How much value did Leighton destroy?


From JP Morgan:

  • The remerging focus on allegations of corrupt behaviour reminds investors that mgmt has work to do to address “legacy” issues. Until these issues are addressed fully, we expect pressure to remain on LEI’s share price. Retain Neutral on LEI.
  • Focus returns to allegations of corruption–Press reports from the Fairfax Media published overnight follow a 6mth investigation of allegations of corrupt behaviour in LEI’s international operations. The keyallegation surrounding a bribe paid to obtain an oil & gas construction contract in Iraq has been subject of an Australian Federal Police (AFP) investigation since LEI self-reported the issuein early 2012. However, the reports suggest that: (1) More widespread (though not specified) corrupt activitiestook place. (2) Information may have been withheld from investigators. (3) Former mgmt, including former CEOs Wal King and David Stewart, knew of and, in some cases, condoned activities.
  • No significant new information revealed…- In response to the reports, LEI stated that no new allegations have been made and that the Group “takes these accusations seriously”. Further, LEI notes a number of changes that have taken place over the past 2yrs including internal investigations into the alleged corrupt practices and implementing new risk mgmt systems and Code of Conduct.
  • …but a reminder that issues remain to be dealt with–The core allegations in these reports remain under investigation by the AFP and no charges have been laid. However, these reports remind investors of the risks remaining to the Group from “legacy” issues that have yet to be fully dealt with. If the investigations lead to charges being laid, the Group would need to address them through a legal process. If the Group is then found guilty, it could incur financial penalties and enforceable undertakings to address any shortcomings. The Group could also face reputational damage and, in certain circumstances, find it more difficult to bid on work if clients deem that the Group is unfit. But, we believe these risks are small at this stage until the AFP reveals its position.

Meanwhile, the SMH quotes Deutsche:

Deutsche Bank research analyst Craig WongPan has taken a look at Leighton Holdings and the key implications for the building firm following the Fairfax Media investigation on alleged bribery claims.

He recommends a hold on Leighton and notes that its Australian operations are unlikely to be affected given that the allegations were linked to overseas contracts.

“In our view the key implications are reputational damage and impairment of the Iraq receivable. We do not believe LEI’s Aus operations will be materially affected as they are managed separately from where the kickbacks occurred,” WongPan writes in a research note.

“With the stock trading broadly in line with our TP we retain a Hold. … We assume reputational damage reduces our offshore revenues by 20 per cent.”

Citi is more frank:

  • Further alleged impropriety issues identified — Australian media reports today identified alleged instances of impropriety in LEI’s International business in addition to the Iraq investigation and Indonesian barge project, and that impropriety issues were known to senior management. LEI responded it was not aware of any new allegations in addition to the Iraq and Indonesian barge issues. Shares closed down ~10%, reflecting the risk to earnings and cash collection from reputational damage.
  • Negative implications for LEI offshore growth — Reputational damage relating to today’s allegations is likely to negatively impact LEI’s ability to grow offshore WIH and earnings, a key growth driver for LEI given domestic cyclical headwinds. Offshore earnings (ex-Thiess Indonesia) account for 13% of our LEI FY14e group EBIT, while offshore WIH was 27% of total LEI 1H13 WIH. It is worth noting LLC’s US business took ~3 years to recover from its New York billing investigation issue.
  • Offshore cash collection likely to prove more challenging — Cash collection remains a key risk for LEI due to an estimated ~$1.5bn increase in underclaims in the last 18 months. Iraq, Indonesia and Mongolia make up >$700m of the ~$1.5bn increase in LEI underclaims, and today’s media allegations are likely to make cash collection in these geographies, as well as HLG cash collection, more challenging. We model a ~$200m reduction in 2H13 working capital vs. LEI’s target of ~$500m.
  • Potential implications for senior management and board unclear — The extent of the potential implications for LEI’s current senior management and board relating to today’s impropriety allegations are unclear. LEI has made major improvements to its risk management and governance standards, but today’s allegations are likely to significantly increase investor concerns around LEI’s corporate governance.
  • Lower TP to $15.35, downgrade to Sell — Our EPS forecasts are unchanged, but we lower our TP to $15.35 on a lower PE multiple (9x from 11x) and due to applying a 10% discount to our valuation to reflect the increased risk to offshore earnings and cash collection, as well as increased investor concerns around corporate governance. With an ETR of negative 7%, we downgrade LEI to Sell from Neutral.

Yep, add in the “prolonged and severe” mining capex ahead, the phrase “wide berth” springs to mind!

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.