Saipem has warned again; this is its second major profit warning in the past six months. The company now sees 2013 earnings before interest and taxes at a loss of EUR 300 million-350 million versus its prior projection of EUR 650 million-750 million in profit.
First, there has been a significant deterioration in Saipem’s relationship with Sonatrach following a step-up and widening of the scope of the corruption investigations by the Algerian authorities. The relationship has now completely broken down, and Sonatrach is now pursuing liquidated damages for three key projects. As we feared, Saipem now expects to record a EUR 300 million-350 million charge for unrecoverable costs.
The breakdown should push its net debt to around EUR 5.1 billion at the end of 2013, in line with our earlier thoughts and a reversal from the firm’s position in April that its EUR 4.8 billion in net debt would decline modestly by the end of 2013. To be fair, Saipem did indicate the forecast was dependent on progress on the Algerian situation, but we believe that the firm has very limited contact with the authorities investigating the corruption probe, and as a result, the scenario was optimistic.
Second, after putting in place a new management structure for the engineering and construction business in April, the new manager found significant issues with contracts in Mexico and Canada. Poor subcontractor selection and subcontractor execution led to delays and cost overruns, resulting in a EUR 260 million negative impact to 2013 EBIT. Saipem is a relatively new operator in both contracts, necessitating a heavier-than-usual reliance on subcontractors while it gains experience in the region.
Third, the firm has been affected by technical issues for its vessels in the offshore engineering and construction segment. The productivity of the Castorone will be lower than expected, due to delays after finding issues during sea trials. Also, the delivery of faulty equipment to Saipem for a vessel under construction that was due to be delivered in June has caused delays and additional costs. At this stage, it should be clear that Saipem is a deeply troubled contractor that is in the midst of a complete overhaul of its business. While the problem contracts appear to have been approved by the now-departed management team, the ongoing oversight of the contracts is the responsibility of the current team, and it still seems that new CEO Umberto Vergine (who took over in December 2012) is struggling to understand Saipem’s book of business.
It appears that he’s operating in triage mode, dealing with poor profitability from legacy contracts, the rapidly mushrooming Algerian crisis, and now problem contracts in Canada and Mexico. We question whether the firm has had the time and ability to do a deep enough dive into its current global backlog to fully ascertain there are no more problem contracts. The replacement of regional management responsible for the poor contracts is a plus, but it also introduces new management in what effectively seems to be a crisis situation where some stability is needed.
Saipem remains confident that the current contracts it is signing will be beneficial for its profitability in the 2014 time frame, thanks to its position of strength as a key oil and gas engineering and construction firm. We are growing more uncertain here as well, particularly if clients begin to question Saipem’s financial and operational stability, given its weakening net debt position, and begin to demand more onerous contract terms. The relationship with Eni is probably important to clients here, and Eni now faces a unpalatable situation with the loss of Saipem’s dividend (worth EUR 150 million to Eni in 2012), having to support Saipem’s increasing debt load, and questions about whether it should retain a relationship with Saipem given the noncore nature of the company to Eni.
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