like ongoing contracts, customer bases and other IP.

Contracts could prove to be particularly valuable acquisitions if picked up at reduced prices in a distressed takeover. The rising IHS Markit/CIPS UK Construction PMI number cited above reflects the fact that significant contracts are beginning to be won again as businesses look to the post-COVID world.

According to IHS Markit economics director Tim Moore: “The rebound (in the PMI) was supported by the largest rise in commercial development activity since last September as the successful vaccine roll-out spurred contract awards on projects that had been delayed.”

Clearly, though, the worst of the pandemic could still be ahead for a considerable number of construction firms. It may be the case that companies will have won contracts, but still be struggling and potentially be open to an acquisition to help them fulfil their projects.

Grow through acquisitions now and flourish post-COVID-19
Obviously, it is currently hard for construction firms to grow organically due to the impact of COVID-19. However, construction activity will pick up as the UK exits lockdown for (hopefully) the last time.

Firms that go into this post-COVID marketplace in an already strong position will be the best-equipped to really make the most of what could be a booming industry, with delayed contracts and new projects sure to be coming on stream in big numbers.

Firms that have the cash to target acquisitions should be looking to make their moves now, with acquisition opportunities likely to be everywhere over the next few months. Those with the capital to do deals could pick up bargains and ambitiously scale their operations in anticipation of the post-pandemic recovery.



The UK’s construction sector is a resilient one, as has been abundantly shown by how it has adapted to the extraordinary challenges posed by COVID-19. However, with levels of distress so high and a multitude of factors impacting construction companies, the worst of the crisis could still be ahead for the sector.

This will create opportunities for acquisitive parties to step in and snap up companies and contracts that could easily flourish and prove massively lucrative in the post-COVID-19 world. With record-breaking levels of government stimulus available and the construction industry certain to pick up as restrictions begin to lift, now could be the perfect time to buy into the sector.

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