July 25 (Bloomberg) -- Balfour Beatty Plc, the U.K. construction company whose chief quit in May after predicting a profit drop, is in merger talks with rival Carillion Plc to form the country’s biggest builder with a market valuation of about 3 billion pounds ($5 billion).
A deal would create a market-leading service and construction business able to serve more clients and cut costs, the builders said in a statement yesterday, adding that they’re trying to develop a strategy and business plan. Balfour and Carillion surged as much as 13 percent and 14 percent respectively in London trading today.
Balfour, based in London, has struggled since the global recession, with a lack of building work in the U.K. and the cancellation of projects across Australia, where the company cut hundreds of jobs last year. A merged company would benefit from Carillion’s booming services business as the Wolverhampton, England-based builder expands its maintenance offerings for the rail, oil and telecommunication industries.
“Sometimes the girl next door is the right one to marry,” said Liberum analyst William Shirley. “A deal would offer huge potential synergies, perhaps 250 million pounds, significant operational improvements and could be largely self-funding.”
Before today, Balfour shares had dropped 4.4 percent in the last 12 months while Carillion gained 14 percent, valuing the companies at 1.6 billion pounds and 1.45 billion pounds respectively.
No final decision has been reached regarding the structure of any merger, the companies said. Both boards would need to be satisfied that a tie-up would produce “very significant value creation” for shareholders, they said.
Carillion has also been expanding in new markets such as Canada to make up for a construction slump in its U.K. home market. The company’s share of revenue from the U.K. dropped to 78 percent in 2012 from more than 90 percent five years earlier, according to data compiled by Bloomberg. The U.K. government is one of the biggest customers of both Balfour and Carillion.
Andrew McNaughton stepped down as Balfour chief executive officer on May 6, following 13 months in his post, after saying that earnings will be “significantly” lower than forecast. Chairman Steve Marshall has taken over on an interim basis.
This month, Balfour said profit at the engineering services unit will fall by 65 million pounds this year, 35 million pounds more than announced earlier, after new management identified project delays and contractual disputes.
“Balfour Beatty has been under pressure since Andrew McNaughton departed as CEO,” Andrew Nussey, an analyst at Peel Hunt, said. “Richard Howson, CEO of Carillion, would be expected to be CEO of the combined company if the proposed deal goes ahead.”
Carillion, which this month said it is the preferred bidder for the expansion of the main stand at Liverpool Football Club, on July 2 affirmed its full-year targets after saying that its performance in the first half was in line with expectations.
A decline of construction work and rising energy prices in Europe also prompted other builders in the region to merge and cut costs. Actividades de Construccion y Servicios SA, Spain’s biggest builder, gained a majority stake in German rival Hochtief AG in June 2011 after a nine-month battle. French cement company Lafarge SA this year agreed a $40 billion merger with rival Holcim Ltd. of Switzerland.
Balfour’s plan to sell Parsons Brinckerhoff, the New York-based infrastructure consulting company it bought for $626 million in 2009, will proceed and isn’t affected by the potential merger with Carillion, the companies said.
Under U.K. takeover rules, the two businesses have until the end of day on Aug. 21 to declare whether they intend to proceed with a transaction.
“Due Diligence needs to be diligent,” said Anthony Codling, an analyst at Jefferies. “Following several profit warnings at Balfour Beatty, Carillion will need to have very sharp pencils indeed when looking over the contracts at Balfour Beatty.”
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