Description

Description

FCC is NOT a bet on an improvement in the macro-economy of Spain.  FCC IS a bet on management execution with a free call option on Spain improving.  If management hits its targets, which are based on continued declines in its Spanish end markets, the stock offers >130% upside.  Due to the heavy cyclical decline in Spain, FCC’s shares are down more than 80% from peak despite possessing three market leading Spanish franchisees and consolidated fundamentals that have reached an inflection point.  Additionally, balance sheet concerns should soon dissipate as a comprehensive debt refinancing is imminent, removing even medium-term concerns over solvency and dilution. 

FCC is the over-levered Spanish market leader in Construction (38% of 2013E “core” sales), Environmental Services (55%) and Cement (7%).  This is a tremendously complex business, so I will focus on management’s operating and balance sheet targets and a summary of how they will be achieved followed by more detail on the “core” businesses.  For more detail on the “non-core” businesses (all for sale), please see previous years’ annual reports (biblical proportions of detail).

New Management

The constant catalyst for FCC is the new CEO, Juan Bejar, who started in his role in January 2013. He has already cut (with full provisions in 2012 & 2013) over 40% of the domestic workforce in Construction and Cement.  One silver lining of the European sovereign credit crisis is that Spain has actually engaged in real labor reforms that have enabled management teams to reduce wages and remove redundancy.  We met with Sr. Bejar in the spring of this year, and enjoyed a beautiful view of Madrid from the top floor of one of the city’s most valuable buildings – one that FCC owned.  In family hands since the turn of the 20^th century, FCC finally hired its first outside CEO, and truly an “outsider” in the William N. Thorndike sense.  He made it a point for us to go through the three layers of security to enter his palatial office to provide tactile context for the degree of mismanagement inherited from his predecessors.  HQ 2.0 provided a markedly different setting during our late summer meeting where we sat in what appeared to be something comparable to a Home Depot Supply store located conveniently within 15 minutes from Barajas Airport, and well outside central Madrid.

Target Summary

Sr. Bejar’s 2015 targets call for reducing net debt from E7.9bn at YE 2012 to E5.2bn at YE 2015 and improving EBITDA from E753mm to E1.2bn.  The net debt target should be reached in 2014 after immense progress in 2013 (close to E2bn shed in 2013 alone).  The E1.2bn EBITDA target is not exceptionally heroic given that the 2011 EBITDA total was E1.256bn and >E200m of negative EBITDA in 2012 was eliminated in the middle of 2013 through the bankruptcy of Alpine, a non-recourse Eastern European Construction subsidiary.  Thus, the starting point is closer to E250mm of incremental EBTIDA necessary on a revenue base of >E6bn and growing, while the heavy lifting with consequent provisioning took place in 2013.  The balance is due to ~E200mm of cost-savings (labor cuts and wage concessions) along with another E50mm of operating leverage (US cement).  The labor and wage cuts began in 2013.  With over 4,000 Spanish Construction and Cement workers made redundant and the remaining 5,000 likely facing some wage garnishment, one can quickly estimate the annual salary of a worker and assess the likelihood of achieving E200mm of cost-saves.  In fact, we believe there is considerable upside to these numbers, which are not reflected in our model.  

Please click here to review management's most recent presentation with summary targets: http://www.fcc.es/fccweb/wcm/idc/groups/public/documents/document/mdaw/mdy1/~edisp/cscp079802.pdf; more detail from the March presentation here: http://www.fcc.es/fccweb/wcm/idc/groups/public/documents/document/mdaw/mdu3/~edisp/cscp074823.pdf

Our 8x target multiple was derived by taking a small discount to the average of where FCC has traded over the past 5 and 10 years on a forward EV/EBITDA basis (Bloomberg).   This is also supported by a sum of the parts based on global peers by division.  Lastly, our revenue estimates reflect a 0% real GDP growth environment where growth in FDI, tourism and net exports offset continued declines in public sector spending.

Divestiture Summary and Balance Sheet Conviction

We believe that FCC’s debt will be refinanced before year-end, consistent with management’s guidance on its Q3 earnings call: “We're expecting comments with a deadline of 15th of November. We expect to have this closed before – the agreement should be closed before the end of the year.”  We believe that this catalyst, in concurrence with the sale of Energia, its alternative energy subsidiary with E780mm of debt (classified as “Liabilities associated with non-current assets classified as held for sale”), will lead to balance sheet comfort and a significant near-term re-rating of the shares.  With regard to Energia, on its Q3 earnings call, management stated that “And when it comes to Energy, we are also in the final process with two final bidders. We also expect to sign before year-end.”  The company expects the net debt figure to decline from E7.9bn at YE 2012, to less than E6bn at YE 2013.  This year-end figure does not include any benefit from the sale of several assets that we believe will be disposed of quickly.

