CBI - Chicago Bridge & Iron

[Spekulatius]

Yes, I know about the sale. I think they sell it for 12x operating earnings.

 

FWIW, Their backlog is now 85% fixed cost. In the 2012 annual report, the breakdown was as follows:

The Nature of Our Primary Contracting Terms for EPC Projects, Including Cost-Reimbursable and Fixed-Price or a Combination Thereof, Could Adversely Affect Our Operating Results.

We offer our customers a range of contracting options, including cost-reimbursable, fixed-price and hybrid, which has both cost- reimbursable and fixed-price characteristics. At December 31, 2012, the distribution of our backlog was approximately 55% cost-reimbursable, 38% fixed-price and hybrid, and 7% Lummus Technology.

[ScottHall]

Edit: Decided to delete this because I don't want to influence anyone on this stock. Is not really my intent.

 

[RadMan24]

The contracts CB&I is working on, they have a high success rate of completing on time and below budget. It's 2 related projects that are the last of its "type" in the whole backlog really hitting CB&I hard. That, and nuclear. I would not fear too much the rest of the lineup, assuming management is credible when they said on conference call every other project is making money

 

I know that's a big assumption for many.

[Green King]

The contracts CB&I is working on, they have a high success rate of completing on time and below budget. It's 2 related projects that are the last of its "type" in the whole backlog really hitting CB&I hard. That, and nuclear. I would not fear too much the rest of the lineup, assuming management is credible when they said on conference call every other project is making money

 

I know that's a big assumption for many.

 

you mean like them saying that we will see free cash flow for the past few years.

[RadMan24]

Exactly.. Of course, management claims the Nuclear business ate up all its cash flow. They mention on the call 2nd quarter should have positive cash flow. Again, we'll see how it plays out, lot of uncertainty and risk.

 

The one thing that is a certain, to a degree at least, is that the technology business could be spunoff and demand a valuation of at least $1.5 billion, if necessary. If this were to occur, you'd want the restrictive covenants lifted so that shareholders would retain a stake in the spunff division, as its seemingly the only positive element at the company (fabrication has had issues, but overall a good business as well).

 

 

 

[Green King]

Exactly.. Of course, management claims the Nuclear business ate up all its cash flow. They mention on the call 2nd quarter should have positive cash flow. Again, we'll see how it plays out, lot of uncertainty and risk.

 

The one thing that is a certain, to a degree at least, is that the technology business could be spunoff and demand a valuation of at least $1.5 billion, if necessary. If this were to occur, you'd want the restrictive covenants lifted so that shareholders would retain a stake in the spunff division, as its seemingly the only positive element at the company (fabrication has had issues, but overall a good business as well).

 

I am not sure if that passes as able and trustworthy management.

[RadMan24]

The new CEO comes from a different line of business, from Lummus, so hopefully, they are able and honest going forward.. No one likes to admit a several billion dollar mistake that may take out the company. Asherman had to go, damage is done at this point. I'm not attesting to buy the stock, if anything, I have a tiny amount out of the money 19' leap calls, that either pay off handsomely or go to $0.

[xazp]

Hey Spek,

 

  Good to see you here.  We have a different opinion of CBI, which is quite OK.  I know where you're coming from.  I sold the company in disgust at $40 and bought back in when the company tumbled.  Still underwater on recent purchases, sadly.  I'm OK with that.  I'm used to that. 

 

  I see CBI today as pretty analogous to BAC 5-years ago: a shitty acquisition, litigation risk, management with credibility problems, recurring "one time" charges, an industry in the midst of a slowdown.  I don't think you liked BAC either if I'm remembering right.  It's done pretty well since I mentioned it. 

  I actually feel like CBI will resolve faster than BAC, which had to deal with trillions of dollars of shit mortgages.  I see CBI returning to normalized earnings in anywhere between "now" and maybe two years (the approximate completion date for Cameron LNG) - I don't have a prediction when.  I think normalized earnings are $4/share+.  I think normalized FCF is in the $350M range.  I think it's trading at a P/FCF  normalized of 4-5. 

 

But even if you say, well that's ambitious, what is their past cash flow like?  Well in the last three years they've had nuke problems, and those problem CCGTs.  So here's the last three years in their  10K http://s21.q4cdn.com/565943420/files/doc_financials/2016/annual/2016-CB-I-10K.PDF  pg 56.

