Description

Summary

John Wood Group PLC (WG) is a British multinational engineering and consulting business. The company provides project, engineering, and technical services to the oil and gas, industrial, refining, power generation, chemicals, and energy sectors worldwide.

WG is currently in a turnaround situation. The company has been facing challenges in recent years, including legacy liabilities, operational issues, and a cyclical downturn in the energy sector. However, WG has taken steps to address these challenges, including the sale of its Built Environment Consulting division and the appointment of a new CEO.

WG has attracted takeover interest, most recently from Sidara, a Dubai-based competitor. In 29 May 2024, Sidara made a final proposal to the company. This follows a series of bids, with an initial offer of 205 pence per share rejected by WG's board. Sidara's latest proposal is 230 pence per share, representing a 52% premium over WG's closing stock price on April 29, the day before Sidara's initial offer (+25% from WG’s last close).

Based on the latest trading levels, the market appears to assign a low probability that Sidara's offer is finalized. If the board rejects Sidara’s final offer, the stock will undoubtedly decline near-term. However, WG remains significantly undervalued based on normalized earnings and ongoing turnaround efforts. If management continues to deliver on its strategic initiatives, legacy issues are resolved, and the company trades in line with established peers, WG's fundamental value could potentially be 50% to 80% above current levels.

Investment Thesis

Key components

1. Takeover target – John Wood Group continues to be an attractive takeover target due to its improved financial health and strategic market positioning. In May 2024, Sidara Capital made an offer of £2.2 billion ($2.7 billion) to acquire WG, marking a significant premium of more than 50% over the undisturbed market price. This offer is currently under consideration by the board. The interest from Sidara reflects the inherent value and growth potential seen in WG, which remains undervalued compared to its industry peers​.

The approach is the second in the past year. In April 2023, private equity firm Apollo Global Management made a final offer to buy WG for £1.66 billion ($2 billion) in cash. The offer represented a 59% premium to WG's closing price on February 21. On 15 May 2023, Apollo Management Holdings, L.P. ultimately decided not to make an offer for the company. This announcement came after an extended period of detailed engagement between the two parties.

2. Activist involvement – Activist Sparta Capital Management believes WG is undervalued and sees 100%+ upside to the undisturbed trading price of ~150 pence/share. If a higher-priced takeover bid does not materialize, WG remains an activist situation that should serve as a catalyst for a value re-rating in time.
3. Significantly improved balance sheet and strategic reset: The disposal of the Environmental Consulting division in late 2022 was a transformational event for the company, realising ~$1.6bn in cash and reducing leverage from over 4x to ~1.3x. This significant de-risking of the balance sheet placed the business in a much stronger financial position to capitalise on a cyclical upturn again in the energy sector.

The sale also has strategic implementations: “The sale of Wood's Built Environment unit which completed in 3Q22 included infrastructure, water, waste, and environmental end markets, meaning it not only represented a balance-sheet catalyst but a strategic reset and portfolio transformation. Wood is now a near pure-play focused energy-service provider, and has emphasized its exposure toward energy, now at three-quarters of the order book, with most of the remainder as materials. Wood is well-positioned to benefit from higher oil and gas-project investment and for the energy transition, with rising demand for decarbonization and renewable-energy solutions.” Source: Bloomberg Intelligence, 5 April 2023

The board's stance is further supported by WG's strategic initiatives aimed at reducing legacy liabilities, enhancing operational efficiency, and driving long-term growth. The ongoing simplification program, expected to yield annualized savings of around $60 million from 2025, is a key component of this strategy. Additionally, significant contract wins and a growing order book underscore WG's competitive position and future revenue visibility.

4. Resolution of legacy issues– With the balance sheet repaired, WG is in a position to address legacy provisions and liabilities (>$500m) that serve as a significant drag on FCF generation.

WG began a journey in 2017 with the transformational $3.9 billion acquisition of Amec Foster Wheeler (AMFW). The acquisition brought both opportunities and challenges.

The all-share acquisition was designed to gain scale and expertise to help offset a more challenging environment for project work given declining capital expenditure for conventional oil and gas energy projects. However, the acquisition also brought with it a number of drags associated with Amec Foster Wheeler.

