SNC-Lavalin's revelation this week that it was investigating $35 million in "undocumented payments" led to a sharp drop in its share price over the past two days.
Many are speculating that the payments are linked to the engineering giant's business dealings in Libya, and financial analysts are warning there may be another shoe to drop before the firm's troubles are over.
The Montreal-based company's stock fell 20.55 per cent (or $9.94) Tuesday to close at $38.43 on the Toronto Stock Exchange. That was the biggest drop since at least January 1992, and the stock continued its downward slide Wednesday, closing at $37.40.
The sell off followed a press release issued Tuesday in which SNC-Lavalin revealed that its board of directors and audit committee had launched an independent investigation into "$35 million relating to certain payments made in the fourth quarter of 2011 that were documented to construction projects to which they did not relate and, consequently, had to be recorded as expenses in the quarter."
The amount itself was significant enough, but investors seemed just as worried about the ambiguity in the release as well as the admission that the company was investigating the $35 million "and certain other contracts."
"I think it was that 'and other contracts' which may have subtly hinted to everybody else that there's more to come," said Neil Linsdell, a Montreal-based analyst who follows SNC-Lavalin for Versant Partners investment bank.
"What everybody is focused on is the $35 million and what — potentially — other payments were made and who they were to and what they were for and what kind of implications these have for legal accounting and reputational risk."
Strictly speaking, the stock sell-off seemed to be an overreaction to the revised outlook for the fourth quarter of 2011 that SNC presented. It said the $35 million coupled with an additional $23 million in losses from "financial exposure" on its Libyan projects, which had to be abandoned when civil war broke out in the country last year, and other "unfavourable cost re-forecasts" would amount to an $80-million, or 18 per cent, decrease from its previously announced outlook.
"If you take the news at face value, an $80-million charge in the quarter ... does definitely not justify this kind of drop," Linsdell said. "So, the market is reacting to the potential that this goes, I think, much deeper than what we've already seen."
Linsdell revised his recommendation for the SNC stock from "buy" to "neutral" and decreased his 12-month target price from $64 to $57.
He wasn't alone. Several analysts revised their recommendations from "buy" to "neutral" (also called "hold" or "market perform"), although none of the 15 SNC-Lavalin analysts that financial news firm Bloomberg tracks felt the news was bad enough to recommend selling the stock.
By the close of trading Wednesday, seven analysts were recommending buys, seven were advising investors to hold the stock and one was reviewing its recommendation.
SNC-Lavalin's troubles began when its name surfaced in connection with a Canadian consultant, Cynthia Vanier, who was arrested in Mexico on suspicion she had tried to smuggle members of the late Libyan dictator Moammar Gadhafi's family into Mexico at the tail end of the war to overthrow the Gadhafi regime.
A CBC investigation revealed that Vanier had consulted for SNC-Lavalin on the Libyan situation and that SNC-Lavalin financial controller Stéphane Roy was invited to Mexico by Vanier to explore possible work for SNC on water-treatment projects. While there, Roy met with one of Vanier's co-accused in the alleged Gadhafi plot and was with her at the time of her arrest.
The investigation also revealed that the head of the company's construction division, Riadh Ben Aïssa, had close ties to one of Gadhafi's sons, Saadi Gadhafi, and paid to host one of Saadi Gadhafi's bodyguards in Tunisia as the bodyguard prepared plans to smuggle the young Gadhafi to Niger. Roy and Ben Aïssa resigned from SNC-Lavalin — suddenly and without explanation — on Feb. 9.
Some company employees have raised concerns to CBC about SNC-Lavalin's dealings in Libya under the now deposed Gadhafi regime, saying the company seemed to have lost its "moral compass." They questioned some of the contracts SNC had won in Libya, such as a $275-million deal to build a prison.
'The lack of information coming out of the company at this point leads investors to sell now and ask questions later.'— Neill Linsdell, analyst, Versant Partners
No wrongdoing has been proven in connection with SNC-Lavalin's business in Libya, and none of its executives or employees have been charged with any crimes.
Still, speculation has been swirling, and the company has been largely silent, refusing to elaborate on the nature of the $35 million in payments or even to say whether they are related to its business in Libya.
It is that uncertainty and the fear of what revelations are to come that is causing investors to be overly cautious.
It also didn't help that the company postponed the announcement of its fourth-quarter and annual results from March 2 to March 30.
That left some analysts wondering whether the company's directors just learned of the problems recently and moved the date so they could get a better handle on them or whether, as CBC reported, they had already begun investigating in December and moved the March announcement because they uncovered more problems than they initial thought were there.
"The lack of information coming out of the company at this point leads investors to sell now and ask questions later," Linsdell said, although he did say that the bulk of the selling, in his view, was over and that another big drop like Tuesday's was unlikely unless additional negative information came to light.
Frederic Bastien, a Vancouver-based SNC-Lavalin analyst for the Raymond James investment firm, agrees that the company's refusal to address the Libya-related allegations and to explain the extent of its accounting problems to analysts and investors is hurting its stock price.
"Increasingly, investors have no tolerance, no patience, for that kind of uncertainty," he said. "Even the companies with the best track record get pummelled. There's no place to hide anymore in the market."
Bastien downgraded his recommendation for SNC stock from "strong buy" to "market perform" and revised his 12-month target price from $65 to $48.
"While we find it difficult to gauge how the Libyan allegations and the current probe will ultimately weigh on SNC down the road, we feel certain about one thing: their impact on the firm's reputation in the financial markets will be more pronounced than on its earnings power," he wrote in Raymond James's official analysis of the SNC situation Wednesday.
"Although we view yesterday's pullback as overdone and believe that value investors should sharpen their pencils on the name, we don't see any compelling reasons to own the stock until SNC opens up to the Street."
The company is Canada's largest engineering firm and has almost a $10 billion backlog in contracts on the books — contracts that are in progress but not completed — so it will not be easily felled.
Still, the allegations around its Libya associations are already having an impact. Local officials in Illinois have begun to raise a stink about SNC's $300-million US contract to build a new airport south of Chicago, using the unsavory allegations against SNC as new ammunition in their opposition to the plan.
Both Bastien and Linsdell agree that while downward pressure on the stock may continue in the coming weeks, the long-term effect of the upheaval on SNC's business and on the market won't be known for some time.
"Are contract decisions going to be delayed because of this?" Linsdell said. "Are contracts not going to go to SNC because of the reputational impact of this kind of thing? We don't know yet. That's one of the things that, hopefully, we'll understand a little better in the next month."