 

This shows net cash from operating at $650M last year, Capex of $50M, so FCF of $600M.  The three-year average, quite lumpy, is about $200M/year in FCF.  And this period spans nuclear problems, cost overruns, etc - most of what you hate about this company happened in the last 3 years.  Arguably you'll say these problems are intrinsic to the business, but even assuming that "Cameron" is the new Nuke, and we just keep doing these cost overruns - it's trading at a P/FCF (on the trailing 3 years) of 8. 

 

I hope you are not extrapolating from last quarter's cash flow.  This is a lumpy business: cash goes out as they are working to complete milestones, then a big chunk of cash goes in, when the milestone completes.  This is why I don't think the $600M in FCF last year is representative either, but a 3-year average seems OK.  Includes all the bad stuff we know about so far.  Q1 2015 had operating cash flows similar to Q1 2017, but the remainder of 2015 they did about +$230MM in cash flow. 

 

My guess is that net debt falls by > 50% by the end of this year,  though maybe I should give some buffer because they probably ARE going to screw up something or other.  I still feel that is more intrinsically a short-term problem than a long-term problem. 

 

Also you seem to see this business as shrinking.  On the contrary, in Q1, their new awards exceeded revenues by $1Bn, and their guidance is for new awards to continue exceeding revenues for the remainder of this year.  New Technology awards doubled in Q1 q/q, I think of Technology as the "second derivative" indicator for construction awards and that is pointing strongly upward. 

 

Anyway, like with BAC I'm doing a write-up on CBI.  I don't want to spill all the beans but if you have questions we can try to get a little closer on this (I doubt we converge, but it's useful to discuss anyway).  I'll try to address your concerns in my write up (and/or acknowledge them as real risks). 

[Spekulatius]

XAZP- I agree there is pot. value there and I'd like to see your write up. My concern is the Ashermann has severely mismanaged the company and the current balance sheet may not represent to real financial condition of the company yet. I would want the new CEO give some time, to do the housecleaning, and find out if the concerns about their change orders and credit amendments as well as cost overruns are warranted or not. I would wait at least until the next 10-q is filed, before making a decision to invest. Right now, it seems pretty much like a crapshoot to me.

[xazp]

Hi,

  OK let's back up a little bit.  May 3rd, CBI had a stinker of a quarter - they miss earnings by about $75 million.  The stock drops $500 million.  May 10th, CBI issues a 10Q which has some alarming lines that weren't brought up during the call.  So perhaps appropriately, the stock drops some more.  But since May 10th, CBI has only issued positive news (2 new tech contracts + retirement of Asherman) and the stock has dropped a total of $1.5Bn on a $75 million miss + related 10Q. 

 

  My bet is that $1.5Bn+ of value did NOT evaporate from the company in the last two months. 

 

  Now we've known each other for a long time.  But when I get highly involved in an investment, I do my homework.  You know that in the past, I've broken information that few or no one in the market has known.  So if I'm going to bat, it means, I think I have an edge on the market.  I'm not basing my analysis on a light reading of analyst reports.  I am digging into primary resources as well as CBI's partners and competitors

filings.  Doesn't mean I'm right.  I can still be wrong, of course, this is an inherently risky situation. 

 

  So very quickly, here are the risks I see:

1.  Westinghouse.  I think the outcome favors CBI.  And I want to be in the stock when the decision comes out (current expectations: before July 4th).  I'll give you a -$100M on this (though I actually think the likely outcome is CBI is at $0+).  I want to be "in" the stock when they release the verdict. 

2.  CCGTs.  For the first time, they are doing reserves on those projects.  That's good news.  They have ~$82M in reserves to burn through.  The projects are ending in 6-9 months if I remember.  They might need more, current pace of losses is ~$75M/quarter, so add another $75M beyond the reserves.  This one is a genuine problem, but, taking reserves is a really good step -- acknowledging, yes, this is an ongoing problem.

 

3.  "Unapproved change orders" - these are not nearly as ominous as they sound.  But there is risk in here, I'll say ultimately -$100M.  I expect a good chunk of the headline $500M number to go down, and to be converted to cash, in Q2.  So again I want to be "in" for that. 