These drags, both to margins and investor sentiment, include a number of provisions and liabilities that have served as a substantial headwind to cash flow in recent years. The provisions and liabilities have weighed down the balance sheet and impacted WG valuation and its performance relative to peers. 

5. Attractive standalone valuation – WG is attractively valued relative to the sector. More on this in the ‘Valuation’ section below.
6. Solid market position & growth prospects: WG is well-positioned to benefit from the ongoing recovery in the energy sector and the global shift towards sustainable energy solutions. The company’s order book grew by 4% to $6.3 billion in 2023, with sustainable solutions accounting for a significant portion of new contracts. Noteworthy contract wins, such as the detailed engineering project for Woodside Energy’s Trion floating production unit and a two-year contract extension with Brunei Shell Petroleum, highlight WG’s competitive edge in high-growth markets. These contracts not only reinforce WG’s market position but also provide a strong foundation for future growth​.

Sources of mispricing

1. Legacy issues: The principle reason for this opportunity existing is WG’s poor recent performance and legacy liabilities resulting in a misperception that WG’s earnings power is impaired into the medium term as a result of these issues.

The stock price fell by almost 40% in 2022.  The company's stock price has fallen by over 50% from its pre-COVID high of £4.22. This is due to a disappointing H1 FY21 performance, which was caused by delayed projects and investment decisions among its customers as a result of the COVID pandemic. The company issued revenue and profit warnings as part of its strategic review announcement during 2022. The strategic review also included a further lowering of guidance for the FY21 year outturn.

2. Sector challenges: Additionally, engineering/energy services is a difficult and relatively low margin business that tends to be highly cyclical and prone to booms and busts, with Saipem and McDermott International being prominent recent examples of this. This volatility and perceived lack of business quality has resulted in considerable investor aversion to the sector in recent times.

3. UK-listing: A third factor behind the mispricing is WG’s profile as a UK-listed stock, with the UK equity market seemingly out-of-favour among institutional equity investors with generally less interest in UK equities relative to US-listed names.  Apollo's opportunistic bid for WG is part of a recent takeover wave involving UK-listed companies by private equity firms and overseas acquirers.  In a letter to WG’s board in December 2022, Sparta Capital (activist) presciently expressed its concern that “the current significant undervaluation makes the company vulnerable to take over.” Sparta has more recently suggested moving the company’s primary listing to the United States in an effort to improve the valuation.

WG’s own legacy issues now appear to be contained and/or resolved and its balance sheet transformed, while its earnings power is set to inflect upwards again given that it is well positioned to benefit from a cyclical upturn in the energy sector.

Investors do not appear to fully appreciate this repositioning of the business and if public markets fail to re-value WG accordingly then private markets are likely to do so, as the recent takeover interest clearly indicates.

Takeover offer from Sidara

Over the past several weeks, WG has been at the center of significant takeover interest from Sidara Capital, a Dubai-based engineering and consulting firm. This interest has resulted in multiple takeover bids, reflecting Sidara's intent to acquire the entirety of WG's issued and to-be-issued share capital.

On April 30, 2024, Sidara made an unsolicited preliminary cash offer of 205 pence per share, valuing John Wood Group at approximately £1.4 billion ($1.8 billion). This initial offer represented a premium of about 35.5% over WG's closing price before the offer was made public​. However, WG's board unanimously rejected this offer, stating that it significantly undervalued the company's intrinsic worth and future prospects.

Following the rejection of the initial bid, Sidara raised its offer to 212 pence per share on May 8, 2024, increasing the total valuation to approximately £1.47 billion ($1.86 billion). Despite the improved terms, WG's board again rejected this revised offer, maintaining that it continued to fundamentally undervalue the company. WG's board has justified its rejection of Sidara's offers by pointing to the company's robust growth strategy and significant progress in recent financial performance.

For the year ending December 31, 2023, WG reported a revenue increase of 8% to $5.9 billion and a 9% rise in adjusted EBITDA to $423 million. These figures reflect the company's successful efforts to streamline operations and focus on high-margin segments like sustainable solutions and consulting​.

On Wednesday, Sidara, announced a 230p per share proposal. This represents a 52% premium over John Wood Group's closing stock price of 151.30p on April 29, the day before Sidara's initial proposal. Sidara stated that Wood has not engaged with it since the initial approach. Sidara added, "We do not believe our proposal can progress unless Wood's board engages with us and the deadline is extended."

