In June, Yunex Traffex celebrated its first birthday after being spun off from Siemens Mobility last year. Almost immediately it uncorked the champagne for another milestone: being bought by Italian transportation group Atlantia for nearly €950m ($955m).
Meanwhile, Vance Street Capital acquired Eberle Design (EDI) and PTV Group co-owner Bridgepoint bought a majority stake in Econolite, one of the best-known US names in traffic signal control and traffic management in the US.
These deals are part of a clear strategy: Econolite is paired with PTV Group, with synergies in geography and service; Vance Street Capital has made three ITS buys in the last six months alone, with EDI following Polara and Carmanah Technologies into the private equity firm’s traffic management and pedestrian safety portfolio.
There are a variety of reasons why this is happening. “From a US-centric point of view, there's pent-up demand for infrastructure improvement,” says Greg McKhann, former chief operating officer of McCain, now an adviser to investors looking at ITS firms. “And that's in part getting ready for autonomous vehicles, and in part because of the Infrastructure Investment & Jobs Act – recognition that one of the few things the two political parties could compromise on was infrastructure.”
This will be the case despite, as seems likely, inflation and other global shocks meaning that budgets come under pressure: roads need to be maintained and new technology needs to introduced; and states received federal funding to get through the Covid-19 pandemic, not all of which was spent.
“Even if the economy gets choppy, these infrastructure programmes take a long time to put together and implement. The more certainty you can give an investment return, the better investors like it,” reasons McKhann.
“So the facts that there's a massive Infrastructure Bill underpinning the investment in transportation infrastructure, and then most of the states in the US are in relatively good financial health, mean this favourable investment period should continue for some time.”
It’s far from plain sailing: relatively slow economic growth and rising interest rates have the capacity to throw a spanner in the works, as McKhann points out: “Interest rates are rapidly rising from historically low levels and have popped up really quickly, and history suggests this should slow the rate of home and vehicle purchases and consumer demand.”
For investors planning to hold companies for a number of years, these fluctuations may not particularly enter their calculations. But McKhann acknowledges some possible storm clouds: “What do rising rates mean for things like the pace of putting in electric vehicle (EV) charging infrastructure, if the rate of buying Teslas or other EVs from BMW or Audi or whoever slows down? One potential benefit of private equity owning an ITS business in a rising interest rate environment is the deeper pockets to enable ongoing investment in things like innovation and production capacity - things that might be compromised without adequate financial strength behind a business.”
This is key: private equity firms have money to spend – so-called ‘dry powder’ – perhaps as much as $4.6trn, according to The Economist. Only a fraction of this will be in ITS, of course, but still…
“Many of the private equity firms raised large funds in 2020-21,” says McKhann. “And given that ITS is a space that they like - plus the Infrastructure Bill, and the financial health of government agencies, at least in the US - that should be a recipe for continued investment here.”
Pros and cons
So the money and the interest are there: but is that good or bad for the ITS industry? “The expected positive outcome is that you get more efficient companies that can innovate more quickly and bring new products and more holistic solutions to market,” says McKhann. “If you put together several companies, you can employ best practices across all of them, you may be able to balance workload across the businesses, you may find production economies of scale, and you're spreading administrative costs over a bigger revenue base so companies get incrementally more efficient”
Private equity investors may also bring additional resources to aid management teams of their portfolio companies – for example, supply chain experts to help navigate the challenges many manufacturers are facing.
New combinations can certainly become more than the sum of their parts. “If you have company A and company B both owned by private equity, they might say: ‘Let's share your product development roadmaps: are there synergies? Can we be more efficient in R&D? Can we invent a great new solution if you combine some functionality from product A and functionality from product B?’ Putting them together in a new way might provide a more elegant, integrated solution: one plus one equals more than two,” he adds. “Fresh capital entering the industry means that if you’re a smaller player that is undercapitalised, or if you've got 10 great ideas, but your balance sheet only lets you fund your one or two, new money comes in and they say: ‘Let’s discuss your 10 best ideas and we’re willing to fund five’. So there should be a broader range of growth-focused ideas which get funded.”
The enthusiastic entry of private equity into ITS could also have the knock-on effect of sparking investment from venture capitalists (VCs), who typically put in their money at an earlier stage of a company’s development – a riskier investment. “There’s the classic entrepreneur who puts a new mortgage on their home to raise money to start something in their garage, and then it gets to a certain level of maturity, the idea has got traction in the market, and they go to raise venture capital,” says McKhann. “If the venture capital community sees private equity active in a market, providing increased investment exit paths for the VCs, they are more likely to fund the earlier stage ideas.”
Even if a firm is 10-15 years from being at the stage of an EDI or Econolite, early-stage investment might become more attractive simply by virtue of later-stage investment being more prevalent.
“Whether you're in venture capital or private equity, if you like an idea, you like a company, like a management team, there's got to be an exit opportunity in five or six or eight years or whatever,” McKhann continues. “And with more private equity investment offering an exit for entrepreneurs with more established companies, that increases the confidence of the venture capital community.”
So what about the potential downsides? Private equity often employs debt – perhaps more debt than companies on their own might have used. In a weak or declining market, this might create more risk. “If you have a privately-held company with very little debt, they can withstand a recession pretty well,” says McKhann. “Maybe they cut back on a few things, they might trim at the edges if necessary. With more debt you may have reduced flexibility in the event of a big downturn in the market. That said, private equity-owned companies typically are careful to maintain sound balance sheets, and they have better access to capital than company founders, which helps them weather bumps in the road.”
Private equity-owned companies may also require a greater emphasis on profitability at a certain point in their cycle than would otherwise be the case. For instance, a private equity backer in year four or five of their investment period might not sanction a million-dollar spend on new tech. “Later in the investment period there may be a sharper profit focus than there is early in the investment,” McKhann says.
One final potential negative is that consolidation in the ITS industry may create pricing problems for transportation agencies which require products and services. Putting together two big beasts could create a combined offering which in effect becomes the only game in town for certain procurements putting upward pressure on prices and creating a less competitive market.
McKhann is not so sure that this theory holds water. “If you're consolidating the more established, proven, profitable companies under private equity so they are getting bigger and more powerful, their success tends to attract competition - entrepreneurs and venture capital enter with innovation, fresh ideas and new business models,” he says.
Some employees might not want to be part of a bigger company which is less nimble and more ‘corporate’, where the private equity people have to approve their good ideas. They leave and in turn attract venture capital to start up on their own.
“The market is normally self-correcting,” smiles McKhann. “If you’re down to three or four big companies on the planet doing all the ITS, there will be people quitting and forming new companies. So maybe agencies have fewer supplier options for a while until new innovation springs up: it's the cycle of business. All things considered, increased investment in the ITS industry should prove to be a significant positive trend. Availability of capital in our sector will encourage innovation, and ultimately save lives and improve our ability to address transportation efficiency.”