Description

Short Idea:
The Shaw Group provides engineering, construction, and maintenance services primarily in the power, environmental, and infrastructure markets. Their preferred business is in constructing power plants, but recent projects have included roof repair in Florida. From what I have been able to determine, the company’s primary activity appears to be issuing press releases, and its primary method of generating cash appears to be selling stock to investors.

1) Free Cash Flow has been negative in 4 of the past 5 fiscal years.
2000 – ($103MM)
2001 – ($27MM)
2002 - $241MM
2003 – ($228MM)
2004 – ($50MM) (10K not out yet – info. from conference call)
2005E – Company guidance for FY 2005 CFFO is $25MM to $50MM with a cap-x budget of $30MM. They could make it 5 negative years out of 6.

2) The share count has risen from 31MM to 63MM over the same time period. Recent equity offerings are:
- April ’04 – Issued 2.3MM shares at $12.35/share.
- October ’03 – Issued 23MM shares at $10/share.

3) A substantial percentage of the reported earnings come from releasing accounting reserves from projects acquired as a result of purchasing troubled companies. The balance of these reserves should be down to aprox. $16MM by now, and at the current rate of use, will be gone within the next year. By my calculation, SGR has benefited their income statement from these reserves as follows:
- FY 2003: Released non-cash reserves of $43MM accounting for 58% of reported earnings.
- 1Q ’04: Used reserves of $11MM. Still had no earnings that quarter.
- 2Q ’04: Used reserves of $5MM accounting for 94% of reported earnings.
- 3Q ’04: Used reserves of $4MM accounting for 23% of earnings.
- 4Q ’04: Audited financials not out yet, but I believe that SGR used aprox. $4MM in reserves accounting for 26% of reported earnings.

4) SEC Investigation (Informal for now): On June 10, 2004, SGR announced that the SEC was conducting an informal investigation of their accounting practices. Management has acknowledged that the investigation appears to focus on acquisition accounting. In addition, on June 8, the CEO and CFO of the company presented at a sell-side conference, and never said a word about potential accounting issues, or an SEC investigation. We believe that the SEC contacted the company 1-2 weeks before the sell-side conference.

5) The Astoria Plant: SGR has begun construction on a $570MM 500MW power plant in Astoria, NY. This plant is brown-field construction that will necessitate environmental remediation, and is in an area that will require use of very expensive union labor. In addition, some local officials have been unsupportive of the location of the plant and the use of Liberty Bonds to finance part of the project. We believe that some potential builders never bid on the project due to expected problems, and that other bids were around $850MM. SGR got to issue a press release touting the revenue from the $570MM project, and will get to book profits early in the process due to percentage of completion accounting. This has helped them sell more stock; however, the most likely result is that it will cost SGR more to build the plant than they will ever be paid. This is one example, but their competitors say that SGR has a habit of overbidding on fixed price contracts.

6) Consistent earnings misses, guidance reductions, and general fudging of the numbers:
- 1Q ’04: SGR had EPS of $0.00 vs est. of $.15 - $.16. The only reason they didn’t have negative earnings excluding extraordinary items was the use of accounting reserves. Full year guidance was lowered to $.55 to $.65. They ended up missing the lowered guidance too.
- 2Q ’04: EPS of $.06 missed the $.08 est. Lowered 4Q guidance again to $.28. They missed that too.
- 3Q ’04: EPS of $.16 missed Street est. by $.01 - $.02. The company touted their positive FCF of $37MM for the quarter; however, we believe that much if not all of this FCF may have come from billings/cash received in advance of starting projects (up $104MM in the quarter), and from including income from variable interest entities in cash from operations instead of investments.
- 4Q ’04: SGR announced earnings of $.17 vs Street estimates of $.16, but $4.7MM of the $10.6MM in net income is from minority interest below expectations and from earnings from unconsolidated above expectations. In other words, SGR missed the earnings from operations by $.07 (due to G&A which was $9.4MM above est.), and made it up with below the line items that aren’t subject to the same level of accounting scrutiny.

Catalyst

Catalyst Section:
- Business model that burns cash and relies on the financial markets to remain in business.
- Continued misses of earnings.
- Negative FCF.
- Running out of non-cash reserves to inflate earnings.
- SEC investigation could become formal.
- At the time of this writing, SGR stock is up 25% over the past 3 months and still missing numbers.