The remaining assets for sale include (along with our estimated proceeds):

Versia Logistics: Iberian-focused firm responsible for transporting, storing, preparing and distributing orders for leading companies across global industries; sales have declined by mid-single digits over the past few years, reflecting the economic malaise in Spain and Portugal.  Peers trade at 0.34x sales (ID Logistics, Norbert Dentressangle, Logwin AG,  Deufol SE, Echo Logistics, Interbulk Group), we think 0.16x is fair (trough multiple on trough sales) (E40mm).

Versia Urban Furniture: This business designs, installs, maintains and handles advertisements on high-quality street furniture designed to suit the area.  This is a diversified, global business.  Sales have been flat over the past five years with Spain shrinking (<36% of sales), while ROW grows.  Peers trade at 4.4x sales (JC Decaux, Clear Channel Outdoor, Lamar Advertising).  We expect 1.3x sales (E160mm).

Global Via: This is an infrastructure/concession asset that while defensive in nature, has been heavily impacted by the crisis due to traffic declines.   We assume 0.6x book value based on the €400mm reported at YE 2012 post-impairment test.

Other: There are several other small assets for sale that management believes can raise a couple hundred million (Realia, Industrial Waste, etc.).  We expect ~E300mm of remaining sales.

Idiosyncratic Risks

Risk #1: Rights Issuance Caused By Weakness in Spain

Bear Argument: Divestitures and/or EBITDA surprises negatively to the downside due to poor macro conditions and/or macro downside and FCC’s banks force a dilutive rights issuance

Mitigate(s):

Near-term communication: Management said less than a month ago that the debt refinancing would be complete by year-end.

Banking relationships: Sr. Bejar has had relationships with FCC’s banks going back several decades.

Cement and construction: Both are bottoming according to the Spanish government and major competitors.

Environmental services: While revenue might decline, the government has increased the municipality payment cycle, so cash flow is much stronger.

Cost saves: The business had been mismanaged at every level.  Sr. Bejar believes best in class peers have SG&A that would equate to several hundred million Euro cuts of overhead.

Sign Posts: Refinancing announcement in December.

Risk #2: Rights Issuance Caused by Vice-Chairman Esther Koplowitz Personal Finances

Bear Argument: Esther Koplowitz purchased 63% of Veolia’s 28% stake (formerly her’s sister’s stake) in FCC in 2004 for €575 million. The remaining 37% or €335 million was purchased by a group of private investors that were able to put the stake to Ms. Koplowitz after 5 years. It is believed that nearly all of this was put back to her at a pre-determined price (likely 3-5x higher than current), which was financed through a securitized loan by BBVA. As a result, there is a chance that Ms. Koplowitz is effectively insolvent with no control of her stake, and that BBVA may not be aligned with shareholders given that they are a major lender to FCC

Mitigate(s):

Timing: The shares have been lower several times over the past year and yet it appears that no trigger occurred for a mandatory rights issue. 

Conversations with management suggest that Ms. Koplowitz is very much engaged with senior management and believes in the restructuring plan. 

The balance sheet metrics are moving in the right direction with nearly ~€2bn of debt shed in 2013

The banks do not want to run FCC.  It is sadly one of the healthier businesses in the country.

Signposts:

Refinancing: announcement expected this month; after which we would welcome a secondary sale to make the stock more liquid and remove any possible hindrances to Sr. Bejar’s restructuring plan

Press: Over the past several days, the Spanish press has been reporting recently that Ms. Koplowitz and BBVA are in discussions to restructure the debt in B-1998, Ms. Koplowitz’ investment vehicle.  The most recent article suggest that she would have to sell a 3.8% stake in FCC to satisfy the funding requirements of her banking partners given that the dividend, cut by Sr. Bejar immediately upon taking the helm in early 2013, no longer services the interest cost. We believe that the third largest holder, Bill Gates, who purchased 6% of the Company in October 2013 for ~E14.50 per share, likely has a direct line into B-1998 and would consider purchasing her stake (would remain under 10%).

Operating Summary

Business Overview

Construction provides four key services: Civil Engineering (57% of sales in 2012 - predominately motorways, highway and road building – predominately heavy infrastructure), non-residential commercial (18% - schools, offices, healthcare centers, sports arenas, etc.), Industrial (14% - complex manufacturing facilities) and residential (11% - homebuilding).  The business is now 62% domestic (2013E) and the rest is fairly diversified.  The business was actually 68% INTERNATIONAL in 2012.  In early summer 2013, Juan Bejar made the difficult, but prudent decision to put FCC’s non-recourse Central European subsidiary, Alpine, into bankruptcy.  This was the biggest driver of EBITDA declines in 2012 (accounted for >E200mm of negative EBITDA in 2012).  Putting this business into bankruptcy is the most important driver of achieving both the EBITDA and net debt targets.  This divestiture results in an increase more than E200mm of EBITDA from the E753mm base and reduces debt by nearly E700mm.  We expect the Domestic business to experience EBITDA declines by 30% from 2012 (a business that should posses an almost entirely variable cost structure with plenty of fat to cut still).  We expect International EBITDA margins of <5% in 2015.  The International business grew by 11% during the first 9 months of the year YoY with International backlog up 19% YD. The overall backlog YTD through September is E5.6bn (down 4%), but excludes E2bn of awards in Q4 (Riyadh Metro, Mersey Bridge, etc.).  Domestic has also bottomed due to recent contract wins.  Given the deconsolidation of Alpine, the intersegment revenues are a bit unknown.  We should have more clarity shortly (read: my base sales numbers could be off a bit).

