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Bottom Fishing - Alstom

July 31, 2013 | About:
Chandan Dubey

Chandan Dubey

97 followers
Current price: €25.4

Shares outstanding: 304 mn

Pension liability: €1.6 bn

Net Cash: -2.3 bn

EV: €11.5 bn

P/S: 0.4 P/B:1.5

FCF: €351 mn (2012)

Business: Alstom (XPAR:ALO) is active in three segments - power transmission, power generation and transportation.

It designs and installs services for generating and transmitting power (turbines, windmills, plants, grid installations). It also designs and provides service for trains, trams and metros. It maintains leadership in rail transportation and it is among the top three companies in power generation and transmission.

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The following is the revenue breakup from 2012.

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The company has fantastic growth opportunities in the emerging markets like China, India and South America. There is a shift towards providing better services to the populace there. For example, in India new metros are being operated in Delhi, Bangalore and Chennai. They have all been designed and installed in the last decade or so.

Alstom has a clever strategy to tap this market. Instead of trying to compete directly, it invests in the already existing companies. The following is a partial list of its partnerships across the globe.

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History

1928 Alsthom is formed as a result of a merger between Thomson-Houston and SACM.

1932 Acquires french firm Tarbes, a manufacturer of electric locomotives and hydraulic equipment.

1978 Delivers first TGV to SNCF and goes on to break many high rail speed records.

1986 Alsthom’s foundational factory in Belfort receives an order from EDG for the largest gas turbine in the world.

1988 Alsthom acquires the 100% of the rail transport equipment division of Belgian engineering firm ACEC SA.

1989 GEC Alsthom is formed as a holding company by merging the power and transport activities of CGE with UK General Electric Company PLC.

1994 GEC Alsthom acquires rail vehicle manufacturer Linke-Hofmann-Busch from Salzgitter AG.

1998 The group lists on Paris Stock Exchange and changes its name from GEC Alsthom to Alstom. Alstom acquires Sasib Railways from Italy.

1999 Alstom sells its heavy duty gas turbine business to GE. Alstom and ABB merge their energy business to form ABB Alstom Power. Alstom acquires ABB’s share in 2000.

2000 Alstom acquires 51% stake in the Italian firm Fiat Ferroviaria, the world leader in tilting technology.

In 2003, Alstom is on the verge of going bankrupt. The CEO Patrick Kron in an article written on Dec. 7, 2007, describes the situation.

Alstom’s difficulties were the result of a combination of four factors: a technical problem, an inadequate operational performance, an impossible financial situation, and the temporary collapse of its most important market. A rescue operation was hampered because these four factors had to be handled simultaneously and the various bodies involved, including banks, shareholders, clients and employees had to be convinced that there was a future for Alstom, in spite of feelings of pessimism and general distrust. Acting as a catalyst, the French state took on the challenge of making a successful last-ditch attempt to turn the company around.

Alstom did not create the technical problem itself but inherited it from ABB. ABB had sold new generation gas turbines which did not function properly, putting Alstom with the steep cost of fixing the problems as well as compensating its clients. Several of the design flaws required research and in the end it cost Alstom €4 billion to € 5 billion to fix them.

Alstom had grown two fold in three years and the acquisitions were not properly integrated to achieve optimization. Several of the monitoring systems were not functional and Alstom was suffering repeated heavy losses in some of its big projects. On top of that, Alstom’s debt jumped 20 times because of acquisitions and the fact that one of the existing shareholders, Alcatel, wanted out. To make the situation worse, some of the customers like Renaissance Cruises collapsed and due to financial crisis, there was a distrust between clients and the firm. The high debt was making them fidgety in committing to an order because in the case of bankruptcy they would lose the advance.

Bankruptcy from one of the most respected French firms would have shaken the confidence of investors in France and would have had dire consequences for the French economy. Keeping that in mind, the French government bought 21% of the company for €800 million (which they sold for €2 billion after 18 months).

The 2000 acquisition of a turbine business from ABB group had a design flaw with $4 billion associated costs. To make the situation worse, a major customer of Alstom, Renaissance Cruises, collapsed financially. The company was forced to consider filing for bankruptcy. Alstom’s share price had dropped some 90% in the last two years and it had more than $5 billion in debt. They also had to dilute shareholders. When Patrick Kron arrived there were 250 million shares, but by the end of 2005 they had ballooned to 5.5 billion! The company lost more than 98% of its value during the period.

