CBI - Chicago Bridge & Iron

[RadMan24]

So, I started looking at CBI today. Scary stuff. Before the Shaw acquisition, their balance sheet looked quite ok. Not a lot of LT debt and not much of goodwill. They acquired shaw for $3.4B ($2.9B cash and $0.5B equity). Now, here is where it gets tricky.

 

At December 31, 2013, our goodwill balance was $4.2 billion (including $3.3 billion associated

with the Shaw Acquisition). -- p38, annual report 2013

 

So, they paid $3.4B for Shaw and increased the goodwill by $3.3B ? That needs some digging. Because, it looks quite weird.

 

The company has now $4.2B goodwill, $1.5B LT debt and only $2.8B in equity (so a negative TBV of $1.4B). The debt covenants from the 2013 annual report is as follows.

 

The New Revolving Facility has

a borrowing sublimit of $675.0 million (with financial letters of credit not to exceed $270.0 million) and certain financial covenants, including a maximum

leverage ratio of 3.00, a minimum fixed charge coverage ratio of 1.75, and a minimum net worth level calculated as $1.7 billion at December 31, 2013.

 

And finally, from the 2014 annual report.

 

At December 31, 2014, we were in compliance with all of our restrictive and financial covenants associated with our debt and revolving credit and other facilities, with a leverage ratio of 1.65, a fixed charge coverage ratio of 5.32, and net worth of $2.7 billion.

 

The combination of the goodwill, LT debt and covenants are not making me comfortable with this investment.

 

The shareholder letter of 2014 is also not very helpful. The guy talks about how awesome CBI is in a very fluffy language. There is one mention of debt in the letter.

 

For 2015, we expect our cash flows from operations to provide us with the flexibility to

meet our capital allocation priorities of returning value to our shareholders, maintaining an

appropriate cash balance for our operations, continuing to service our debt as planned and

growing the company strategically.

 

This does not really fill me with confidence here. How are you guys comfortable here ? I read the full thread and it seems the FCF more than what is being reported and it is growing at 13% a year or so. But, is this all or I have made some mistake in the calculations of the balance sheet risk ?

 

Read some transcripts they are also published with the SEC, help explains some accounting questions that you may have.

[100 Shares]

Is there any news event associated with the 9% drop today? I couldn't find anything.

[jgyetzer]

Guessing it's the usual oil prices etc...

[gokou3]

wow.. up 10% AH

 

CB&I to Sell Nuclear Construction Business to Westinghouse

http://finance.yahoo.com/news/cb-sell-nuclear-construction-business-213300840.html

 

 

[racemize]

wow.. up 10% AH

 

CB&I to Sell Nuclear Construction Business to Westinghouse

http://finance.yahoo.com/news/cb-sell-nuclear-construction-business-213300840.html

 

makes that acquisition look like a dud...  some validity to the goodwill write-offs the short was talking about.

[KCLarkin]

makes that acquisition look like a dud...  some validity to the goodwill write-offs the short was talking about.

 

It was a good short call, no doubt, but I'm not sure that the thesis played out exactly as PP described.

 

Thesis:

However, we believe CBI will be forced to write-down its grossly overstated goodwill, which CBI wrote-up to offset its

repeated write-downs of Shaw’s book value, but at a time when Shaw’s value was declining. CBI’s write-down of Shaw

goodwill is likely to trigger a debt default, heightening the risk of a liquidity crisis or a pre-emptive dilutive equity raise

 

Actual:

The company has secured relevant waivers and amendments relating to banking and credit facilities underscoring the support from banking partners for this transaction.

 

I'm not even convinced the cookie jar accounting was a real problem. Based on my fuzzy memory, I think the reserve makes sense given the problems they were having with the nuclear contracts.

 

The real problem is that cash flow and net income diverged substantially for a very long period. And the gap would only close if CBI won a favorable settlement from Westinghouse or the utilities. Note: probably not wise to value a company on PE when there is such a big gap between NI and OCF.

 

Now, CBI gets really interesting. Operationally, this is a phenomenal company that was taken down by a bad acquisition and two bad contracts. They have a major debt problem and macro headwinds. But the complexity of percentage of completion contracts makes this a company that only an accountant would love.

 

---

But wait! What's with all the VIEs? This is clearly Enron.

 

[racemize]

I'm hopeful that they have gotten rid of the bad apple in the shaw acquisition and that they can continue on with their historical excellence.  A couple of bearish articles I was looking at recently:

 

http://www.fool.com/investing/general/2015/03/09/the-chicago-bridge-and-iron-merger-with-shaw-a-mar.aspx

 

http://www.fool.com/investing/general/2015/07/19/the-trouble-with-cbis-backlog.aspx

 

The backlog one seems overly negative to me.