Cementos Portland (“CPV”), the 69.8% owned listed subsidiary of FCC, has three major components.  The Spanish cement company (40% of 2013E sales) is fully integrated with ~30% market share.  In the USA, Giant is a mid-size Mid-Atlantic regional integrated cement player (37% of sales- 3rd largest on East coast).  Despite the political instability in Tunisia, the one Tunisian plant that CPV possesses continues to grow, supported by export volumes and long-term domestic infrastructure (17% of sales with growth offset entirely by fx YTD).  The remaining 6% of sales is from a small export business to the EU mostly driven by the UK.   

Spanish cement consumption declined by over 67% from 2008 to 2012 (2012 AR/Seopan).  We expect additional revenue declines for that segment of 38% in 2013 (seems overly bearish after an OK Q3 – down 34% YTD), down 10% in 2014 and flat in 2015.  Spanish consumption is well below 1^st world replacement metrics currently, but we are not willing to make a bet on any kind of recovery at this point.  That being said, this is an inherently good business driven by transportation costs and significant capital investment required to enter a market.  The domestic business generated E131mm of EBITDA in 2011 and cost-cutting (layoffs announced and now largely executed along with double-digit wage concessions) alone should enable that business to generate E62mm of EBITDA in 2015 – with most of the improvement occurring in 2014.  We expect continued improvement at Giant and for Tunisia to be largely flat (some industry capacity additions coming).  2013 was a year of significant charges related to restructuring.

Services is the foundation of FCC, established over 100 years ago, and has four main components: National Environmental Services (domestic municipality waste management), International (international municipality waste management), Water (water management systems globally) and Industrial Waste (waste management).  These businesses are characterized by long-term contracts (multi-decade in some cases), relatively inelastic demand and structural growth for the International segment.   Dominant share (largest player where three companies possess >85% of the market) has insulated margins in Spain with cost-cutting to come that should increase margins from 2013 levels (still expect 200bps of compression in Spain from 2012).  Services is the most stable part of the business, but Sr. Bejar believes there is still a significant amount of overhead to cut from a business that has been run for over a century with little professional focus on cost optimization.   

The National Environmental Services business dominates the industry with close to 40% market share where #2 and #3 possess an incremental 57%.  Scale and multi-decade (century plus) relationships with municipalities have created a tremendous moat.  As a result, even through the economic crisis in Spain, this business has continued to remain steady with strong double-digit EBITDA margins.  2013 will be the toughest year for the business driven by sweeping legislation that mandated zero budgets for local municipalities.  That being said, the Federal government also implemented significant reforms to the payment schedules for government suppliers.  The II Suppliers Payment Fund will result in a E300mm working capital inflow.  After which, FCC anticipates potentially E600mm of working capital inflows reflecting the 2011 / 7 EU directive mandating that payments are made bimonthly versus every 6 months.  Management’s strategic plan does not include any significant working capital improvement resulting from these measures (first of which is “in the bag” with E200mm to be received in December and an additional E100mm expected in Feb 2014). 

The International business is similar to the National business in that it is a waste management business, but with a slightly larger focus on heavy assets from energy-from-waste plants to incineration plants.

The business also offers waste collection, transport, treatment, disposal and street cleaning. Scale is lower than in Spain with commensurately lower margins, but the business should grow over the medium term due end market growth in Poland, Bulgaria and Romania.

Water is FCC’s single best business and offers full service water solutions from a la carte services, including contracts for installation and management to serving as a full service integrated water utility for municipalities – FCC’s Aqualia is the 3rd largest water company in the world.  Most of these contracts are multi-decade.  The International portion of Water is global with exposure from Saudi Arabia to Algeria to the US.  We expect continued growth in this business from both a revenue and margin perspective.

Lastly, Industrial Waste, handles waste for private corporations (96% of sales). Contracts are shorter in length (project based).  The business is 56% International (mostly US) with primary end markets in Energy (sludge management) and Industrials (think hazardous chemicals).  International could grow due to increased investment in LatAm and the Persian Gulf.  We expect Spain to continue to decline similarly to Cement.  Overall, we are flat-lining this business with cost-cutting driving higher EBITDA.

Catalyst