2004 Alstom sells its T&D activities, power rentals business, diesel manufacturer Meinfesa. Alstom receives EU backing valued at €2.5 billion.

2005 Alstom’s turbines clock 1.5 million operating hours with sales in Italy, Germany, Spain and Thailand. It demonstrates that Alstom’s gas turbines are technologically advanced and quite reliable.

2006 Alstom sells its marine division, and Alstom power converts to an LBO. Bouygues acquires the French holding of 21% for €2 billion.

2007 Acquires Spanish wind turbine manufacturer Ecotecnia.

2009 Alstom acquires 25%+1 share of Russian leader in locomotive manufacturer Transmashholding.

2010 Alstom reacquires its T&D business which its sold to Areva in 2004 and names it Alstom Grid.

2011 Alstom signs a MoU for high speed rail line between Baghdad and Basra.

2012 Begins construction for $1.2 billion order from city of Montreal, wind turbines for wind farm contracts in France, and Ulfa, a factory in Russia to manufacture small and medium hydropower plants.

Management

The current CEO and chairman of the board is Patrick Kron. He oversaw the turnaround of Alstom during the financial crisis of 2003 which in some sense he inherited from his previous administration, given that he was hired in the beginning of 2003.

He writes two shareholder letters every year telling what the company is up to. It will be instructive to go through them to get a sense of the turnaround and the subsequent outperformance by Alstom.

March 2005 Beyond the current fiscal year, ALSTOM should be in a position to enter a new phase of profitable growth. We aim to further improve our operational

performance, targeting a 6% to 7% operating margin in March 2008 which should lead, combined with a strict management of our working capital, to a substantial increase of our free cash flow and thus to a further reduction of our debt

Nov 2006 An exceptional level of free cash flow, at €747 million, has been generated as a result of further improvement in working capital, notably on the back of strong commercial activity.

Nov 2007 Since 1st April 2007, the Group finalised several acquisitions, such as Wuhan Boiler Co. in China and Ecotècnia in Spain. Ecotècnia currently designs, assembles and installs a wide range of onshore wind turbines spanning from 640 KW to 2 MW, and is currently developing new wind turbines with a capacity of up to 3 MW.

May 2008 Thanks to this very high cash flow, the Group turned cash positive during fiscal year 2007/08, from a net debt of €64 million on 31 March 2007 to a net cash of €904 million on 31 March 2008, after payments relating to acquisitions and dividends distributed in July 2007

Nov 2008 After being steadily among the top performers of the Paris Stock Exchange over the past years, Alstom’s share price has sharply declined during the recent weeks. Clearly, the financial crisis and its expected adverse impact on the global economy have hit the stock market in general, and the capital goods sector in particular, with concerns about a potential decrease in future demand. Firstly, we have a strong cash position and available bonding lines. Our record high backlog provides us with a much better visibility than other companies and will give us time to adapt to a downturn in demand if any. In addition, most of our customers are financially very strong and thus less exposed to credit limitations. And, importantly, the long term drivers of our markets both in power generation and rail transportation remain solid, financial crisis or not.Our financial situation has been further strengthened by the generation of a high free cash flow of €1.2 billion during this first semester. We have a net cash position of €1.9 billion, twice the March 2008 level.

May 2009 Thanks to this very high free cash flow, Alstom has a net cash position of €2,051 million at 31 March 2009, after payment of the dividend. The capital expenditure programmes launched to reinforce Power’s industrial base in Asia and the USA as well as to strengthen Transport’s competitive positions in Europe will be completed, while future investments are strictly prioritised.

November 2010 With the acquisition of the transmission activities of Areva T&D on 7 June 2010, Alstom has reached a decisive stage in its development by forming a new Sector, named Alstom Grid, which complements the existing Sectors in power generation and rail transport.

May 2011 Alstom and Shanghai Electric signed a letter of intent on 20 April 2011 for the creation of Alstom-Shanghai Electric Boilers Co., a 50/50 joint company combining both partners’ activities in the boiler market for coal power plants. World leader on this market, the joint company would supply new boilers.

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May 2012 This strategic development has been particularly active in Russia where Alstom completed its investment in Transmashholding, the Russian leader in railways. 25%+1 share.

RED FLAG: No talk about net debt which has turned positive for the first time since its restructuring took hold. At least of the order of $1.3 billion. In sharp contrast to net cash of $2.2 billion in 2011.