As of now, Sidara has until June 5, 2024, under the UK takeover code, to either make a firm offer or withdraw its interest. The ongoing developments will be closely monitored by both the market and WG's stakeholders, as they could significantly impact the company's strategic direction and shareholder value in the near term.

Company overview

Wood Group is a British multinational engineering and consulting business with headquarters in Aberdeen, Scotland. It is listed on the London Stock Exchange as well as being a constituent of the FTSE 250 Index.

WG operates with three main segments: Operations, Projects, and Consulting.

Operations: Wood Group's Operations segment provides a range of services to the energy industry, including:

• Operations and maintenance (O&M): Wood Group provides O&M services for a wide range of assets, including oil and gas production facilities, pipelines, and power plants.
• Asset integrity management (AIM): Wood Group provides AIM services to help clients manage the integrity of their assets and reduce the risk of unplanned outages.
• Production optimization: Wood Group provides production optimization services to help clients improve the efficiency of their operations and increase production.
• Project management: Wood Group provides project management services for a wide range of energy projects, from small brownfield modifications to large greenfield developments.

Projects: Wood's Projects segment provides engineering, procurement, and construction (EPC) services to the energy industry. The segment has a strong track record of delivering complex projects on time and within budget.

 Wood's Projects segment offers a wide range of services, including:

• Front-end engineering and design (FEED): Wood's FEED services help clients define the scope of a project and develop a preliminary design.
• Detailed engineering: Wood's detailed engineering services help clients develop a final design for a project.
• Procurement: Wood's procurement services help clients source the materials and equipment needed for a project.
• Construction: Wood's construction services help clients build and commission a project.
• Wood's Projects segment has a global workforce of over 10,000 people and operates in over 50 countries. The segment has a strong track record of delivering complex projects on time and within budget.

Consulting: Wood Group Consulting's services can be broadly grouped into two categories: technical consulting and digital advisory and implementation.

Technical consulting represents around 55% of Wood Group Consulting's revenue. In this category, Wood Group Consulting's experts act as an extension of its clients' engineering teams. Wood Group Consulting provides a unique combination of advisory and tangible engineering solutions, filling the gap between management consultants and engineering providers. Wood Group Consulting creates value through early-phase studies, execution, and operational phases. Wood Group Consulting maximizes its clients' return on investment by improving throughput, lowering operational costs, extending asset life, and improving safety.

Technical consulting is home to Wood Group Consulting's carbon capture center of excellence and new energies, which includes renewables and hydrogen. Wood Group Consulting also has a portfolio of proprietary technologies covering low carbon hydrogen, methanation, delayed coking, and partnerships for other technologies such as sustainable aviation fuel and plastics recycling.

The other part of Wood Group Consulting's business, which accounts for about 45% of revenue, is digital advisory and implementation. In this category, Wood Group Consulting's consultants deliver a range of proven solutions to help clients collect, store, and analyze data to maximize the performance of their assets. Wood Group Consulting automates facilities, optimizes assets, and reduces emissions through its digital solutions.

Company background

Takeover of Amec Foster Wheeler:  Wood Group has been left with a hefty debt pile since taking over rival Amec Foster Wheeler for £2.2bn in 2017. It has also faced legacy lawsuits, including a $115m settlement made last year for a damages claim filed in 2016.

Sale of environmental consulting: Wood Group's sale of its environmental consulting division (“Built Environment”) to WSP Global Inc. was agreed on June 1, 2022. The division was sold at ~16x EBITDA when the overall group traded at a multiple of less than half that figure. Wood received gross proceeds of $1.9 billion for the sale. Wood Group's sale of its environmental consulting division to WSP Global Inc. was a strategic move that will allow the company to focus on its core businesses. The environmental consulting division was a small part of Wood Group's overall business, and it was not a core focus for the company. The sale of the division will allow Wood Group to focus on its oil and gas, power, and engineering businesses, which are the areas where the company has the most expertise and experience.

The sale of the environmental consulting division is a positive move for Wood Group. It is a strategic move that will allow the company to focus on its core businesses and capitalize on the changing energy landscape. The sale is also a sign of the company's commitment to sustainability.

