Valuation of the Engineering and 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

The engineering and professional services industry is benefiting from the continuing business trend towards outsourcing. Companies are hiring outside firms for services such as accounting, research, and staffing. Outsourcing is popular because it allows companies to cut costs and focus on their core operations. Outsourcing benefits the professional services sector by creating a need for educated professionals.

Engineering

The engineering sector provides design and development services to a wide range of industrial sectors. The sector supports the development of ships, aircraft, machine tools, and a wide range of electrical and mechanical equipment. Demand for engineering services is tied to the demand for the products they help design and create. As industrial production ramps up in response to an improving economy, demand for engineering services can be expected to increase. The rising cost of fuel and material resources may have a limiting effect on the capital available from the industrial sector, but engineering companies that serve the oil and gas sector stand to benefit from increased production in that arena.

The aerospace and defense sector is a major client for the engineering industry. Demand for commercial aircraft is recovering from a previous decline and major producers such as Boeing and Airbus are increasing production. Boeing's 787 airplane is being well received and in response, Airbus is increasing capital spending on upgrading its A350 plane and developing the new A380.

Western production of fighter planes is also on the rise, as nations that purchased inexpensive Russian fighter planes have found that aftermarket support for them is often limited at best. There are current buyers for updated versions of Lockheed Martin's F-16 and Boeing's F-15, and Lockheed Martin/Boeing's F-22 is now in production.

Accounting, Bookkeeping, and Finance

The accounting sector provides financial advice and services. As long as there is money to be managed, financial services will be in demand. Major auditing firms have what amounts to a public franchise, since the law requires publicly traded companies to get independent audits. This industry segment is highly regulated, particularly after the major accounting scandals in 200 land 2002.

Traditionally, the Big Four accounting firms - PricewaterhouseCoopers, Ernst & Young, Deloitte & Touche, and KPMG - have been the almost exclusive auditors of corporations with $1 billion or more in revenue. This is starting to change. Large companies have begun bringing their business to "second-tier" firms such as Grant Thornton and BDO Seidman. There are a number of factors behind the switch to these smaller firms. Some companies feel that the smaller firms provide more personal service and some companies switch seeking lower prices for their audits. But in some cases, the Big Four themselves are driving the change by resigning from some of their exisiling accounts in order to focus on their largest, most profitable clients.

Accounting firms today must go to great lengths to avoid any appearance of being criminally liable. KPMG, an accounting firm under investigation for selling questionable tax shelters, has reached a settlement under which it will pay $456 million and accept an outside monitor of its operations. This agreement heads off a potential criminal indictment of the firm, which could have had devastating consequences for the company. Accounting firm Arthur Andersen collapsed after it received such an indictment. KPMG is not entirely off the hook, however. Its agreement preserves the possibility of criminal charges for KPMG in the event the firm violates the terms and it includes a strong acknowledgment of wrongdoing.

The outsourcing trend also continues in the financial sector. A number of small and midsize banking companies are outsourcing financial services such as mortgage servicing to subservicing agencies. Astoria Financial Corp., for example, has announced plans to close its mortgage operations and eliminate 72 jobs. Astoria Financial, the parent company for Astoria Federal Savings & Loan, will instead offer private-label mortgages serviced by Dovenmuehle Mortgage Inc.

Mergers and Acquisitions

The number of merger and acquisition deals in the engineering and professional services industry has been on the decline since 1999 and 2000. Deal activity saw a slight rise in 2004 in both the mid-cap and large-cap markets. Purchase prices relative to revenues have remained fairly steady, although the large-cap market shows a bit more fluctuation over the past six years.

Outlook

The professional services industry serves a broad range of other industries. Corporate demand for engineering, research, accounting, and other professional services may increase as indicators of overall economic recovery continue. As the economy shows signs of improvement, more businesses will be willing and able to outsource tasks to professional services industry firms. The defense sector seems likely to continue supporting engineering and research, aircraft development is improving, and the demand for auditing and accounting services continues.

Sources: American Banker, New York Times, Value Line