November 2012 As you may know, the Group carried out a €350 million capital increase last month. this operation aimed primarily at financing on-going transactions, mainly the remaining payment related to the 25% stake in the russian rolling stock Company transmashholding. During the semester, capital expenditures were maintained at a high level, allowing the four sectors to pursue notably their investments in emerging markets.

May 2013 Renewable Power acquired the wholly-owned subsidiary of Rolls-Royce, tidal Generation Ltd. Cash generation remains a top priority and we continue to anticipate a positive free cash flow year after year over this period.

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Financial Situation

The company came a long way from 2003 financial crisis when it almost filed for bankruptcy. When the next financial crisis hit, the company had already reinforced its balance sheet and had a record €2.3 billion in cash.

guuK-nWzrI6yumtvPkt1PN1PUOPPFw8aELh9thS4During the year 2010, the company made acquisitions worth of €2.5 billion. Arguably, the market had recovered by then and that probably meant that Alstom had to pay a lot more than what it would have if the acquisition were done in 2009. Understandably, there was a €1.5 billion increase in the goodwill of the company during 2010!

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The company can still safely take on more debt and the interest cover is comfortable at around 5.

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Valuation[b][/b]

Following is the cash flows of the company.

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The company is not a consistent free cash flow generator. Following is the RoIC comparison from one of the most bureaucratic company in Europe, Siemens.

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Siemens at least gets points for consistency. Alstom’s figures are all over the place. It seemingly made a turnaround, had blowout 2009 and 2010 and then sank to wherever it turned around from. The FCF as well as the RoIC figure point to a loss is operational performance and or management becoming conceited.

The company also has nearly €5.4 billion in goodwill with negative tangible book value.

With such a bad track record of cash management, it is hard for me to say what the value of the company is. I would be very leery to pay more than €18 a share.

Risks

Alstom has already faced many of the risks which ended up costing it a lot. The business deals with complex technology and their might be severe contractual obligations in case their equipment malfunctions.

These risks may also be inherited because of acquisition, as happened in case of the acquired turbines business from ABB.

Alstom’s business is highly contractual in nature. It has to win contracts to keep its factories working. These are generally long term in nature and in case of unforeseen circumstances, it might end up Alstom costing more than the contractual payment it will receive.

Alstom has also been alleged to have bribed government employees to win contracts. In 2005, the Mexican authorities imposed $27,000 fine on Alstom and disqualified them from obtaining contracts from the federal government for two years. There was another investigation launched by the Swiss and the French authorities in 2008 when it was alleged that Alstom had bribed to win contracts in Asia and South America between 1995 and 2005. In 2012, European Anti-fraud Office opened an official investigation into the contract for a Slovenian power plant. Alstom notes in its registration documents.

These procedures may result in fines, the exclusion of Group subsidiaries from public tenders and third-party actions.

Conclusions

I like the management’s clairvoyance, and in some respect am fascinated by Alstom’s business. I like the fast-running TGV trains, the trams and feel that the servicing business will only grow with time. The capital expenditure in the emerging markets and significantly increased spending there will add to the top-line of Alstom. Unfortunately, Alstom does not have a great track record of capital allocation or cash management. It had positive FCF for a while but has gone back to huge debt load, negative tangible book value and negative cash flows. With a different management, probably things would have looked different.

It also irks me that some of the letter from the CEO is less honest than I expected. For example, when the company first turned from a net cash position to a net debt position after the turnaround, the net cash discussion as well as the figures were missing from the shareholder letters. A similar thing happened with FCF. When it was positive there was a bar chart and the CEO would talk about it at length but the first time when it went negative, the bar chart disappeared and it was removed from the highlighted items on the letter. In all fairness though, the CEO did say that the FCF has been negative in the text. Still this change of style in the letter irked me both times.

I am not a buyer at these prices, even though the stock trades at near 52-week lows.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.0/5 (14 votes)

Comments

Adib Motiwala
Adib Motiwala - 11 months ago
Chandan,

thanks for posting. Just wanted to give feedback.

It would be great to start with the current price , market cap, EV , shares out standing on top. That gives readers a frame of reference.

You later mention " _
cdubey
Cdubey premium member - 11 months ago
Hello Adib,

It seems your comment was unfinished. I will edit the article.

Thanks.

Please leave your comment:


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