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A lot of work ahead!

  • 07 Nov 16

Business Historically, Bilfinger was a construction company with 95% of its revenues stemming from this business in 2000 and only 5% from services. As a result of numerous acquisitions (in the Industrial, Power and Building & Facility field) and disposals (of Concession, Construction and more recently the whole Building & Facility division), the company is no longer a construction company but a provider of services for industrial plants (and power plants: the Power division is up for sale on a unit basis). Indeed, after the divestment of the Building & Facility division and the strategic decision to focus on the Industrial division, Bilfinger is a leading international industrial services provider. The company delivers customised engineering and services to customers in the process industry. Bilfinger enhances the efficiency of assets, increases their availability and reduces maintenance costs. The portfolio covers the entire value chain: from consulting, engineering, fabrication and installation through to comprehensive maintenance concepts and their implementation including turnarounds. Bilfinger stands for the highest standards of quality and thus meets the strict requirements of customers active in the chemical (20%), energy (29%), oil & gas sectors (31%) and pharmaceutical sectors (4%) as well as other sectors (16%). The company generates an annual output volume of more than €4bn with about 40,000 employees. Bilfinger has a c.€1.5bn market cap. Recommendation and upside We initiate Bilfinger with a sell recommendation and 15% downside. Main earnings drivers: • Restructuring: as the restructuring goes on, financial performance should be improved. • A recovery in the oil and gas sector: this would have a positive effect on the top line and hence the bottom line. Need to know Bilfinger has suffered in the past two years from turmoil in the energy and oil & gas sectors to which many of its important customers belong, resulting in six profit warnings within two years. The first three warnings, which took place between June and September 2014, were the result of the former management not appreciating the gravity of the situation, being too optimistic and trying to stay on board. As a result of the first two profit warnings the management in place at that time led by CEO Roland Koch was fired. Investor trust was also hit by the abrupt departure of Per Utnegaard although it now seems that the fit with the company had not been ideal. Bilfinger in effect acts as a private equity company by buying and selling engineering-related businesses. Call it a de facto specialist fund. In our view, some of these transactions may have been intended to delay or mask the unwinding of aggressive past accounting practices. The company’s poor earnings quality may have been masked by acquiring companies and allocating more to intangibles, notably goodwill, in order to provide room for future earnings growth through lower-than-required depreciation expenses. However, as the power market has collapsed the goodwill impairment has underlined the fact that some of the profits recognised in the past may have been borrowed from the future, which is now the present. The goodwill impairment also shows that Bilfinger paid too much for these businesses by buying them at the top of the cycle, which is not great for a private equity type business. In our view, the sale of the Building and Facility division, the company’s most profitable division, was driven by the need to avoid tapping the equity market and the company’s limited access to the debt market with pressure from bankers due to the rapid deterioration in the unsellable Power division. As a result of the sale of the Building & Facility division, the two remaining divisions, namely Industrial and Power, are respectively unmanageable and unsellable under current conditions. The Industrial division needs to be extensively restructured, which means high restructuring costs, and the Power division needs to be broken down into three baskets, namely what can be sold, what can be restructured and what needs to be shut down, implying additional restructuring costs. Finally, if the proceeds from the sale of the Building and Facility division are not fully absorbed in this restructuring process they will have to be reallocated to new acquisitions, which means transaction costs. Overall, we are not sure the company can exit this process without destroying additional shareholder value in the medium term. History tells us that it is not that easy to rebuild a sound business from the scraps of an inefficient one. Next trigger Owing to this legacy of missed targets and following several months of strategic review, the new CEO Thomas Blade will need to present a set of fairly conservative targets to give the market some form of anchor. In a sense, Bilfinger has learned from its mistakes meaning that we see some potential for upside risk linked to the new targets expected to be announced imminently. We nonetheless prefer to await their announcement before taking a more positive view on the stock as these targets may fall short of market expectations.