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SNC-Lavalin faces complex choices as it charts Plan B
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With shares trading near 10-year lows, engineering company's options range from a sale to a breakup
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By NICOLAS VAN PRAET
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Saturday, February 16, 2019 – Print Edition, Page B1


MONTREAL -- Barely four months ago, SNC-Lavalin Group Inc. revived a team of internal and external advisers to analyze the options for a radical reshaping of the Canadian engineering and construction company in the face of mounting odds that it would face trial for corruption. Their task: Come up with a Plan B for the multinational in case it has to go to court.

Today, the company's problems have deepened and its plight has become highly politicized. The Globe and Mail reported last week that the Prime Minister's Office put pressure on the former justice minister to shelve the criminal prosecution against SNC-Lavalin in favour of a negotiated settlement.

Quebec is pressing Ottawa to order such a settlement, called a remediation agreement, but the federal prosecutor's office seems intent on pushing forward with a trial.

The stock has plunged to lows not seen in a decade. A dramatic move to protect shareholder value looks more urgent than ever.

What path SNC-Lavalin's board and management will take remains a matter of speculation and disagreement among analysts, money-managers and industry observers alike. From breaking up to negotiating a rescue or simply cutting loose some assets, opinion is divided. The only agreement among the roughly dozen people interviewed for this story is that the company's ambition to become the world's biggest engineering company should be shelved. The optimism investors had that the company was on a solid trajectory under chief executive Neil Bruce has been badly rattled.

"When hope becomes your only investment thesis, it is time to move on," said Charles Marleau of Montreal wealth management firm Palos, which sold off its SNCLavalin stock in the wake of the latest developments. "I no longer have any confidence in this company."

SNC-Lavalin stunned the market on Jan. 28 with a cocktail of bad news, saying profit for 2018 would come in more than 50 per cent lower than previously expected and that its business prospects in Saudi Arabia have deteriorated, contributing to a $1.24billion writedown of its oil and gas business. Perhaps most worryingly, the company disclosed previously unknown trouble with a major mining contract for Chilean copper producer Codelco.

Two weeks later and after examining its options on that contract, SNC reduced its profit expectations again and said it was halting all future bidding on mining engineering, procurement and construction projects.

The company also said it had negotiated temporary debt covenant relief from lenders, which include pension fund Caisse de dépôt et placement du Québec. It could now pull the plug on a plan to sell a piece of its 16.7per-cent stake in Toronto's Highway 407 toll road.

The situation has become even more complicated as the corporation comes under intense national scrutiny.

S&P Global ratings this week cut SNC-Lavalin's credit rating to the cusp of junk, saying it expects the company's credit metrics to worsen over the next two years.

The ratings agency said SNC will face headwinds over the same time that could slow growth and cause earnings and cash flow volatility. Credit firm DBRS Ltd. put the company's issuer and senior debentures ratings under review with negative implications, citing "growing concerns regarding risk management and project control issues."

"It's very surprising" how quickly things have deteriorated for the corporation, said Mona Nazir, an analyst at Laurentian Bank Securities. "I think that everything right now, behind closed doors, is on the table because the situation has changed so rapidly."

Among the company's Plan B options is selling the engineering and construction business in its entirety, according to analyst Benoit Poirier at Desjardins Capital Markets. Such a transaction would likely generate "substantial interest" from buyers, he said.

With SNC's stock price falling and no controlling shareholder, a hostile offer remains possible, although any bidder would have to square off against the Caisse, which has a nearly 20-per-cent stake in SNC and has sent a strong signal that it wants the multinational to remain in Quebec.

A Caisse-led buyout is an avenue being touted by some investors. "Your Plan B is hope maybe the Caisse will come and rescue you, buy the whole thing," said Norman Levine, managing director of Portfolio Management Corp. in Toronto, an investment firm that owns SNC shares. "There is no easy answer here." A Caisse official declined to comment.

Another scenario is that SNCLavalin pursues a breakup, a nuclear option being advocated by some shareholders in the event the company's legal limbo continues indefinitely. "If it goes to trial, I think the best option for the company would be to begin to sell off pieces," said Michael Willemse, analyst at Taylor Asset Management in Toronto, which holds SNC shares. "We just don't believe the company would continue to exist in its current form."

Yet, another possibility is that SNC winds down operations in Canada. The company no longer counts on contracts here for most of its sales, and has reduced its revenue footprint in Canada from as high as 66 per cent of total sales in 2013 to about 30 per cent today.

If SNC-Lavalin is banned from the Canadian market - which is not a certainty even with a criminal conviction because of potential changes coming to federal procurement rules - SNC management has told Desjardins that it would be able to shift its exposure to other regions and away from Canada over three years.

SNC first set up the Plan B team in the wake of federal charges in 2015. It resurrected the team last fall after failing to win a remediation deal. The company declined to comment on the current status of the group and would not talk about strategy beyond previous statements by management.

What SNC would leave in its wake with such a move is not inconsequential. It would tear a big hole in Quebec's economy, with the loss of a headquarters and 3,400 jobs. It would also mean a loss of expertise. Although it has been argued that other firms would move in to take SNC's business and SNC employees would find work elsewhere, the scope of the company's activities and capabilities will be hard to match in the short term and bidding processes could become much less competitive.

Some equity analysts, including Maxim Sytchev at National Bank of Canada, say SNC should pursue targeted asset sales and shrink its business to increase the quality of its contract backlog and lower risk. Mr. Bruce has been improving the predictability of SNC's business over time - for example by cutting the number of fixed-price contracts it bids on, which are far riskier. But he could take that even further by stopping the booking of any fixed price contracts at all, at the expense of growth.

One hazard of unloading assets in the near term is that SNC comes off as a distressed seller. Mr. Bruce has said the company will not sell any piece of the 407 unless it gets the price it wants. Still, buyers might be even less willing to pay that amount now. The same holds true for its resources businesses.

But with the market expecting SNC to sell a portion of its stake in the highly profitable 407, not selling might make things worse. The toll-road stake has always provided a minimum value for SNC's share price. Monetizing some of it would not change that because cash would also provide a floor for the shares, said Colin Stewart, chief executive of JC Clark Ltd., a Toronto-based asset management firm.

Regardless of strategy, much of the company's future hinges on the outcomes of its legal battles, which can be almost impossible to predict.

SNC has launched a formal challenge to the Public Prosecution Service of Canada's decision not to engage in talks on a remediation agreement. If that fails, the Trudeau government could step in and issue a directive to settle the charges. Police in Quebec are also investigating alleged payments by the company to obtain a 2002 contract for work on Montreal's Jacques Cartier bridge, meaning more charges could be coming.

In situations like these, valuation doesn't matter, said Bruce Murray, chief executive of investment firm the Murray Wealth Group. "I just know there's a mess so stay away," he said. "It's called the cockroach theory. The cockroaches keep coming until they don't."

Associated Graphic

The plight of SNC-Lavalin, whose headquarters in Montreal is seen on Tuesday, is dividing analysts and investors, but it is commonly agreed that the company's next steps should include setting aside its ambition of becoming the world's biggest engineering firm.

DARIO AYALA/THE GLOBE AND MAIL


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