 

4.  Cameron LNG.  There is risk here, but not of the magnitude that GOldman says ($500M).  I'll give you another -$100M here but that's probably double counting with #3.  But understand to the extent Cameron LNG is having problems, it's because there was emergency level flooding, natural disaster, FEMA, and I do not ding CBI for "causing" this, but I do think they'll have to pay for some portion of the overruns caused by the natural disaster.  I don't think Cameron is emblematic of larger problems at the company, it's just they didn't predict the 1 in 100 year kind of rains they experienced. 

 

5.  Balance sheet.  Don't really get the issue here, UNLESS you believe the Capital Services sale is not going through.  (I have not seen any analyst say this).  I don't understand the maquarie guy's focus on EV and debt during a quarter that the sale should wipe out 40% of their debt.  I think net debt will be chopped in half by the end of the year.  No one brings up debt before the sale, but after the sale is announced, they worry about debt? 

 

Now in my judgement, these issues are short-term, and likely to be cleared in the next year.  I don't view these are recurring.  I don't blame CBI for the 1-in-100 year rains at Cameron LNG.  Westinghouse, when completed, is the end of the nuke stuff.  CCGTs will be completed at a loss, and then they move on.  Of course if you see these problems as signals that CBI will face recurring problems of a large magnitude, (i.e. they don't know how to bid properly), then it's plausible that the long-term value really has decreased by $1.5Bn.  There's a risk, of course, and I'm not omniscient. 

 

My view is in a year or so, all these issues will clear out and you'll be left with a company earning ~$400MM in earnings and cash flow, which you can presently buy for about $1.6Bn.  Probably a wild ride until they clear out all those issues.  Possible double or triple if you wait out the bad news. 

 

 

[leadingusforward]

xazp -

 

Thanks for all the info.  Like others, I look forward to your more detailed report.

 

I'm intrigued by the very low price for this high quality business.  However, I'm concerned about an adverse ruling in the Westinghouse suit.  Even if the odds favor CBI, strange things can happen in a court.  There is a wide range of outcomes - $0 to $2.2 billion.  What gives you confidence that a worst case decision wouldn't be a real hardship for CBI?  With BAC, there were billions set aside in reserves for such decisions.

[RadMan24]

Recent Goldman report cuts EPS over three years cuting Cameron losses. Not saying he is correct, but market starting to think company won't have normalized EPS of around $3 a share for another 3 years.

[xazp]

Hi,

  My article will spell this out more fully:

  But to briefly address both of your concerns -

  1)  strongly suggest watching the Supreme Court oral arguments for the case, starting at 22 minutes and you can draw your own conclusion about the likely outcome.  Also find the opinion for OSI, paying attention to who wrote it.

  2)  Cameron is more complicated, but here's a little nugget I haven't seen mentioned anywhere: Cameron has a contingency budget for cost overruns.  This should offset part or all of the cost overruns; I agree it's a risk, and Goldman is right to focus on it, I just think their magnitude is wrong.

 

CBi does have the option of taking reserves against the project, which would allow them to normalize earnings much faster. 

 

 

xazp -

 

Thanks for all the info.  Like others, I look forward to your more detailed report.

 

I'm intrigued by the very low price for this high quality business.  However, I'm concerned about an adverse ruling in the Westinghouse suit.  Even if the odds favor CBI, strange things can happen in a court.  There is a wide range of outcomes - $0 to $2.2 billion.  What gives you confidence that a worst case decision wouldn't be a real hardship for CBI?  With BAC, there were billions set aside in reserves for such decisions.

[RadMan24]

Here's one link to Goldman report - just so you can compare your notes if interested. I may recommend calling IR to see if they can provide more color on Cameron project, when I spoke to them earlier in year, they were confident they would still come out ahead (granted, very few trust former ceo) 

 

https://www.streetinsider.com/dr/news.php?id=12998401&gfv=1

 

[xazp]

I did read the Goldman report and mention it in my article.  I also talked to IR. 

