SNC-Lavalin: Buy A Highway, Get The E&C For Cheap

This is my most recent research piece on SNC-Lavalin Group published on Seeking Alpha: SNC-Lavalin: Buy A Highway, Get The E&C For Cheap.

Unfortunately the publication of my article corresponded with a significant press release from SNC and a public statement from the CDPQ . On the news the stock went from $25 to $21 per share. That’s my timing for you.

Of course nobody wants to see bad news but I believe this is the news that we were looking for. I see the recent announcements as positives.  It’s like a doctor telling you that you are getting brain surgery to remove a tumor. It’s not good news but that’s what needed. Short-term pain for a better future.

In the article I said that I wouldn’t be surprised that the new CEO takes the quarter as an opportunity to ditch guidance and dump more bad news and that’s exactly what happened. SNC took a $1.9b impairment charge link to its oil and gas division, Kentz. They already took a $1.2b impairment charge back in February. SNC bought Kentz for $2.1b back in 2014. The CDPQ, the largest shareholder with 19.9%, publicly came out against the deterioration of SNC performance. Back in the spring the CDPQ said they will “be a rock” for SNC, I guess they are losing patience like everyone else.

SNC is facing many headwinds, operationally, financially, politically, reputationally…let’s quickly address them:

  • SNC has been having operational issues. SNC some good assets and bad assets. The recent restructure announced will have SNC focus on its strong points. SNC is still in business. They are still winning contracts. SNC is walking away from Turnkey lump sump projects, the key source of its problems. Exit: O&G, mining, and construction which are its least profitable activities.They will focus on design, nuclear, engineering services “EDPM”.  They will be less risky and more cash-flow predictable. More details on the new strategy is expected in the fall. The future SNC might look like more of a WSP Global or Stantec.
  • Finance: SNC took on a lot of debt for its WS Atkins acquisition of $3.6b in 2017. Despite paying a big price for Atkins, it’s one of the strong points of SNC today. To deal with the debt SNC is selling part of their private highway, cut the dividend, and is engaged on a cost cutting program. Once the sale is completed SNC debt’s level should be back to their historical norm of low debt. SNC also has $13.87 (post-H407 sale) of net assets in their Capital Investment Portfolio.
  • Politics: Unfortunately SNC was in the middle of a political scandal for the Trudeau’s Liberal government. SNC was also a victim of a diplomatic spat between Saudi Arabia and Canada. There’s not much in SNC’s control at the moment. Hopefully after the election the government will finally find a solution to SNC’s legal problems.
  • Reputation: SNC didn’t murder anybody but you would think they did. Their reputation is not good. It’s affecting employee morale and departures. The public perception of the company is toxic. SNC is managing a PR crisis. SNC, a 100+ year old company, has its brand; a once valued intangible asset is now in the garbage bin. You can change a reputation. Merck’s Vioxx is responsible for the death of 38,000 people and the company is still around. With SNC it will take time. I don’t expect anything before the Canadian Federal election in October. Plus they have to Libya bribery court case they have to deal with. It will take a lot of time, a string of good news/quarters, and communications to deal its reputation.

With the recent announcements, SNC has a market cap of $3.6 billion, the same price they bought WS Atkins in 2017. Atkins is one of the most respected planning and project management firm in the world. The stock is cheap and very attractive for a competitor looking to expand. The CDPQ has ~20% and RBC recently built a 16.6%. I understand this is a difficult stock to hold or even buy. It’s not supposed to be easy. I believe SNC will eventually emerged a better company.

I suggest to read the article for a more in-depth analysis.
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GameStop – Hard Reality Ahead

I’ve been following the retailer GameStop (GME) on and off for a couple years now. It’s trading at $4.80 a share with a market cap of $490m. The stock has been in free fall for a couple years now.  It did stabilize for a bit last year when they were shopping the company around but they ended up not doing anything.

GameStop

They recently slashed the dividend that had a yield of over 10%. The move will save them $157 million a year. When you see a juicy 10% dividend yield, it usually means that it’s too good to be truth. The large majority of times it means that the company is not healthy and I’m not surprised they cut it. They have a failing business with $468m in debt plus $550m in operating leases.

I’m looking at it for a shorting point of view. Shorting is very risky even though GameStop gives you the vibe that it’s the next Blockbusters. People are playing videogames more than ever. It’s just they are not buying their games at GameStop like they used too.

GME might survive, in a different form. They have a collectible business that is growing but very small. Somebody might take them private. They just announced a Dutch Auction buyback. Maybe its a zero. They have enough cash to pay their bills for a while. They have Net Operating Losses (NOL) which could be attractive to another retailer. Shorting is a hard game to play. Plus betting on a retailer going to zero is not a game I’m comfortable with. That’s why I don’t short.

They operate 5,800 stores in 14 countries. I don’t know what’s going with ThinkGeek.com. They bought the company in 2015 for $140m and I know they took some impairment charges on the brand name.

The reality is that the long-term outlook of their core business doesn’t look good. They are in the wrong line of business at the wrong time. Sure the next generation of consoles (PS5 and Xbox) might give them a short-term boost (or hurt them because people are delaying their game purchase), but the hard reality is that all the games are going over the cloud. It’s much more convenient and more profitable. They are cutting out the middle men by going directly to the consumer (digital delivery). This is a pattern we have seen with music, video, and now video games. It’s just taking longer for video games because of the more demanding hardware/software/Internet requirements. We have the technology today. When was the last time you bought a music CD or a DVD? Video games are going the same way.

A hobby retailer that seems to be doing well is Games Workshop (GAW.l), which is the company behind Warhammer. Maybe GameStop with their collectibles and reach can emulate the good side of that business. But it would have to be on a smaller scale on cheap rent real estate. That’s probably not what investor want to hear.

Ironically, GameStop was once a streaming video game innovator. It bought Spawn Labs in 2011 to create a kind of Netflix for video games. But it was too early: The technology wasn’t quite ready, and GameStop shut down Spawn Labs in 2014.

The competing landscape is also changing. Google is getting into gaming with Stadia, a cloud gaming streaming service. Apple is getting in the business too. Nintendo is pushing their games on the mobile. And Sony and Microsoft are working on the next generation of console.

I don’t know what happened in the board room when they were looking to sell the company around. Maybe the offer wasn’t good enough (I bet it looks great in hindsight now). The business of selling new and used console is a dying one. The business would be good in the hands of independent retailer or a private owner that has the patience to work things out.