Valuation of the professional services industry

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Number of M&A Deals in the

Professional Services Industry

Group 87 of the Standard Industrial Classification (SIC) code covers engineering, accounting, research,

management, and related services. This SIC group covers a range of business services requiring educated professionals, including architectural and surveying services; research, development and testing services; accounting, auditing, and bookkeeping services; and management and business consulting services. Diverse industry segments such as physical and biological research, financial consulting, and public relations are included within SIC group 87.

Because of its diversity, the professional services industry is affected by a number of factors. In addition to the economy, the industry must cope with a range of legal and regulatory issues as well as changes in the marketplace driven by heightened security measures and the possibility of war in Iraq.

Accounting and Consulting

Historically, the accounting industry has been allowed to be largely self-policing. In the wake of several major accounting scandals, however, federal regulators have scrambled to restore confidence in corporate America by creating new rules and oversight bodies to clean up the accounting industry. Newsweek reports, "This January, the SEC issued more rules than in any month since it was created in 1934."

The accounting scandals of 2002 and the regulatory attention that followed them have shaken up the accounting and financial consulting segment of the professional services industry. Many large consulting firms have downsized. Midsize firms are struggling and many smaller firms have gone out of business.

One major change that impacts this industry segment is the separation of auditors and consultants. The Securities and Exchange Commission has approved new rules barring auditors from offering many non-audit consulting services, including legal advice, management consulting, and the designing of financial information software systems. The new rules do not forbid auditors to provide tax advice, a lucrative business that the accounting industry lobbied hard to keep.

The separation of auditing and consulting services means that big accounting firms are no longer able to use audit engagements as an opportunity to spot other clients needs such as information technology, human resource management or financial research. Midsize firms will have a better chance to sell their consulting services now that they are no longer competing against this advantage. The new rules, and the new climate of regulatory scrutiny, are also likely to make audits more complex and more time consuming, thus allowing accounting firms to charge more for them.

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Median Price Ratios for Mid Cap

M&A Deals in the Professional

Services Industry

Median Price Ratios for Large Cap

M&A Deals in the Professional

Services Industry

Consolidation in this segment is driven by a move away from self-ownership towards more disciplined corporate structures, as well as by the need for large accounting firms to separate their consulting and auditing functions.

Engineering and Research

While corporate spending on engineering and research has been impacted by the current economic downturn, business demand is being generated by the national security and defense industries. The Army has formed a new unit, the Research, Development and Engineering Command (RDECOM) to oversee the Army's various research laboratories and engineering test centers. The purpose of the change in the Army's structure is to increase the development of useable military technologies, not only as theoretical research bit also as real products in the hands of soldiers. The military is not only looking for new developments within its own research and engineering departments, but also in academia and national commercial laboratories.

Scientific research is subject to regulation, and therefore also subject to changes in the political landscape. The Secretary's Advisory Committee on Human Research Protections (SCAHRP) was created last fall after several patients were harmed in US medical experiments. The SCAHRP, created by the Bush administration, replaces the Clinton-appointed National Human Research Protection Advisory Committee.

The Secretary's Advisory Committee has been challenged on the grounds that its members primarily represent research institutions with financial stakes in medical experimentation, while none of the 11 members is a professional patient advocate. "Without consumer advocates, there's no one there to remind them that the purpose of human-- research protections is to protect humans, not to protect university research institutions," said patient advocate Abbey Myers, who served on the equivalent Clinton administration panel. The SCAHRP has also been criticized on the grounds that its charter includes embryos and fetuses as human research subjects.

Outlook

Despite the economy and the scandals, professional services remain in demand. Financial, information technology, and management consulting services are still a vital part of the corporate landscape. Engineering, laboratory testing, and research services serve a number of diverse industries, including the growing defense sector. Companies in the professional services industry must remain flexible to changes in regulation and oversight in order to thrive.

Sources: Consulting to Management, Deal Retriever, Defense Daily, Done Deals, Investor Relations Business, Journal of Accountancy, Newsweek, Seattle Times

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Market Summary

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