 

I think most of the analysts have some fixed view of CBI (bearish, bullish, neutral), and they throw in these numbers to create a price target consistent with their view.  So here's the Goldman analyst's situation: if he sticks with his former price target of $33, he has to call this a strong buy with a 100% implied return.  That's not something he wants to do.  He needs to find a way to push the price target to the current level (he's neutral on the stock).  So they talk about Cameron, or Westinghouse and they apply a number that makes sense with their buy/sell recommendation.  This is why the numbers are awfully round: $500 million here, $1.5 billion there.  These aren't numbers they calculated from a probabilistic view of risk, these are numbers they're using to derive the right price target. 

 

The "tell" here is that the Cameron delays are 10 months old.  What new information in the last few weeks would convert a $0 loss estimate to a $500 loss estimate?  The last time Westinghouse was in court was 1.5 months ago.  So why the sudden urgency to discuss it now?  Well I think the triggering event is not new information, but rather the price drop.  So they drop the price target, which of course drops the stock, etc, etc. 

 

[Spekulatius]

The new information is the disclosure in CBI's 10q and 8-k. As I see it , the unapproved change orders have mushroomed from ~$100M to more than $500M in just one quarter, the disclosure about CBI reaching their debt ceiling intra quarter is now.

 

My own take is that this business is not as good as some make it. FLR for example, which appears to be better managed, is struggling too with profitability, although they do not seem to have the issues with cash flow that CBI does. At $15/ share, there is certainly opportunity here, if they get their ship in order. I personally wait for new management to make to clean house, before making any investment decision.

[xazp]

That happened a month and a half ago.  Goldman came out suggesting large losses happened maybe a month later.  So are they reacting to the Q or are they reacting to the price? 

 

I think the article is going up on SA sooner or later (I'm a little confused by the process).  I have a section on "unapproved change orders" and Cameron LNG.  How about read that and get back to me.  My view, it's a risk, but I don't think people understand what an "unapproved change order" is.

 

It is a signed contract for work to be done by CBI, usually (always?) on a reimbursement basis.  The contracts were signed before the work began. 

 

There is risk there, I'm not arguing against that, but of a lower magnitude than people think (IMO)

 

 

 

 

The new information is the disclosure in CBI's 10q and 8-k. As I see it , the unapproved change orders have mushroomed from ~$100M to more than $500M in just one quarter, the disclosure about CBI reaching their debt ceiling intra quarter is now.

 

My own take is that this business is not as good as some make it. FLR for example, which appears to be better managed, is struggling too with profitability, although they do not seem to have the issues with cash flow that CBI does. At $15/ share, there is certainly opportunity here, if they get their ship in order. I personally wait for new management to make to clean house, before making any investment decision.

[xazp]

 

https://seekingalpha.com/article/4082822-chicago-bridge-iron-huge-risky-mess-think

 

I think the article is here, look forward to your feedback. 

 

 

 

The new information is the disclosure in CBI's 10q and 8-k. As I see it , the unapproved change orders have mushroomed from ~$100M to more than $500M in just one quarter, the disclosure about CBI reaching their debt ceiling intra quarter is now.

 

My own take is that this business is not as good as some make it. FLR for example, which appears to be better managed, is struggling too with profitability, although they do not seem to have the issues with cash flow that CBI does. At $15/ share, there is certainly opportunity here, if they get their ship in order. I personally wait for new management to make to clean house, before making any investment decision.

[leadingusforward]

Very well written and cogent article.

 

In exploring possible downside scenarios, how do you see CBI handling their more restrictive debt covenants if the sale of Capital Services does not go through for some reason?

[xazp]

Capital services worries me.  I think I have an edge on Westinghouse, and potentially even Cameron, but there is no way for me to divine what's going on at Veritas or CBI now. 

 

Here are the things favoring it closing:

- As far as I can tell, Veritas has closed all their acquisitions.  Their "currency" is the ability to close acquisitions/sales, since they are a P/E firm.

- They have cash on hand to do it, as they raised a few billion immediately before this acquisition.

-  Purchase agreement says Veritas has to pay $40M in liquidated damages if the deal doesn't go through. 

- There's no obvious MAC or reason the deal wouldn't close, Capital Services had a normal Q1. 

- Don't think there's any real regulatory issues.

 

I don't see any urgency for Veritas to close.  The Q2 date is important to CBI.  I don't think it particularly matters to Veritas. 

 

A marginally delayed closing (I think it has to be done by August in the Purchase Agreement) I don't think the debt holders would really care. 