 

Anyway, they have said that net income and cash flow should match this year, and it did end up matching by the end of last year too. 

[gokou3]

The real problem is that cash flow and net income diverged substantially for a very long period. And the gap would only close if CBI won a favorable settlement from Westinghouse or the utilities. Note: probably not wise to value a company on PE when there is such a big gap between NI and OCF.

 

FWIW, their pro-forma financials (ex. divested businesses) do show that 2015H1 OCF is a positive $380M and is significantly greater than NI.

https://www.snl.com/Cache/1001203727.PDF?Y=&O=PDF&D=&fid=1001203727&T=&iid=4234612

 

I guess they will have some DTA from the writedown that they can shield their tax from for the next little while?

[KCLarkin]

Yes, I was referring to past cash flow problems. I suspect this is probably pretty compelling now, but I haven't looked at the pro-forma yet.

[KCLarkin]

Am I seeing this correctly:

- CBI drops awful nuclear contracts +15%

- Fluor wins nuclear contracts +7%

[racemize]

Am I seeing this correctly:

- CBI drops awful nuclear contracts +15%

- Fluor wins nuclear contracts +7%

 

All news is good news.

 

Reminds me of the Berkshire deal where both parties in dispute had write-ups after it was over.  Can't remember the counter party though now...

[physdude]

Am I seeing this correctly:

- CBI drops awful nuclear contracts +15%

- Fluor wins nuclear contracts +7%

 

I think this is because the contracts were awful for CBI due to the delays. Fluor will not be liable for the delays so getting a new contract is good for them. CBI is still overall well down due to the contracts and, given what they were saying regarding their liability in the last conference call, I am surprised that they are getting rid of this part of the business at such a big loss.

[MrB]

Am I seeing this correctly:

- CBI drops awful nuclear contracts +15%

- Fluor wins nuclear contracts +7%

 

I think this is because the contracts were awful for CBI due to the delays. Fluor will not be liable for the delays so getting a new contract is good for them. CBI is still overall well down due to the contracts and, given what they were saying regarding their liability in the last conference call, I am surprised that they are getting rid of this part of the business at such a big loss.

 

 

- CBI drops awful nuclear contracts +15%

- Fluor wins nuclear contracts +7%

- Westinghouse -?%

 

There is a big chunk of debt here. 8k seems to suggest CBI is being released

[racemize]

big sell off from BRK this quarter.  seems a bit surprising to me.

[benhacker]

It's interesting, I felt that the acquisition accounting was a sign management was trying to manage EPS to hit their bonus targets.  I talked to others who felt the acquisition was a disaster and the negative revisions to valuation post acquisition close were just a sign that CBI realized they bought a lemon.

 

it's clear that my guess that management was a little shady, vs. the alternative narrative that they were dumb was wrong.  They were dumb, and made a terrible acquisition.

 

I made a small profit here and sold above $45... but clearly not my finest hour.

 

I think Combs made a bad judgement here, especially at his av. cost.  There was no benign way to explain how they accounted for the Nuclear deal... it was bad.

 

I bet all the coattailers here are going to take a hard look at this again, and sell...

 

Ben (no position)

[racemize]

I agree that this acquisition seemed to have a lot of issues, or at least one major issue.  The accounting around the nuclear portion was certainly bad.  I still think it is possible that the acquisition wasn't completely a disaster as they filled out their business quite a bit and got a lot of backlog.  Here's what management said in the last conference call on it:

 

Michael S. Dudas - Sterne Agee CRT

Well. Thank you. So, maybe to kind of – on the nuclear transaction, Phil, as you look back at what the Shaw transaction provided you and given the solution here can you maybe put in context, how you felt it went and how it's provided for CBI going forward? And Mike, just on the cash flow neutral aspect, so, there'll be some cash outflows going out with the closure of this transaction, maybe you can bring a little more clarity to that.

 

Philip K. Asherman - President, CEO & Member-Supervisory Board

Mike, circle back on the – what are you saying on your first part of your question about the Shaw transaction.

 

Michael S. Dudas - Sterne Agee CRT

No, I was just – given what's happened and where the company is positioned going forward and looking back on how this all turned out with the transactions upcoming, how do you feel it all turned out?

 

Philip K. Asherman - President, CEO & Member-Supervisory Board

I feel great. No regrets. But, if you look at the combined company and considering any transaction is a way of growing the company in real terms, if you look at just the year prior to the transaction compared to the year after the transaction, we went from – new awards from $7 billion to $16 billion. We went from backlog to $10 billion to $30 billion. We went from gross profit from $5 billion to $12 billion. We kept – we lowered our S&A. We raised EBITDA from $522 million to $1.1 billion.

