value and opportunity

After KPN and TNT Express, we highly welcome another Dutch company with an imploding stock price, Royal Imtech.

The company:

Royal Imtech seems to be active mostly in everything which on can install into buildings, such as heating, securities, electrical equipments etc. although the company profile on its website sounds like a perfect score at “bullshit bingo”:

Imtech offers added value with integrated and multidisciplinary total solutions that lead to better business processes and more efficiency for customers and the customers they, in their turn, serve. Imtech also offers solutions that contribute towards a sustainable society – for example, in the areas of energy, the environment, water and traffic.

Nevertheless, until recently (November 2011) Imtech was highly coveted by analysts as “clean tech” super star , with a 100% buy rating and price targets of 30 EUR per share and more.

The problem

In beginning of February, Imtech came out with a “bombshell” press release.

Not only did they have to postpone their earnings release, but they also indicated that they have a loss of min. 100 mn EUR in their fast growing Polish business. The press release contains this “gem” of potential accounting fraud:

The Board of Management has also determined that a promissory note and pledged accounts related to the Adventure World Warsaw project – amounting to around 200 million euro – that had been recognised in the half-yearly 2012 financial statements under cash and cash equivalents must, according to IFRS, be reclassified under current financial assets. Most of this amount was recognised as an advance payment under work in progress for the four projects concerned. This advance payment was considerably higher than the incurred costs. As stated above, the advance payments have not become available to Imtech. The effect of this is incorporated in the expected write-off of at least 100 million euro

This potential fraud leads to another problem: As net cash is part of their loan covenants, the company already indicates that all of a sudden, they are now in breach with their loan covenants:

The consequence of the expected write-off will be that, when its 2012 financial statements are drawn-up, Imtech will no longer fulfil its covenants with lenders – average ratios of 3.0 maximum for net debt/EBITDA and 4.0 minimum for interest coverage. As a result Imtech will begin consultations with its lenders. Imtech has retained Rabobank as its financial advisor for these consultations.

The share price fell of course like a stone following this announcements:

One interesting aspect about Imtech is the fact that some rumours about aggressive accounting were circulating already late last year. Of course management denied all allegations at that time.

Interestingly, Imtech had already a quite high short interest at that time, almost 10% of the market cap was short at the end of the year. Thanks to the new regulations about short disclosure one could see that the “smart money” like Dan Loeb’s Third Point is short the share.

Why bother at all ?

One of the reasons I looked at Imtech is that based on many metrics, Imtech looked like a great stock and even more now at the current price levels. I am sure, Imtech will show up now on many “value screens”. Even in my BOSS model, Imtech looks quite compelling.

If we look at some measures, Imtech really looks like a great company:

	EPS	DIV	ROE	ROIC
31.12.2002	0.61	0.42	17.4%	21.9%
31.12.2003	0.57	0.36	14.5%	41.7%
31.12.2004	0.58	0.36	12.5%	17.1%
30.12.2005	0.69	0.36	18.4%	18.6%
29.12.2006	0.86	0.36	21.9%	19.5%
31.12.2007	1.17	0.36	26.4%	21.4%
31.12.2008	1.46	0.47	29.7%	18.3%
31.12.2009	1.62	0.59	28.2%	16.3%
31.12.2010	1.70	0.64	21.4%	#WERT!
30.12.2011	1.72	0.65	17.3%	11.4%

One can see growing earnings, growing dividends, nice free cashflow and double digit ROIC and ROEs. So what is not to like ?

The big question

So the question is: Is Imtech a great company which has just facing a bump on its road to further success or is there a real problem with the company ?

There are some examples of great companies with similar problems, for instance Hugo Boss AG, the German luxury Group. In 2002, they detected fraud in their US subsidiary (“channel stuffing”) and had to restate their 2001 balance sheet significantly. I just found this research note from Commerzbank in 2002 where they downgraded the stock from 16 to 9 EUR per share. Looking back, this would have been the perfect entry point for Hugo Boss. The stock since then performed ~30 p.a. until now (a 15-bagger so to say) against 7.7% of the CDAX.

However with Imtech, I have some doubts due to the following reasons:

Acquisitions:
Imtech more or less looks like a typical “roll up”. On the “acquisitions” page of their homepage one can see that they have done like 10–15 acquisitions per year. With roll ups, it is very difficult to asses the reported numbers of such a company because of the large leeway available for accounting for acquisition. Even cash flows can be “massaged” quite significantly as we have seen many times before.
As a result, Imtech carries significant goodwill. This in itself is not necessarily a problem, but together with significant accounting problems, this might become a problem quite soon.

Type of fraud
As mentioned above, this fraud was not “only” about faking sales but also about faking on-balance sheet cash. As we know now, Imtech has quite tight credit covenants. So in my opinion this implies that the fraud has some connection to the whole group and is not only a result of some renegade employees in a subsidiary. Imtech seemed to have general problems with cash and fulfilling its covenants before.

Summary:

In theory, Imtech could be a great company which had bad luck with management in a subsidiary. This would be a good entry point to buy a great business at rock bottom prices.

However, at least in my opinion, the history of the company as a “roll up” as well as the type of fraud makes me cautious. So for the time being this will be just sit back and watch what is going to happen (and trying to learn more…).

Maybe if they really go the way of a big rights issue as indicated in this Bloomberg story might be an interesting entry point, but only if the issues regarding the fraud have been clarified in the meantime and the business is viable. Otherwise, the good parts of the business will most likely go to the creditors and the shareholders might get nothing (but the blues).