The Environmental Lab Market: Recent Trends and Developments

1. The Environmental Lab Market:Recent Trends and Developments Recreation Food Steve Maxwell Laboratory Association of New Hampshire June 20, 2013

2. Historical Perspective • The industry developed following the landmark environmental legislation of the late 1970s and early 1980s • Growth was rapid during the 1980s, and in to the early 1990s, and many firms exhibited strong profitability • This growth and profitability drove rapid entry into the business • By mid 1990s, a sustained period of over-capacity began to emerge • Price competition gradually became widespread, and increasingly fierce, facilitated by on-going productivity and automation advances • With excess capacity, it became easier to grow via acquisition than by construction of new “green-fields” capacity • Hence, a long period of industry consolidation commenced

3. Consolidation Trends • Even as early as the late ‘80s, firms embarked upon consolidation strategies – on the premise of fragmentation and economies of scale • Enseco was the first “mega-company” – consolidating three major labs, and then going to the public markets in the late 1980s • With continuing add-on acquisitions, Enseco merged with IT Labs, and was re-formulated as Quanterra in the early 1990s • STL emerged in the late 1990s, eventually acquiring a weakened Quanterra and some fifteen other companies, to become the dominant industry player – with over $350 million in revenues • TestAmerica later merged with STL, and remains the largest player • Key acquisition-based players today include Eurofins and ALS

4. The Current Situation • Over-capacity seems to be a permanent feature of the industry • Although M&A activity remains strong, this is still a very fragmented industry relative to most other businesses • Price competition has remained fierce, with only very occasional lulls in intensity – there is always someone happy to bid lower • Although long predicted to do so, the excess “fringe” capacity never seems to go away • Productivity advances have been extraordinary and continuous • Private equity firms have tried their hand at the business • Yet, there always seems to be at least one or two acquisition-based companies, interested in trying to expand in the business

5. Top 25 Labs - 2012

6. Longer Term Revenue Trends

7. Longer Term Revenue Trends

8. Key Strategic Questions • There are a number of key strategic questions, or paradoxes, about the lab industry which remain generally unanswered. For example: • Centralized vs. de-centralized systems • Big labs vs. small labs • Optimal sales and marketing strategies • Specialization vs. diversity of analytical service offerings

9. New Markets, Growth Opportunities • Because of this constant situation of excess capacity and severe price competition, most firms have looked far and wide for growth and diversification opportunities in other areas • Within the general environmental sector, some firms have focused on radiological testing, air testing, dioxin work, or other specialties • But when a new or more attractive market emerges, many firms quickly rush into it, erasing any higher profit opportunity • Some environmental labs have also looked farther afield, at other analytical service industries, including food, pharmaceutical, mineral and drug testing, as well as various other new sectors – but generally without much success • Today, many firms are gearing up to test “emerging” contaminants

10. Merger and Acquisition Trends • Because of the continued fragmentation of the business, many different players have attempted consolidation strategies • But in retrospect, few if any can be judged to be successful • Just as in laboratory and instrumentation capacity, there always seems to be an excess of sellers in this industry as well • This – along with the general growth and profitability prospects for the business – has worked to keep valuation levels low • For the last fifteen years or so, valuation levels have hovered around the 3.5 to 5.0 times true trailing EBITDA – although there are of course exception well below and somewhat above that range • No particular reason to expect significant change in the future

11. Ownership Transition Issues • Ownership transition is important in a private firm – liquidity for owners, reduced uncertainty for employees, orderly transition for the business • Alternatives include various types of internal ownership transfers, as well as a partial or total sale of the company to a third party • Internal transfersoften allow the firm to maintain its independence and “culture,” continuity in terms of employees and clientele, and may provide a stronger incentive to more entrepreneurial employees , but may be more difficult, time-consuming or contentious to consummate – may be more difficult to “do business with friends,”and the “selling price” will typically be lower for the selling or exiting principals/shareholders • External sales may bring a higher price to sellers, greater career opportunities for employees, and greater access to capital resources or new markets and clients, but may also lead to a gradual or perceived loss of independence or culture • change is never comfortable -- some people may feel threatened, or may be worried about their jobs

12. The Valuation Process • The value of a private illiquid firm is typically calculated by constructing certain “multiples” for similar transactions or for similar companies – or companies with a known market value – and then applying those multiples to the firm to be valued •  The multiples most commonly utilized are ratios of cash flow, but sometimes revenues, operating profits, or book value are also used  It is important to realize that these are only rough rules of thumb – each individual deal is different •  The actual value paid will depend on a wide range of issues specific to the individual buyer and seller: • “strategic” value – regarding sector, geography, capabilities, etc. • recent financial performance • strength of management • diversity and strength of clientele • future business development opportunities

13. Alternative Deal Structures • Most transactions are done with some combination of cash, debt and stock • Most smaller deals only include components of cash (current vs. future) and stock • Cash is always “king” but sometimes there can be strong upsides in accepting the buyer’s stock as deal currency • Sellers should always make sure they have tax advice when considering different sorts of deal structures • “Earn-outs” are very common in this industry, but can have both strong advantages or disadvantages: • Works to keep the selling firm motivated, to achieve the earn-out • But seller is judged on management and performance of a business that he or she no longer really controls • May be difficult to accurately measure performance

14. Common Seller Mistakes • Waiting for better financial prospects • Limiting the field of potential buyers • Entering unilateral discussions prematurely • Communicating the asking price • Not knowing or fully qualifying the potential partner/buyer • Disclosing an insufficient amount of information at the outset – invitation to renegotiate price later • Allowing the buyer to gain access to important information prematurely – especially competitors • Creating a less-than-urgent pace • Failing to administer a competitive process • Not hiring the proper team of advisors

15. Why Many Deals Go Bad • A lack of strong strategic guiding principles – too much focus on the “hunt” • A lack of clear ground rules about the combination “process” • Not enough attention to the details – lots of moving parts in a deal • Poor communication and stakeholder outreach • Overly aggressive growth or financial performance targets – setting impossible objectives • No explicit consideration of the integration process in the financial forecasts • A general cultural disconnect – often difficult to mesh two companies where operating styles, philosophies and cultures vary • Management keeping information too close – get the employees involved and motivated to make things work • Deviating from the plan, or allowing the wrong changes to the plan

16. The Future Outlook? • The environmental testing business remains a critical – if vastly under-appreciated – component of stronger and more sustainable environmental stewardship • The demand and criticality of environmental sampling and testing will continue into the long-term future – although the revenue size of the business may not expand very quickly • We are likely to see at least marginal growth in certain field, mobile and real-time testing technologies which will also moderate future growth in the fixed-laboratory portion of the business • As the regulatory, technological and marketing complexities of the business continue to grow, the smaller and weaker capacity will gradually drop out of the business • New sub-markets may develop, but they will quickly be filled • Transaction prices are not likely to improve appreciably • Some firms will have a good business in this market, but they must continuously figure out how to sell smarter and operate cheaper