Management & strategy

Ken Gilmartin, Wood Group's Chief Executive Officer (CEO), leads the management team. Gilmartin has over 30 years of experience in the energy and industrial sectors and has held several senior positions at Wood Group.

Profitable growth: Wood will focus on priority markets in geographies where it can lead and gain higher reward for the work it delivers. Wood will also align its solutions and portfolio towards these growth markets and underpin them with its corporate development strategy. Management will focus on solidifying the balance sheet and resolving legacy issues before returning to regular dividends and buybacks.

Activist investor: Sparta Capital Management

Activist Sparta Capital holds roughly 2.6% of Wood Group. Sparta Capital Management Ltd is a London-based alternative investment manager founded by Franck Tuil in 2021. The firm specializes in long-term value investing and has a team of experienced investment professionals with a proven track record of success. Sparta originally wrote to Wood Group’s Board of Directors in December 2022 to express its concerns about the company's share price. Sparta Capital believes that the current share price does not reflect the intrinsic value of the company.

Sparta Capital believes that Wood has a leading position in structurally growing markets globally. The company's balance sheet is robust and fit for purpose, and it generates reliable and predictable operating cash to invest in its future and reward its shareholders.

Recent results

The financial performance of WG over the past year has been impressive. For the year ending December 31, 2023, the company reported revenues of $5.9 billion, an 8% increase from the previous year. Adjusted EBITDA also saw a significant rise, growing by 9% to $423 million, with margins slightly improving to 7.2%. This growth is attributed to strong performances across all business units, particularly in the high-margin Consulting segment and sustainable solutions. These results underscore WG’s successful turnaround efforts and strategic shift towards more profitable and growth-oriented segments​. Management upgrading outlooks for fiscal year 2024 and 2025, expecting 2025 to exceed previously established targets.

The company’s net debt, excluding leases, stood at $694 million at the end of 2023, up from $393 million the previous year. This increase was mainly due to free cash outflows and adverse currency movements. However, WG’s ongoing simplification programs and planned asset disposals are expected to generate significant cash flows, which will help reduce debt levels and improve the company’s financial flexibility. Free cash flow for the year was negative $265 million, reflecting the company’s investments in growth and simplification efforts​.

Valuation

Upside

If the board were to approve Sidara’s latest bid of 230 GBp per share +25% over a short time horizon. Management’s improve guidance would suggest EBITDA of ~$450mn in FY 2025. Applying 7x to 8x multiples (based on peers, in-line with the Apollo failing bid multiple, and assuming normalized operations) would suggest intrinsic value of ~280 GBp to ~325 GBp (+50% to +80% from current levels).

Downside

The downside for WG is likely near the undisturbed share price of approximately £1.45 per share (-25%), based on a valuation of around 5x FY23 EBITDA. This valuation is in line with the recent valuation of fellow energy services peer Saipem at around 5x NTM EBITDA, and is conservative given that Saipem is also in a turnaround situation.

While there will likely be a near-term decline if the board rejects Sidara’s latest offer. An investor could size accordingly, leaving room to add if the offer is rejected and the price falls. The shares would be a compelling bargain at those levels if management continues to deliver on the turnaround.

Risks

1. Deal collapse: The primary near-term risk is that WG’s board rejects the final bid from Sidara and the stock falls back to pre-petition levels (-20%). WG’s long-term intrinsic value is likely significantly
2. Global Energy CAPEX Growth: If global capital expenditures in the energy sector do not grow as expected due to weakened macroeconomic conditions, WG's order books could be negatively impacted​.
3. Strategy Execution and Order Wins: Management’s progress in the turnaround has been positive to date. However, WG could fail to effectively execute its strategic initiatives or secure new orders, leading to lower sales and margins than anticipated​.
4. Project Execution: Poor delivery on projects can significantly harm WG’s business development efforts and cash flow.
5. Legacy Provisions and Liabilities: Failure to adequately address legacy provisions and liabilities can continue to drag on WG's cash flows and pressure the balance sheet​
6. Operating Leverage: WG's high operating leverage means that fixed costs are a significant portion of total costs. This can amplify the impact of revenue fluctuations on profitability

Catalyst

  Board accepts Sidara offer, future (higher) takeover offers, continued turnaround, return to paying dividends or buying back shares