SNC-Lavalin encouraged to overhaul business model, sell off Canadian construction operations
June 5, 2019 by David Kennedy
TORONTO—Facing steep legal challenges and the threat of a 10-year ban on Canadian federal government contracts, SNC-Lavalin Group Inc. is being encouraged by one financial analyst to divest a key part of its Canadian business.
In a recent research note, Canaccord Genuity analyst Yuri Lynk said the engineering and construction giant must take “bold actions” to improve its performance and redefine its value to investors.
Pointing to the company’s lingering legal issues surrounding its actions in Libya between 2001 and 2011, Lynk said SNC-Lavalin is in a “tough spot.” Just last week, a Quebec judge ruled there’s sufficient evidence to send the company to trial on fraud and corruption charges.
“While the outcome and consequences of its corruption trial are out of the company’s hands, there is another, often overlooked, issue weighing perhaps even more heavily on SNC shares,” Lynk said in a May 29 note to clients. “An issue that management can do something about.”
The company’s free cash flow — a measure of the cash a firm generates minus its capital expenditures — has been negative since 2012, Lynk noted. He singled out poor execution on fixed-price construction contracts, specifically lump-sum turnkey, or LSTK work, for much of the blame.
To counter the problem, Lynk is urging management to alter the company’s business model to focus on engineering and procurement services while exiting construction.
He recommends SNC-Lavalin sell off its Infrastructure unit, which generates about 66 per cent of its revenues in Canada, mainly from working on major projects such as Montreal’s Champlain Bridge, Toronto’s Eglinton Crosstown and Stage 2 of Ottawa’s LRT. The move would eliminate much of the risk associated with LSTK contracts, Lynk said, adding that the company should continue offering construction management services. In this scenario, it could remain a player in Canada’s P3 market as part of construction consortia, but step away from leading the builds.
“We recommend letting the construction experts such as Aecon, Bechtel, Dragados, EllisDon, Kewitt, and others do their thing,” he said in an April note to clients in which he first floated the idea.
While the sale of its construction business would be a major shift for the company, Canaccord estimates that in 2017 only about 500 of the 6,600 people employed in SNC-Lavalin’s Infrastructure unit were working in construction roles. The bulk of the workforce was dedicated to engineering. In other words, “most” of the construction scope of projects was subcontracted.
The recommendation comes as the federal government put changes to its so-called integrity regime on hold this week. The update to how Ottawa prosecutes corporate misconduct could have benefited the Montreal-based firm.
Last month, top SNC-Lavalin executives floated numerous “Plan B” options, including one that involved breaking up the company, at a private investor luncheon. At the time, the company said it continues to evaluate “all possible scenarios” to create maximum value for its shareholders.