 

A canceled closing would mean more covenant changes, would probably come at a price, and they'd probably turn around and try to sell to the next-highest-bidder.  With the $40M in liquidated damages,

probably comes out about the same, though of course shareholders would be twisting in the wind even longer.

 

Can't really tell for sure.  I think most mergers that get to this stage, go through.  But how many don't: 10%? 

 

Very well written and cogent article.

 

In exploring possible downside scenarios, how do you see CBI handling their more restrictive debt covenants if the sale of Capital Services does not go through for some reason?

[RadMan24]

Well, Veritas could be hustlin' to get a better deal; or given that the new CEO owns very little stock (old CEO sold big portion of ownership at $35) he has no incentive to publicly address these concerns/issues until at the opportune time - once he is CEO. Further, he could be coming in with the basic assumption that they are going bankrupt and he'll lead the company after restructuring. It's all speculation until quarter end and you get the conference call and 10Q. Unfortunately, major events are to be announced before then that are adding to the risk and uncertainty.

 

Inherently, I think owning out of the money long dated calls could be an intriguing play. In a 1 year to 18 month time frame, all of these issues would have played out. By then, you'll know if the stock is an investment, or bankrupt, and your options will likely have tripled or more, or have simply expired worthless. Small position size obviously.

 

I wrote an article a few before yours as well, xazp - look for homor simpson if interested.

[xazp]

Well if Cameron and Freeport are really losing a billion dollars or whatever, here's a nice outcome:

- Bankrupt Cameron and Freeport JVs; sell the rest of the E&C backlog to a competitor for $1Bn

- Sell Capital Services for $700M (slight haircut from current offer)

- Sell Fabrication Services for $2Bn (a ~7x EV/EBITDA)

- Sell Tech for $1.2Bn (~10x EV/EBITDA)

- Pay off net debt ($2Bn)

 

Would yield about $30/share in liquidation :).  I think other companies would love their technology and fabrication divisions those are really good.  Depending on whether they actually screwed up at Cameron and Freeport, E&C has a value (per CSFB) between $500M and $3.2Bn. 

 

I don't think bankruptcy is a good option here... too damaging to the ability to grab new business. 

 

 

 

 

 

 

Well, Veritas could be hustlin' to get a better deal; or given that the new CEO owns very little stock (old CEO sold big portion of ownership at $35) he has no incentive to publicly address these concerns/issues until at the opportune time - once he is CEO. Further, he could be coming in with the basic assumption that they are going bankrupt and he'll lead the company after restructuring. It's all speculation until quarter end and you get the conference call and 10Q. Unfortunately, major events are to be announced before then that are adding to the risk and uncertainty.

 

Inherently, I think owning out of the money long dated calls could be an intriguing play. In a 1 year to 18 month time frame, all of these issues would have played out. By then, you'll know if the stock is an investment, or bankrupt, and your options will likely have tripled or more, or have simply expired worthless. Small position size obviously.

 

I wrote an article a few before yours as well, xazp - look for homor simpson if interested.

[xazp]

I liked your article "Homer." 

 

Just sharing some more information here - it's partially hypothetical, but some parts of the Cameron jig saw puzzle are fitting together for me. 

 

1)  I think sometime last year, fabrication services discovered they could not make pipe spools for Cameron (and Freeport) in time.  This was compounded by flooding which

halted production of the pipe spools further. 

  A) They took a $45M charge against fabrication during Q4 2016. 

  B) I'm guessing some of this is in dispute, whether a delay on the fabrication from flooding, counts as an excuse for delays at Cameron LNG.

 

2)  Those pipe spools are prerequisites to some of the Cameron construction.  This is the basis for the "Cameron is 6 months delayed" comment in November.

 

3)  In Q1 2017 call, Asherman says, we've turned the corner - the pipes are all done.  This means that bottleneck is over.  Then he says some vague stuff about the project, and says some vaguely comforting things about Sempra and the owners.  Sempra also says some vaguely comforting stuff about CBI.  It's all vague, though, which scares the crap of CBI shareholders :). 

 

4) They then take a $24M charge on Cameron, in the 10Q they directly acknowledge this charge is for fabrication delays and schedule delays.  This is good because since the bottleneck is over, they should be in a position to estimate the cost for the delay. 