 

So, I would have to say that the combination of the two companies did what we wanted to do and in addition to add a number of areas that we needed to diversify in and gave us more control of other projects like pipe fabrication and extended our scope to plant maintenance and got us into power generation vis-à-vis the combined cycle. So, I mean, we're very pleased with all of that. As you know, we needed to solve this issue with the nukes and we've done that. And, we're only looking forward now. And, we think the combined company is well-positioned to take advantage of everything we see in front of us.

 

Moreover, it seems that while a lot of the reevaluation from ~$90 was warranted, the current price relative to 2016 earnings seems to me to still be a good one, as the cash flow issues should be resolved at this point (unless management's guidance is false).  That's why I'm confused at selling now. 

 

Or saying it another way, the question is the price now vs the future cash flows, not the terribleness of the previous acquisition, right?

[Dalal.Holdings]

Important to remember that Berkshire reduced its stake during the third quarter -- before CBI disclosed it was divesting out of the nuclear construction business. Perhaps BRK did not anticipate this divestiture and sold because of nuclear concerns.

 

Either way, it does look like the Shaw acquisition was a major management blunder. CEO & board should exercise restraint when it comes to future acquisitions.

 

CBI should financially recover after divestiture as we believe the remaining business is highly attractive in terms of cash flows. Management should refrain from any similar disastrous acquisitions and should return excess capital to shareholders, especially as buybacks if share price remains in this range.

[racemize]

Important to remember that Berkshire reduced its stake during the third quarter -- before CBI disclosed it was divesting out of the nuclear construction business. Perhaps BRK did not anticipate this divestiture and sold because of nuclear concerns.

 

Either way, it does look like the Shaw acquisition was a major management blunder. CEO & board should exercise restraint when it comes to future acquisitions.

 

CBI should financially recover after divestiture as we believe the remaining business is highly attractive in terms of cash flows. Management should refrain from any similar disastrous acquisitions and should return excess capital to shareholders, especially as buybacks if share price remains in this range.

 

Agreed completely on acquisitions. 

 

It's true that they sold prior to the announcement. However, even prior to the nuclear disposition, it still seems like they sold low.  Of course, we don't know the outcome yet, so they may yet be right.

[gokou3]

Has anyone figured what percentage (say revenue-wise) of their Shaw acquisition has been disposed to Westinghouse?  My cursory understanding is CBI offloaded the nuclear construction business but retain the maintenance and decommissioning businesses, but I don't have a breakdown of the revenue/profit contribution of each.

[RadMan24]

It's interesting, I felt that the acquisition accounting was a sign management was trying to manage EPS to hit their bonus targets.  I talked to others who felt the acquisition was a disaster and the negative revisions to valuation post acquisition close were just a sign that CBI realized they bought a lemon.

 

it's clear that my guess that management was a little shady, vs. the alternative narrative that they were dumb was wrong.  They were dumb, and made a terrible acquisition.

 

I made a small profit here and sold above $45... but clearly not my finest hour.

 

I think Combs made a bad judgement here, especially at his av. cost.  There was no benign way to explain how they accounted for the Nuclear deal... it was bad.

 

I bet all the coattailers here are going to take a hard look at this again, and sell...

 

Ben (no position)

 

Einhorn increased position. He's cost per share is around 40, whereas Berkshire was north of 60. Depends on the coattailer you follow.

[physdude]

Southernsun increases its stake to over 11%. This is strange because I thought there was some sort of 10% limit.

[farbelow]

Has anyone figured what percentage (say revenue-wise) of their Shaw acquisition has been disposed to Westinghouse?  My cursory understanding is CBI offloaded the nuclear construction business but retain the maintenance and decommissioning businesses, but I don't have a breakdown of the revenue/profit contribution of each.

 

CBI's last 10-Q, note 4 'Disposition of nuclear operations' states at the bottom revenue and pre-tax income for the nuclear operations that they disposed: approx. 2B revenue and 200M profit per year. Shaw's last revenue in 2012 was 6B and profit volatile. So it looks like CBI disposed 1/3 and kept 2/3 of Shaw's business.

