SNC-Lavalin Group Inc. shares surged after the company struck a plea deal to resolve the criminal case against it, removing uncertainty that had been hanging over the stock for many months.
The settlement means the company will plead guilty to one fraud charge and submit to three years on probation and pay a $280-million fine. The stock-market value of the company went up more than $800-million in response, as the share price gained 19 per cent to close at $28.70 in Toronto.
In September, the shares traded as low as $15.47, which was down 75 per cent since mid-2018. That shocking decline for a formerly blue-chip Canadian company implied that investors were giving value only to its stake in Ontario’s Highway 407 toll road and that its global engineering business – which underpinned SNC’s 110-year history – was worthless.
For institutional investors, the legal settlement removed the major obstacle toward a turnaround for the company, which has also been hit hard by unexpected losses in a number of business lines, including the parts of the company that do work for resource companies such as miners.
“These are all historical issues. I think we have a clean break going forward, and we can focus on the fundamentals of the business,” Charles Nadim, manager of the Canadian equity portfolio at Jarislowsky Fraser, the Montreal-based investment management firm, said.
“If you look at the underlying business, throughout this period [of legal uncertainty] they continued to win very nice contracts,” Mr. Nadim said.
Analysts sounded upbeat. “While the guilty plea may result in some short-term uncertainty, we believe this should be outweighed by the positive impact of the settlement,” Benoit Poirier, an analyst at Desjardins Securities, said in a note.
Mr. Poirier added that the $280-million fine that SNC agreed to pay as part of the settlement was almost half the $500-million fine used in his earlier analysis of the stock.
But the biggest benefit should come as investors ascribe a higher valuation to SNC’s engineering services division.
The market’s dramatic reaction on Wednesday afternoon – the shares briefly surged 35 per cent higher after an hours-long trading halt was lifted – suggests that the resolution to the charges, stemming from contracts in Libya between 2001 and 2011, came as a surprise to many investors used to bad news.
At times, SNC looked like a company that was floundering with no way out. It announced a writedown to its oil and gas division in January. Chile’s state miner Codelco cancelled a contract with SNC valued at US$260-million in March. And in July, SNC said it would no longer bid on fixed-price construction projects because of poor financial returns on them.
Financial results were mostly dismal in recent quarters. It reported a $2.1-billion loss in the second quarter of this year and slashed its quarterly dividend to 2 cents a share from 10 cents. In the third quarter, which ended Sept. 30, SNC reported that revenue fell 5 per cent from the previous year and EBITDA (or earnings before interest, taxes, depreciation and amortization) fell 17 per cent.
But the low share price raised the stock’s allure among some investors and analysts who believed that SNC was being overly punished by the market, even though its engineering operations were relatively sound.
Earlier this week, Canaccord Genuity included SNC among its top picks for 2020. Analyst Yuri Lynk noted that the company’s debt levels were manageable, the engineering services division would generate $338-million in free cash flow in 2020 and SNC would be able to handle its backlog of construction projects – mostly Canadian light-rail transit projects, where execution has been solid.
Bets by some institutional investors have paid off handsomely.
Hanif Mamdani, head of alternative investments at the investment management arm of Royal Bank of Canada, said in a letter to investors in June that SNC’s share price was “nonsensical.” Between March and June, RBC’s investment management unit increased its stake in SNC from 11.8 million shares to 29.2 million shares, or 16.6 per cent of the company, according to Bloomberg.
Wednesday’s rally, which delivered the stock to its highest price since early May, raised the value of RBC’s stake to $838-million, up $133.7-million.
Jarislowsky Fraser bought 17.9 million shares in late August, bringing the firm’s holdings to about 19 million shares or 10.8 per cent of the outstanding shares, according to Bloomberg. The rally raised the value of this stake to about $545-million, up $87-million.
Mr. Nadim estimates that the shares can trade between $40 and $50 within the next three years amid improving confidence in SNC’s operations.
“We think the stock is still very cheap,” Mr. Nadim said.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.
David Berman