The news has gone from (very) bad to worse at engineering construction player Forge Group, with its third profit downgrade in less than two months. The company now expects lose $20m to $25m at the ‘pro-forma’ (excluding the horror power contracts) earnings before interest, tax, depreciation and amortisation level. That compares with the previous forecast of $45m to $50m profit.
Our estimated valuation when we purchased the stock was in the range $60m to $250m, attributing no value to the power segment and valuing the construction business on a knockdown multiple due to the industry headwinds it faced.
That now seems optimistic. The company has indicated a further $23m to $28m will be lost on the West Angelas Power Station, and yesterday’s downgrade knocks at least another $70m from the June 2014 balance sheet. But this latest announcement is more troubling when you consider the changes in assumptions that need to be made around Forge’s future earnings power. The downgrade to the valuation needs to go much further.
Yet the stock fell only 9% yesterday, wiping $7m off the market capitalisation, which now sits at around $80m including the ANZ warrants. Why such a muted response? The saving grace seems to be that Forge has announced approaches from ‘various third parties’ suggesting a takeover offer may be on the cards.
But if investors are banking on a takeover offer to bail them out with a sweet offer, they probably should think twice. Our experience with Norfolk Group suggests that in these circumstances a predatory low-bid is more likely.
Forge has no negotiating position to speak of. ANZ is now in the driver’s seat and with the debt balance ballooning and the company now running at an operating loss, they can’t be happy with the status quo. All a potential bidder needs to do is convince the bank of the deal (the directors of the target company won’t resist if insolvency is on the cards) and it’s a fait accompli.
We said in Forge Psychology: Value Investor Turned Day Trader that we wouldn't know for some time whether our profitable investment was luck or skill. It's becoming clearer by the day that Lady Luck will be getting the kudos for this one.