[MrB]

I agree that this acquisition seemed to have a lot of issues, or at least one major issue.  The accounting around the nuclear portion was certainly bad.  I still think it is possible that the acquisition wasn't completely a disaster as they filled out their business quite a bit and got a lot of backlog.  Here's what management said in the last conference call on it:

 

Michael S. Dudas - Sterne Agee CRT

Well. Thank you. So, maybe to kind of – on the nuclear transaction, Phil, as you look back at what the Shaw transaction provided you and given the solution here can you maybe put in context, how you felt it went and how it's provided for CBI going forward? And Mike, just on the cash flow neutral aspect, so, there'll be some cash outflows going out with the closure of this transaction, maybe you can bring a little more clarity to that.

 

Philip K. Asherman - President, CEO & Member-Supervisory Board

Mike, circle back on the – what are you saying on your first part of your question about the Shaw transaction.

 

Michael S. Dudas - Sterne Agee CRT

No, I was just – given what's happened and where the company is positioned going forward and looking back on how this all turned out with the transactions upcoming, how do you feel it all turned out?

 

Philip K. Asherman - President, CEO & Member-Supervisory Board

I feel great. No regrets. But, if you look at the combined company and considering any transaction is a way of growing the company in real terms, if you look at just the year prior to the transaction compared to the year after the transaction, we went from – new awards from $7 billion to $16 billion. We went from backlog to $10 billion to $30 billion. We went from gross profit from $5 billion to $12 billion. We kept – we lowered our S&A. We raised EBITDA from $522 million to $1.1 billion.

 

So, I would have to say that the combination of the two companies did what we wanted to do and in addition to add a number of areas that we needed to diversify in and gave us more control of other projects like pipe fabrication and extended our scope to plant maintenance and got us into power generation vis-à-vis the combined cycle. So, I mean, we're very pleased with all of that. As you know, we needed to solve this issue with the nukes and we've done that. And, we're only looking forward now. And, we think the combined company is well-positioned to take advantage of everything we see in front of us.

 

Moreover, it seems that while a lot of the reevaluation from ~$90 was warranted, the current price relative to 2016 earnings seems to me to still be a good one, as the cash flow issues should be resolved at this point (unless management's guidance is false).  That's why I'm confused at selling now. 

 

Or saying it another way, the question is the price now vs the future cash flows, not the terribleness of the previous acquisition, right?

 

It is idiotic for Asherman to look back on that transaction without any regrets. If this was your company for the last 5 years and your CEO stood in front of you making such a statement what would your response have been? Add to that the way that he reported results to you then you have to ask the question whether this guy is just trying to fool you or is he fooling himself; the latter is infinitely worse.

[physdude]

Southernsun increases its stake to over 11%. This is strange because I thought there was some sort of 10% limit.

 

I got this from whalewisdom (http://whalewisdom.com/stock/cbi) but they apparently double counted the shares from Southernsun's 13f with the number they report being exactly double that in the 13f. So the stake is only 5.6% or so.

[KCLarkin]

It is idiotic for Asherman to look back on that transaction without any regrets. If this was your company for the last 5 years and your CEO stood in front of you making such a statement what would your response have been? Add to that the way that he reported results to you then you have to ask the question whether this guy is just trying to fool you or is he fooling himself; the latter is infinitely worse.

 

Maybe we are misinterpreting this acquisition.

 

Denali Investors has a very good reputation. They were Shaw shareholders and opposed the CBI offer because they thought it was low-ball. According to their numbers, the pro-forma (after synergies) price was 3xEBITDA.

 

http://www.prnewswire.com/news-releases/denali-investors-sends-letter-to-the-shaw-group-shaw-board-of-directors-demanding-appropriate-premium-for-shareholders-cbis-offer-is-inadequate-166059636.html

 

This appears to be an acquisition done at distressed prices. So, part of the rationale could be that we are going to buy these bad nuclear contracts and, in exchange, get a big discount on the rest of the business. If you do a SoP, the nuclear business was probably negative and the rest of the business is positive.

 

So to evaluate the acquisition, you need to do a DCF on the 2/3 of Shaw retained against the original purchase price less any cash outflows due to the nuclear contracts. This is pretty hard to do, given the current macro headwinds. But it is likely that this transaction is not the value destroyer it appears to be.

 

The deal was announced on July 30, 2012. CBI is up 12% since the acquisition was announced. FLR is down 0.7%. Fluor has a better dividend though, so it is probably a wash.

 

CBI has performed in-line since the acquisition was announced.

 

The reason why this stock has performed badly lately:

- Market wildly over-reacted on the upside after the acquisition closed AND berkshire bought it

- The entire segment is out of favor due to low commodity prices

- Multiple compressed due to bad nuclear contracts

 

This is not my favorite industry but you get the chance to buy a phenomenal operator at a big discount.

 

Disclosure: No position. I sold after the sale of the nuclear business was announced. Wanted to raise cash but I think this could be building a base for a very nice run.