 

5)  Late May, all the parties meet on the site.

 

6)  In mid-June, CBI files a request with FERC to dramatically raise the number of employees at Cameron.  I believe this is them try to get to back to schedule by essentially working on all the trains in parallel.  These employees are there to quickly install all that delayed pipe.  Curiously the FERC filing says these employees are there to try to get the project back on schedule.  With the extra employees, the site is empty of CBI on Feb 2019.  This looks to me like a 2-3 month delay not the 6 month delay that's being reported. 

 

7)  My estimate is the delta from before is 7,000 employees for 6 months at $5,000/month ($60K/year).  This is a ~$200M cost overrun.  Maybe even $300M.  But remember it's a JV, so half of the hit goes to CBI. 

 

8)  This part is PURE guesswork:  I think the reason CBI and Sempra were so vague on the conference call is, they both understood the delay, but they needed to have a big pow-wow to decide what to do with it. 

I think CBI showed up and said we have two options:

A)  We run the project as-is, 6 months delayed, and then we go sue each other over liquidated damages at the end because flooding. 

B)  We ramp up the project dramatically and cut that delay in half.  To do this we have to hire a lot of extra workers, we run night shifts, and we have them work in parallel on all three trains.  But this is going to cost us $300M to do.  You pay half out of your contingency, we each take a $75M charge.  We settle those "unapproved change orders" and move on. 

 

9)  This pure hypothetical leads to:  Sempra says, we are completing this faster than we told you a few months ago, and at an unchanged total budget.  CBI says, we book extra revenues, we cleared out a chunk of "unapproved change orders," we took a $75M hit for our culpability in the delays.  And now both sets of shareholders get to go home happy, because they've resolved this in a win/win way. 

 

I just have the intuition that the FERC filing indicates they agreed to "something" - I don't see the rationale for CBI to just start absorbing cost overruns for Sempra's benefit.  I think they're trading time (important to Sempra) for money (important to CBI), probably with CBI still taking a haircut on the deal, but not the huge ones analysts mention. 

 

I dunno ... maybe.  Just conjecture. 

[leadingusforward]

xazp -

 

Thanks for your intellectual honesty about where you have an edge and where you don't.

 

Are there historical examples of similar businesses that have gone bankrupt or restructured? 

 

Also do you mind sharing how big of a position this is for you at cost?

[xazp]

I have a perspective here, not enough for a formal article, but it relates back to your question.

 

Small construction companies go bankrupt all the time.  But AFAIK large construction companies are pretty stable - since they have a diversity of revenue streams and better risk control.  For example, I think a small group of large construction companies have built all the LNG export terminals in the world and it's basically the same group now as a decade ago. 

 

Look up "Australia LNG" for example.  In aggregate, there's $50Bn of cost overruns there, there's Gorgon which is like $20Bn over budget.  All LNG projects are built by a handful of huge construction companies, of which CBI is one.  And guess what - you don't see even a $500M write down (1%) on the construction side of Australian LNG projects.  If you look for some articles, you'll see that around 60% of LNG projects are over budget, and they're over budget a lot.  So being over budget is the norm. 

 

What's unusual is the analysts seem to think CBI is taking 100% to 300% of the cost overruns (I say 300% because they're in JVs, but no one seems to really mention their partners), when historically, I don't think any LNG construction company has lost $500M on a project.  Chiyoda is CBI's partner, they've probably built 40% of the world's LNG export terminals.  They've never lost anything like this amount, but (apparently) have lost all risk control only as it applies to Cameron and Freeport.  My article concedes up to $500M losses at Cameron (CBI would be $250M), but even that is, as far as I know, an unprecedented loss historically. 

Frankly if large construction companies thought the risk/reward was (+$250M to -$1Bn), they'd never build another bridge or power plant.  They'd all be bankrupt sooner or later.  But who knows?  CBI sometimes does dumb things. 

 

Cost basis is in the high teens.  It's big enough that I don't like to look at my brokerage balances :). 

 

 

 

 

 

 

 

 

 

 

xazp -

 

Thanks for your intellectual honesty about where you have an edge and where you don't.

 

Are there historical examples of similar businesses that have gone bankrupt or restructured? 

 

Also do you mind sharing how big of a position this is for you at cost?